For Buffett, inflation is the tax that appears on no income statement yet quietly confiscates the real returns of business owners. Across the high-inflation years of the late 1970s and early 1980s, he returned again and again to a single insight: a company can post handsome nominal earnings and still leave its owners poorer in purchasing power. These passages trace how he taught shareholders to see through reported profits to the corrosive arithmetic underneath, and why asset-light businesses with pricing power are the rare survivors.
Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a positive corporate return into a negative owner return. But the inflation tax is not limited by reported income. Inflation rates not far from those recently experienced can turn the level of positive returns achieved by a majority of corporations into negative returns for all owners, including those not required to pay explicit taxes.
Such favored business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.
Nevertheless, our views regarding long-term inflationary trends are as negative as ever. Like virginity, a stable price level seems capable of maintenance, but not of restoration.
And all of this inflation-required investment will produce no improvement in rate of return. The motivation for this investment is the survival of the business, not the prosperity of the owner.
For years the traditional wisdom - long on tradition, short on wisdom - held that inflation protection was best provided by businesses laden with natural resources, plants and machinery, or other tangible assets ("In Goods We Trust"). It doesn't work that way. Asset-heavy businesses generally earn low rates of return - rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.
Meanwhile, the CPI has more than tripled. Therefore, each share commands about one-third the purchasing power it did at the end of 1964. Regular dividends have been paid but they, too, have shrunk significantly in purchasing power.
When the claim checks outstanding grow sufficiently numerous and when the issuing party can unilaterally determine their purchasing power, the pressure on the issuer to dilute their value by inflating the currency becomes almost irresistible. For the debtor government, the weapon of inflation is the economic equivalent of the "H" bomb, and that is why very few countries have been allowed to swamp the world with debt denominated in their own currency.
Buffett in his own words on camera. Transcribed from the interview; click through to watch the moment.
We don't really want to go into any country where we think that there's a significant probability of runaway inflation. Other people have figured out ways to make money in hyperinflationary situations, but that's not our game.
Well, we can't handle runaway inflation except not to be there in the way of it. Once you create that, it becomes a different world.
A lot of people want a little inflation, but nobody wants a lot of inflation. I do not worry about the Federal Reserve balance sheet; I enjoy looking at it.