The passage of time plays tricks on our memories. Agonizingly slow trials and tribulations in the present appear less extreme when viewed retrospectively.
The historical narrative of the inflation that took hold from the middle of the 1960s to the early 1980s is told knowing that Paul Volcker would have the fortitude to dispense the medicine needed to finally break the fever. However, people who actually lived through those years had no such advance knowledge and conventional wisdom was that high inflation would persist in the 1980s and perhaps indefinitely.
Long term treasuries yielded above 15% in 1981 in anticipation of years of high inflation. When the rate of inflation started to decline, interest rates remained relatively high for many years as market participants remained skeptical.
The exhibit below shows the yield on the ten year treasury since 1962. What’s interesting about the chart is that the current ten year yield of around 4.5% is comparable to yields seen in the mid-1960s and remains very low from a historical perspective. Many charts published in the financial media seem to start around 2005 which creates the false illusion that current rates are historically high.
Double-digit inflation did not return after the spike of the early-1980s and yields began a long multi-decade decline. This decline was hardly in a straight line and those who actually lived through the upward squiggles in the chart could very well have declared the end of the bond bull market at numerous times. In the 1980s, anyone who predicted that the ten year treasury would eventually yield under 1% in 2020 might have been involuntarily committed to a mental institution for observation.
Even Warren Buffett was surprised by the taming of inflation during the 1980s based on comments in his shareholder letters. In early 1987, Mr. Buffett was still expecting a return to higher levels of inflation when he wrote about his distaste for long-term bonds, predicting “much higher rates of inflation within the next decade.”
While I personally recall the later years of the Great Inflation, the extent of my dismay was mostly restricted to feeling cheated when comic books went from 40 cents to a shocking 75 cents over just a few years. But fortunately, reading provides a window to the past as seen through the eyes of people who lived through it.
I’ve read Warren Buffett’s letters to shareholders sequentially many times. By doing so we can see how Berkshire Hathaway evolved over the decades in “real-time” rather than with the benefit of hindsight. My interest in reading about the Great Inflation of the 1970s and early 1980s recently inspired a return to the letters of that period.
Links to the first two articles in this series appear below. Part one covers Mr. Buffett’s views on bonds and interest rates in early 1970. Part two is an overview of how Berkshire’s auto insurance business was caught by surprise during the mid-1970s. In this article, I will focus on Warren Buffett’s comments regarding the great advantage of owning capital-light businesses with pricing power during inflationary times.
False Comfort
“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.”
— Warren Buffett, Appendix to 1983 letter to shareholders
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