My post yesterday got a comment questioning why business owners are so worried about inflation and its affect on debt.
During periods of high inflation, many small business cannot keep pace with higher costs. Their profit margins will shrink as costs go up more quickly than they can increase prices. We are already seeing evidence of this.
When margins shrink, businesses may no longer be good credit risks for banks. Their cost of borrowing money goes up. Or in some cases, they may become out of compliance with the profit margins required in the restrictive covenants in their loans. The banks may force them to move their loans to another bank. That will mean the transaction costs for the new loan and typically higher interest rates.
The Fed will soon begin to use higher interest rates to cool off inflation. The cost of debt goes up. During our last period of inflation in the late 1970s mortgage rates hit 16-18%. Higher rates hung around late into the 1980s, when we still were paying 9% for a prime plus a quarter business loan.
Inflation of 2-3% we can handle. We have had a long period of solid economic growth with modest inflation. Younger entrepreneurs have never known anything else. What many of us think is coming is double digit inflation. That changes everything. Profits will be harder to maintain. Debt will cost more and can become much more difficult to secure.
Those who get out ahead of this will have a better chance to be OK. Those who do not will have a higher risk of failure. See this recent post I wrote on steps entrepreneurs should be taking to shore up their income statements and balance sheets to prepare for a period of much higher inflation.