Inflation Views by the author Bud Labitan

Inflation Views
by Bud Labitan
2021
All rights reserved.
Printed in the United States of America.
No part of this book may be used or reproduced
in any manner without permission.

Table of Contents
Chapter One: 1977, Monetary and Social Inflation
Chapter Two: 1978, Purchasing Power and Investor Difficulties
Chapter Three: 1979, Investor’s Misery Index
Chapter Four: 1980, Accounting Rules vs Real Earnings
Chapter Five: 1981, Inflation acts as a gigantic Corporate Tapeworm
Chapter Six: 1982, Lower general rate of Inflation
Chapter Seven: 1983, Accounting Goodwill vs Economic Goodwill
Chapter Eight: 2021, Where is the Real Rate of Price Inflation Today?
Chapter Nine: 2021, Finding the Wonderful Business

ACKNOWLEDGMENTS
This unpublished and unauthorized book reviews Warren Buffett’s
writing about inflation during the late 70’s and early 80’s. It is
dedicated to the members of the International Society of Value
Investors, a group of friends and acquaintances on Facebook.
This material comes from Warren Buffett's Letters to Berkshire
Shareholders. Additional material also came from several online sources.
These included: The U.S. Bureau of Labor Statistics (BLS), Wikipedia,
Time Magazine, thepeoplehistory.com, Bloomberg, and Barrons. Much of
what I have learned in business and economics has come from the letters of
Warren Buffett to the shareholders of Berkshire Hathaway Inc. and the
letters and speeches of Charlie Munger.
Warren Buffett’s writings in chapters 1-7, appear without quotation marks
for easier readability. My comments and observations in those chapters
appear within boxes. The charts and data are included to give readers a
better sense of the price inflation rates during that time period. Each
instance of the word inflation appears in boldface.
Bud Labitan

Inflation Views
In 1979, Buffett wrote: “Inflation is man-made; perhaps it can be man-
mastered. The threat which alarms us may also alarm legislators and other
powerful groups, prompting some appropriate response.”
During the 1970s and early 1980s, price inflation rates were rising to
distressingly higher double-digit levels. Appointed by President Jimmy
Carter, Paul Volcker Jr. is widely credited with having ended the high levels
of price inflation seen in the United States. Volcker served two terms as the
12th Chair of the Federal Reserve under U.S. presidents Jimmy Carter and
Ronald Reagan from August 1979 to August 1987. Volcker attended
Princeton University as an undergraduate student and graduated with highest
honors. Notice that in his senior thesis, titled "The Problems of Federal
Reserve Policy since World War II", Volcker criticized the Federal
Reserve's post-WWII policies for failing to curb inflationary pressures. In it
he wrote: "a swollen money supply presented a grave inflationary threat to
the economy. There was a need to bring this money supply under control if
the disastrous effects of a sharp price rise were to be avoided."
In order to educate younger readers, I constructed this small book from two
main sources. These writings come from portions of Warren Buffett’s letters
to shareholders from the years 1978 to 1983. And, this first part is a
summary description of Inflation from Wikipedia:

Price inflation is a general rise in the price level of an economy over a
period of time. Our money buys less because a dollar buys fewer goods and
services. Inflation reflects a reduction in this purchasing power per unit of
money. This is a loss of real value in the medium of exchange within our
economy. The opposite of inflation is deflation, a sustained decrease in the
general price level of goods and services.
The inflation rate is the annualized percentage change in a general price
index, usually the consumer price index, CPI. Economists believe that very
high rates of inflation and hyperinflation are harmful, and are caused by
excessive growth of the money supply.

During the Covid-19 pandemic of 2020, the money supply, M2, has been
greatly expanded by about 30%. This was done to help citizens and small
businesses survive the economic shutdown.
In the graph below, notice how the velocity of money (transactions) has
decreased during this same time period. Also, with the Covid-19 pandemic,
there is more uncertainty about the coming rate of economic growth and the
coming rate of price inflation. In the stock market, the average P/E for the
S&P 500 has historically ranged from 13 to 15. The current P/E of 25 is
above this historical S&P average

Low or moderate inflation may be attributed to fluctuations in real demand
for goods and services, or changes in available supplies during scarcities.
However, the consensus view is that a long sustained period of inflation is
caused by money supply growing faster than the rate of economic growth.
So, we should hope that economic growth will grow faster as the money
supply is gradually pulled back.
Inflation affects economies in various positive and negative ways.
Uncertainty over future inflation can discourage investment and savings. If
inflation becomes rapid enough, shortages of goods can occur because
consumers begin hoarding. Today, most economists favor a low and steady
rate of inflation.
The task of keeping the rate of inflation low and stable is usually given to
monetary authorities. Generally, these monetary authorities are the central
banks that control monetary policy through the setting of interest rates,
through open market operations, and through the setting of banking reserve
requirements.
The Federal Open Market Committee (FOMC) judges that inflation of 2
percent over the longer run, as measured by the annual change in the price
index for personal consumption expenditures, is most consistent with the
Federal Reserve’s mandate for maximum employment and price stability.
When households and businesses can reasonably expect inflation to remain
low and stable, they are able to make better decisions about saving,

borrowing, and investment, which contributes to a well-functioning
economy.
Low (as opposed to zero or negative) inflation reduces the severity of
economic recessions by enabling the labor market to adjust more quickly in
a downturn. Low inflation allows central banks the policy to issue more
money and prevent business liquidity traps.
But what about now, May of 2021? I decided to review Warren Buffett’s
writings on this subject of inflation from 1977 to 1983. Buffett’s writings
in chapters 1-7, appear without quotation marks for easier readability.
My comments and observations in those chapters appear within boxes.

Chapter One: 1977, Monetary and Social Inflation
In the 1977 letter to shareholders, Warren Buffett mentioned the word
inflation 2 times.
In 1977 the winds in insurance underwriting were squarely behind us.
Very large rate increases were effected throughout the industry in 1976 to
offset the disastrous underwriting results of 1974 and 1975. But, because
insurance policies typically are written for one-year periods, with pricing
mistakes capable of correction only upon renewal, it was 1977 before the
full impact was felt upon earnings of those earlier rate increases.
The pendulum now is beginning to swing the other way. We estimate
that costs involved in the insurance areas in which we operate rise at close to
1% per month. This is due to continuous monetary inflation affecting the
cost of repairing humans and property, as well as “social inflation”, a
broadening definition by society and juries of what is covered by insurance
policies. Unless rates rise at a comparable 1% per month, underwriting
profits must shrink. Recently the pace of rate increases has slowed
dramatically, and it is our expectation that underwriting margins generally
will be declining by the second half of the year.
Costs in the insurance areas were rising at close to 1% per month, or around
12% for the year. For 1977, the reported annual average CPI, Consumer

Price Index, was around 6.5% However, the dangers of rising price
inflation in a society can accelerate both the fear, uncertainty, and greed
factors that can add more pressure on others to raise their prices in a vicious
cycle with a momentum of its own.
In 1977, Jimmy Carter began his term as the President of United States.
The cost of gasoline was around 65 cents a gallon. However, the nation was
feeling the fear of rising energy scarcity and price increases because of the
OPEC oil embargo of 1973. During the 1973 Arab-Israeli War, Arab
members of the Organization of Petroleum Exporting Countries (OPEC)
imposed an embargo against the United States in retaliation for the U.S.
decision to re-supply the Israeli military and to gain leverage in the post-
war peace negotiations.
The first Star Wars opened in movie theaters in 1977.
Berkshire Hathaway bought The Buffalo News in 1977. At that time, there
was no internet or world wide web. Newspapers were still a profitable
business because they were the main source of news and advertising.
Four years after publishing a proposal for “an idea of linked information
systems,” computer scientist Tim Berners-Lee released the source code for
the world's first web browser and editor on April 30, 1993.

Note that later in 1998, in the release of the CPI for January, the BLS began
using “hedonic based quality adjustments” for its Personal Computers and
Peripheral Equipment item stratum index. The CPI uses hedonic quality
adjustments in item categories that tend to experience a high degree of
quality change either due to seasonal changes, as in apparel items, or
because of innovative improvements and technological changes, as in
consumer appliances and electronics. If we adjust inflation downward
because of the improvement in the quality of the goods, some argue this can
lead to an under-estimation of inflation. Furthermore, the recent pandemic
shutdown distorted statistical numbers up and down in several areas that are
discussed later in this book.

Chapter Two: 1978, Purchasing Power and Investor Difficulties
inflation 1 time.
Worker’s Compensation was a mixed bag in 1978. In its first year as a
subsidiary, Cypress Insurance Company, managed by Milt Thornton, turned
in outstanding results. The worker’s compensation line can cause large
underwriting losses when rapid inflation interacts with changing social
concepts, but Milt has a cautious and highly professional staff to cope with
these problems. His performance in 1978 has reinforced our very good
feelings about this purchase.
Average CPI inflation United States 1978 was 7.62%. Inflation fear was
beginning to spread. In my view, fear, uncertainty, ignorance, and greed
further fueled this cycle. Interest Rates at year end from the Federal
Reserve was at 11.75%
Following on from the oil crisis of the early 1970’s, in 1978, smaller
Japanese car imports accounted for half the US import market. The first
first ever Cellular Mobile Phone was introduced in Illinois.

Chapter Three: 1979, Investor’s Misery Index
inflation 12 times.
Buffett wrote: But before we drown in a sea of self-congratulation, a further
- and crucial - observation must be made. A few years ago, a business
whose per-share net worth compounded at 20% annually would have
guaranteed its owners a highly successful real investment return. Now such
an outcome seems less certain. For the inflation rate, coupled with
individual tax rates, will be the ultimate determinant as to whether our
internal operating performance produces successful investment results - i.e.,
a reasonable gain in purchasing power from funds committed - for you as
shareholders.
In this section, notice Buffett’s writings on the concepts of “purchasing
power” and “investor difficulties” during an inflationary time period. In
1979 the inflation rate rose monthly like this: 9.28%, 9.86%, 10.09%,
10.49%, 10.85%, 10.89%, 11.26%, 11.82%, 12.18%, 12.07%, 12.61%, and
13.29% for December of 1979.
The year 1979 included stressful events that made people more fearful.
Following the return of Ayatollah Khomeini Iran becomes an Islamic
Republic and 63 Americans are taken hostage in the American Embassy in

Tehran. It was also the year of the Three Mile Island Nuclear Accident.
China instituted the one child per family rule in 1979.
In 1979, Berkshire Hathaway purchased Precision Steel Warehouse Inc.
Just as the original 3% savings bond, a 5% passbook savings account or
an 8% U.S. Treasury Note have, in turn, been transformed by inflation into
financial instruments that chew up, rather than enhance, purchasing power
over their investment lives, a business earning 20% on capital can produce a
negative real return for its owners under inflationary conditions not much
more severe than presently prevail.
If we should continue to achieve a 20% compounded gain - not an easy or
certain result by any means - and this gain is translated into a corresponding
increase in the market value of Berkshire Hathaway stock as it has been over
the last fifteen years, your after-tax purchasing power gain is likely to be
very close to zero at a 14% inflation rate. Most of the remaining six
percentage points will go for income tax any time you wish to convert your
twenty percentage points of nominal annual gain into cash.
That combination - the inflation rate plus the percentage of capital that
must be paid by the owner to transfer into his own pocket the annual
earnings achieved by the business (i.e., ordinary income tax on dividends
and capital gains tax on retained earnings) - can be thought of as an

“investor’s misery index”. When this index exceeds the rate of return
earned on equity by the business, the investor’s purchasing power (real
capital) shrinks even though he consumes nothing at all. We have no
corporate solution to this problem; high inflation rates will not help us earn
higher rates of return on equity.
Ironically, many insurance companies have decided that a one-year auto
policy is inappropriate during a time of inflation, and six-month policies
have been brought in as replacements. “How,” say many of the insurance
managers, “can we be expected to look forward twelve months and estimate
such imponderables as hospital costs, auto parts prices, etc.?” But, having
decided that one year is too long a period for which to set a fixed price for
insurance in an inflationary world, they then have turned around, taken the
proceeds from the sale of that six-month policy, and sold the money at a
fixed price for thirty or forty years.
Many insurance companies were buying bonds having fixed rates of return.
The very long-term bond contract has been the last major fixed price
contract of extended duration still regularly initiated in an inflation-ridden
world. The buyer of money to be used between 1980 and 2020 has been
able to obtain a firm price now for each year of its use while the buyer of
auto insurance, medical services, newsprint, office space - or just about any
other product or service - would be greeted with laughter if he were to
request a firm price now to apply through 1985. For in virtually all other

areas of commerce, parties to long-term contracts now either index prices in
some manner, or insist on the right to review the situation every year or so.
Some of our convertible bonds appear exceptionally attractive to us, and
have the same sort of earnings retention factor (applicable to the stock into
which they may be converted) that prevails in our conventional equity
portfolio. We expect to make money in these bonds (we already have, in a
few cases) and have hopes that our profits in this area may offset losses in
straight bonds.
And, of course, there is the possibility that our present analysis is much
too negative. The chances for very low rates of inflation are not nil.
Inflation is man-made; perhaps it can be man-mastered. The threat which
alarms us may also alarm legislators and other powerful groups, prompting
some appropriate response.
Furthermore, present interest rates incorporate much higher inflation
projections than those of a year or two ago. Such rates may prove adequate
or more than adequate to protect bond buyers. We even may miss large
profits from a major rebound in bond prices. However, our unwillingness to
fix a price now for a pound of See’s candy or a yard of Berkshire cloth to be
delivered in 2010 or 2020 makes us equally unwilling to buy bonds which
set a price on money now for use in those years. Overall, we opt for
Polonius (slightly restated): “Neither a short-term borrower nor a long-term
lender be.”

Chapter Four: 1980, Accounting Rules vs Real Earnings
inflation 15 times.
Our own analysis of earnings reality differs somewhat from generally
accepted accounting principles, particularly when those principles must be
applied in a world of high and uncertain rates of inflation. (But it’s much
easier to criticize than to improve such accounting rules. The inherent
problems are monumental.) We have owned 100% of businesses whose
reported earnings were not worth close to 100 cents on the dollar to us even
though, in an accounting sense, we totally controlled their disposition. (The
“control” was theoretical. Unless we reinvested all earnings, massive
deterioration in the value of assets already in place would occur. But those
reinvested earnings had no prospect of earning anything close to a market
return on capital.) We have also owned small fractions of businesses with
extraordinary reinvestment possibilities whose retained earnings had an
economic value to us far in excess of 100 cents on the dollar.
High rates of inflation create a tax on capital that makes much corporate
investment unwise - at least if measured by the criterion of a positive real
investment return to owners. This “hurdle rate” the return on equity that
must be achieved by a corporation in order to produce any real return for its
individual owners - has increased dramatically in recent years. The average

tax-paying investor is now running up a down escalator whose pace has
accelerated to the point where his upward progress is nil.
For example, in a world of 12% inflation a business earning 20% on
equity (which very few manage consistently to do) and distributing it all to
individuals in the 50% bracket is chewing up their real capital, not
enhancing it. (Half of the 20% will go for income tax; the remaining 10%
leaves the owners of the business with only 98% of the purchasing power
they possessed at the start of the year - even though they have not spent a
penny of their “earnings”). The investors in this bracket would actually be
better off with a combination of stable prices and corporate earnings on
equity capital of only a few per cent.
Explicit income taxes alone, unaccompanied by any implicit inflation
tax, never can turn a positive corporate return into a negative owner return.
(Even if there were 90% personal income tax rates on both dividends and
capital gains, some real income would be left for the owner at a zero
inflation rate.) 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. (For
example, if inflation reached 16%, owners of the 60% plus of corporate
America earning less than this rate of return would be realizing a negative
real return - even if income taxes on dividends and capital gains were
eliminated.)

Of course, the two forms of taxation co-exist and interact since explicit
taxes are levied on nominal, not real, income. Thus you pay income taxes
on what would be deficits if returns to stockholders were measured in
constant dollars.
At present inflation rates, we believe individual owners in medium or
high tax brackets (as distinguished from tax-free entities such as pension
funds, eleemosynary institutions, etc.) should expect no real long-term return
from the average American corporation, even though these individuals
reinvest the entire after-tax proceeds from all dividends they receive. The
average return on equity of corporations is fully offset by the combination of
the implicit tax on capital levied by inflation and the explicit taxes levied
both on dividends and gains in value produced by retained earnings.
As we said last year, Berkshire has no corporate solution to the problem.
(We’ll say it again next year, too.) Inflation does not improve our return on
equity.
Indexing is the insulation that all seek against inflation. But the great
bulk (although there are important exceptions) of corporate capital is not
even partially indexed. Of course, earnings and dividends per share usually
will rise if significant earnings are “saved” by a corporation; i.e., reinvested
instead of paid as dividends. But that would be true without inflation. A
thrifty wage earner, likewise, could achieve regular annual increases in his

total income without ever getting a pay increase - if he were willing to take
only half of his paycheck in cash (his wage “dividend”) and consistently add
the other half (his “retained earnings”) to a savings account. Neither this
high-saving wage earner nor the stockholder in a high-saving corporation
whose annual dividend rate increases while its rate of return on equity
remains flat is truly indexed.
For capital to be truly indexed, return on equity must rise, i.e., business
earnings consistently must increase in proportion to the increase in the price
level without any need for the business to add to capital - including working
capital - employed. (Increased earnings produced by increased investment
don’t count.) Only a few businesses come close to exhibiting this ability.
And Berkshire Hathaway isn’t one of them.
We, of course, have a corporate policy of reinvesting earnings for growth,
diversity and strength, which has the incidental effect of minimizing the
current imposition of explicit taxes on our owners. However, on a day-by-
day basis, you will be subjected to the implicit inflation tax, and when you
wish to transfer your investment in Berkshire into another form of
investment, or into consumption, you also will face explicit taxes.
Our acquisition preferences run toward businesses that generate cash,
not those that consume it. As inflation intensifies, more and more
companies find that they must spend all funds they generate internally
just to maintain their existing physical volume of business. There is a

certain mirage-like quality to such operations. However attractive the
earnings numbers, we remain leery of businesses that never seem able to
convert such pretty numbers into no-strings-attached cash.
1980, Yearly Inflation Rate USA was13.58%
Year End Close Dow Jones 963
Interest Rates Year End Federal Reserve 21.50%
Average Cost of new house $68,700
CNN (Cable News Network) began broadcasting on June 1st
, 1980. The
American-based network founded by Ted Turner was headquartered in
Atlanta, Georgia. It was the first 24-hour news network available to cable
TV subscribers. In November of 1980, Ronald Reagan was elected
President of the USA. The nation seemed to want an end to a stagnant
economy and want a pro-business leader.
Who deserves credit? At his first press conference, Fed Chairman Paul
Volcker said: “If we are going to progress and prosper, we need a sense of
confidence that we are moving toward price stability at home.” The country
was experiencing an annualized inflation rate of 13%, and the only way to
bring about price stability was to raise rates dramatically. During his tenure,
Volcker raised the federal funds target from about 11% to 20%.
Consequently, inflation fell from over 14% in 1980 to less than 3% in

1983. But the precipitous decline was too late for President Jimmy Carter,
who had lost to Ronald Reagan in the election of 1980.

Chapter Five: 1981, Inflation acts as a gigantic Corporate Tapeworm
inflation 14 times.
In fairness, we should acknowledge that some acquisition records have been
dazzling. Two major categories stand out.
The first involves companies that, through design or accident, have
purchased only businesses that are particularly well adapted to an
inflationary environment. 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. Managers of ordinary ability, focusing solely on
acquisition possibilities meeting these tests, have achieved excellent results
in recent decades. However, very few enterprises possess both
characteristics, and competition to buy those that do has now become fierce
to the point of being self-defeating. The second category involves the
managerial superstars.
Over half of the large gain in Berkshire’s net worth during 1981 - it totaled
$124 million, or about 31% - resulted from the market performance of a

single investment, GEICO Corporation. In aggregate, our market gain from
securities during the year considerably outstripped the gain in underlying
business values. Such market variations will not always be on the pleasant
side.
In past reports we have explained how inflation has caused our
apparently satisfactory long-term corporate performance to be illusory as a
measure of true investment results for our owners. We applaud the efforts of
Federal Reserve Chairman Volcker and note the currently more moderate
increases in various price indices. 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.
1981
Yearly Inflation Rate USA 10.35%
Median Price Of and Existing Home - $66,400 -
Average Income per year $21,050.00
Major News Stories of 1981 include: The Aids Virus Identified, Iran
Hostage Crisis Ends, Post It Notes launched, Riots in UK Cities, Anwar

Sadat assassinated.
We saw the First Flight of the Space Shuttle Columbia. 1981 was also the
first year that the word “Internet” was mentioned. A software operating
system, MS-DOS was released by Microsoft along with the first IBM PC.
In Politics, a group “Solidarity” inspired popular protests and a general
strike in Poland. The UK government started the process of privatization of
Nationalized Industries. This was later followed by many other countries
around the world. President Ronald Reagan appointed Sandra Day
O'Connor, the first woman to join the US Supreme Court on July 7th
, 1981.
Notice that 1981 shows a decrease in inflation from 11.83% to 8.92%

Despite the overriding importance of inflation in the investment
equation, we will not punish you further with another full recital of our
views; inflation itself will be punishment enough. But, because of the
unrelenting destruction of currency values, our corporate efforts will
continue to do a much better job of filling your wallet than of filling your
stomach.
Inflationary experience and expectations will be major (but not the only)
factors affecting the height of the crossbar in future years. If the causes of
long-term inflation can be tempered, passive returns are likely to fall and the
intrinsic position of American equity capital should significantly improve.
Many businesses that now must be classified as economically “bad” would
be restored to the “good” category under such circumstances.
A further, particularly ironic, punishment is inflicted by an inflationary
environment upon the owners of the “bad” business. To continue operating
in its present mode, such a low-return business usually must retain much of
its earnings - no matter what penalty such a policy produces for
shareholders.
Reason, of course, would prescribe just the opposite policy. An
individual, stuck with a 5% bond with many years to run before maturity,
does not take the coupons from that bond and pay one hundred cents on the
dollar for more 5% bonds while similar bonds are available at, say, forty
cents on the dollar. Instead, he takes those coupons from his low-return

bond and - if inclined to reinvest - looks for the highest return with safety
currently available. Good money is not thrown after bad.
What makes sense for the bondholder makes sense for the shareholder.
Logically, a company with historic and prospective high returns on equity
should retain much or all of its earnings so that shareholders can earn
premium returns on enhanced capital. Conversely, low returns on corporate
equity would suggest a very high dividend payout so that owners could
direct capital toward more attractive areas. (The Scriptures concur. In the
parable of the talents, the two high-earning servants are rewarded with 100%
retention of earnings and encouraged to expand their operations. However,
the non-earning third servant is not only chastised - “wicked and slothful” -
but also is required to redirect all of his capital to the top performer.
Matthew 25: 14-30)
But inflation takes us through the looking glass into the upside-down
world of Alice in Wonderland. When prices continuously rise, the “bad”
business must retain every nickel that it can. Not because it is attractive as a
repository for equity capital, but precisely because it is so unattractive, the
low-return business must follow a high retention policy. If it wishes to
continue operating in the future as it has in the past - and most entities,
including businesses, do - it simply has no choice.
For inflation acts as a gigantic corporate tapeworm. That tapeworm
preemptively consumes its requisite daily diet of investment dollars

regardless of the health of the host organism. Whatever the level of reported
profits (even if nil), more dollars for receivables, inventory and fixed assets
are continuously required by the business in order to merely match the unit
volume of the previous year. The less prosperous the enterprise, the greater
the proportion of available sustenance claimed by the tapeworm.
Under present conditions, a business earning 8% or 10% on equity often
has no leftovers for expansion, debt reduction or “real” dividends. The
tapeworm of inflation simply cleans the plate. (The low-return company’s
inability to pay dividends, understandably, is often disguised. Corporate
America increasingly is turning to dividend reinvestment plans, sometimes
even embodying a discount arrangement that all but forces shareholders to
reinvest. Other companies sell newly issued shares to Peter in order to pay
dividends to Paul. Beware of “dividends” that can be paid out only if
someone promises to replace the capital distributed.)
Note in the table below the year-over-year gain in industry-wide premiums
written and the impact that it has on the current and following year’s level of
underwriting profitability. The result is exactly as you would expect in an
inflationary world. When the volume gain is well up in double digits, it
bodes well for profitability trends in the current and following year. When
the industry volume gain is small, underwriting experience very shortly will
get worse, no matter how unsatisfactory the current level.

In recent years hurricanes have stayed at sea and motorists have reduced
their driving. They won’t always be so obliging.
And, of course the twin inflations, monetary and “social” (the tendency
of courts and juries to stretch the coverage of policies beyond what insurers,
relying upon contract terminology and precedent, had expected), are
unstoppable. Costs of repairing both property and people - and the extent to
which these repairs are deemed to be the responsibility of the insurer will
advance relentlessly.

Chapter Six: 1982, Lower general rate of Inflation
inflation only 3 times.
Buffett was seeing signs of price inflation rates moderating lower. Here are
the monthly numbers: January 8.39%, February 7.62%, March 6.78%,
April 6.51%, May 6.68%, June 7.06%, July 6.44%, August 5.85%,
September 5.04%, October 5.14%, November 4.59%, and December 3.83%
For reasons outlined in last year’s report, as long as the annual gain in
industry premiums written falls well below 10%, you can expect the
underwriting picture in the next year to deteriorate. This will be true even at
today’s lower general rate of inflation. With the number of policies
increasing annually, medical inflation far exceeding general inflation, and
concepts of insured liability broadening, it is highly unlikely that yearly
increases in insured losses will fall much below 10%.
1982
Yearly Inflation Rate USA 6.16 %

Median Price Of and Existing Home - $67,800 -
Average Income per year $21,050.00
While 1982 saw the rate of price inflation decreasing, the U.S. experienced
an economic recession. Lasting from July 1981 to November 1982, this
economic downturn was triggered by tight monetary policy in an effort to
fight mounting inflation.
A break-up of the AT&T monopoly was ordered during January of 1982.
AT&T would give up control of the Bell System (called Ma Bell) that had
owned most of the telephone services in the United States and Canada since
the 1940s. This agreement came as the result of an anti-trust case brought
against the company in 1974 by the US Department of Justice. The break-
up of the Bell System became effective two years later in 1984 when it was
split into seven different independent Regional Bell operating Companies,
informally known as “Baby Bells."

Chapter Seven: 1983, Accounting Goodwill vs Economic Goodwill
1983, Warren Buffett mentioned the word inflation 3 times in the general
text of his letter and 14 times in the appendix section that discussed the
difference between accounting goodwill and economic goodwill. This
section is a great teaching lesson.
In 1983, Berkshire Hathaway purchased control in Wesco Financial
Corporation and Nebraska Furniture Mart. Blue Chip Stamps was merged
into Berkshire Hathaway.
In recent months much better control over costs has been attained and we
feel certain that our rate of growth in these costs in 1984 will be below the
rate of inflation. This confidence arises out of our long experience with the
managerial talents of Chuck Huggins.
For the reasons outlined in last year’s report, we expect the poor industry
experience of 1983 to be more or less typical for a good many years to
come. (As Yogi Berra put it: “It will be deja vu all over again.”) That
doesn’t mean we think the figures won’t bounce around a bit; they are
certain to. But we believe it highly unlikely that the combined ratio during
the balance of the decade will average significantly below the 1981-1983
level. Based on our expectations regarding inflation - and we are as

pessimistic as ever on that front - industry premium volume must grow
about 10% annually merely to stabilize loss ratios at present levels.
We have become active recently - and hope to become much more active
- in reinsurance transactions where the buyer’s overriding concern should be
the seller’s long-term creditworthiness. In such transactions our premier
financial strength should make us the number one choice of both claimants
and insurers who must rely on the reinsurer’s promises for a great many
years to come.
A major source of such business is structured settlements - a procedure
for settling losses under which claimants receive periodic payments (almost
always monthly, for life) rather than a single lump sum settlement. This
form of settlement has important tax advantages for the claimant and also
prevents his squandering a large lump-sum payment. Frequently, some
inflation protection is built into the settlement. Usually the claimant has
been seriously injured, and thus the periodic payments must be
unquestionably secure for decades to come. We believe we offer
unparalleled security. No other insurer we know of - even those with much
larger gross assets - has our financial strength.

Appendix to Warren Buffett’s 1983 Letter to Shareholders of Berkshire
Hathaway Inc.
Goodwill and its Amortization: The Rules and The Realities
This appendix deals only with economic and accounting Goodwill – not the
goodwill of everyday usage. For example, a business may be well liked,
even loved, by most of its customers but possess no economic goodwill.
(AT&T, before the breakup, was generally well thought of, but possessed
not a dime of economic Goodwill.) And, regrettably, a business may be
disliked by its customers but possess substantial, and growing, economic
Goodwill. So, just for the moment, forget emotions and focus only on
economics and accounting.
When a business is purchased, accounting principles require that the
purchase price first be assigned to the fair value of the identifiable assets that
are acquired. Frequently the sum of the fair values put on the assets (after the
deduction of liabilities) is less than the total purchase price of the business.
In that case, the difference is assigned to an asset account entitled "excess of
cost over equity in net assets acquired". To avoid constant repetition of this
mouthful, we will substitute "Goodwill".
Accounting Goodwill arising from businesses purchased before November
1970 has a special standing. Except under rare circumstances, it can remain
an asset on the balance sheet as long as the business bought is retained. That

means no amortization charges to gradually extinguish that asset need be
made against earnings.
The case is different, however, with purchases made from November 1970
on. When these create Goodwill, it must be amortized over not more than 40
years through charges – of equal amount in every year – to the earnings
account. Since 40 years is the maximum period allowed, 40 years is what
managements (including us) usually elect. This annual charge to earnings is
not allowed as a tax deduction and, thus, has an effect on after-tax income
that is roughly double that of most other expenses.
That’s how accounting Goodwill works. To see how it differs from
economic reality, let’s look at an example close at hand. We’ll round some
figures, and greatly oversimplify, to make the example easier to follow.
We’ll also mention some implications for investors and managers.
Blue Chip Stamps bought See’s early in 1972 for $25 million, at which time
See’s had about $8 million of net tangible assets. (Throughout this
discussion, accounts receivable will be classified as tangible assets, a
definition proper for business analysis.) This level of tangible assets was
adequate to conduct the business without use of debt, except for short
periods seasonally. See’s was earning about $2 million after tax at the time,
and such earnings seemed conservatively representative of future earning
power in constant 1972 dollars.

Thus our first lesson: businesses logically are worth far more than net
tangible assets when they can be expected to produce earnings on such
assets considerably in excess of market rates of return. The capitalized
value of this excess return is Economic Goodwill.
In 1972 (and now) relatively few businesses could be expected to
consistently earn the 25% after tax on net tangible assets that was earned by
See’s – doing it, furthermore, with conservative accounting and no financial
leverage. It was not the fair market value of the inventories, receivables or
fixed assets that produced the premium rates of return. Rather it was a
combination of intangible assets, particularly a pervasive favorable
reputation with consumers based upon countless pleasant experiences they
have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the
product to the purchaser, rather than its production cost, to be the major
determinant of selling price. Consumer franchises are a prime source of
Economic Goodwill. Other sources include governmental franchises not
subject to profit regulation, such as television stations, and an enduring
position as the low cost producer in an industry.
Let’s return to the accounting in the See’s example. Blue Chip’s purchase
of See’s at $17 million over net tangible assets required that a Goodwill
account of this amount be established as an asset on Blue Chip’s books and
that $425,000 be charged to income annually for 40 years to amortize that

asset. By 1983, after 11 years of such charges, the $17 million had been
reduced to about $12.5 million. Berkshire, meanwhile, owned 60% of Blue
Chip and, therefore, also 60% of See’s. This ownership meant that
Berkshire’s balance sheet reflected 60% of See’s Goodwill, or about $7.5
million.
In 1983 Berkshire acquired the rest of Blue Chip in a merger that required
purchase accounting as contrasted to the "pooling" treatment allowed for
some mergers. Under purchase accounting, the "fair value" of the shares we
gave to (or "paid") Blue Chip holders had to be spread over the net assets
acquired from Blue Chip. This "fair value" was measured, as it almost
always is when public companies use their shares to make acquisitions, by
the market value of the shares given up.
The assets "purchased" consisted of 40% of everything owned by Blue Chip
(as noted, Berkshire already owned the other 60%). What Berkshire "paid"
was more than the net identifiable assets we received by $51.7 million, and
was assigned to two pieces of Goodwill: $28.4 million to See’s and $23.3
million to Buffalo Evening News.
After the merger, therefore, Berkshire was left with a Goodwill asset for
See’s that had two components: the $7.5 million remaining from the 1971
purchase, and $28.4 million newly created by the 40% "purchased" in 1983.
Our amortization charge now will be about $1.0 million for the next 28
years, and $.7 million for the following 12 years, 2002 through 2013.

In other words, different purchase dates and prices have given us vastly
different asset values and amortization charges for two pieces of the same
asset. (We repeat our usual disclaimer: we have no better accounting system
to suggest. The problems to be dealt with are mind boggling and require
arbitrary rules.)
But what are the economic realities? One reality is that the amortization
charges that have been deducted as costs in the earnings statement each year
since acquisition of See’s were not true economic costs. We know that
because See’s last year earned $13 million after taxes on about $20 million
of net tangible assets – a performance indicating the existence of economic
Goodwill far larger than the total original cost of our accounting Goodwill.
In other words, while accounting Goodwill regularly decreased from the
moment of purchase, economic Goodwill increased in irregular but very
substantial fashion.
Another reality is that annual amortization charges in the future will not
correspond to economic costs. It is possible, of course, that See’s economic
Goodwill will disappear. But it won’t shrink in even decrements or anything
remotely resembling them. What is more likely is that the Goodwill will
increase – in current, if not in constant, dollars – because of inflation.
That probability exists because true economic Goodwill tends to rise in
nominal value proportionally with inflation. To illustrate how this works,

let’s contrast a See’s kind of business with a more mundane business. When
we purchased See’s in 1972, it will be recalled, it was earning about $2
million on $8 million of net tangible assets. Let us assume that our
hypothetical mundane business then had $2 million of earnings also, but
needed $18 million in net tangible assets for normal operations. Earning
only 11% on required tangible assets, that mundane business would possess
little or no economic Goodwill.
A business like that, therefore, might well have sold for the value of its net
tangible assets, or for $18 million. In contrast, we paid $25 million for See’s,
even though it had no more in earnings and less than half as much in
"honest-to-God" assets. Could less really have been more, as our purchase
price implied? The answer is "yes" – even if both businesses were expected
to have flat unit volume – as long as you anticipated, as we did in 1972, a
world of continuous inflation.
To understand why, imagine the effect that a doubling of the price level
would subsequently have on the two businesses. Both would need to double
their nominal earnings to $4 million to keep themselves even with inflation.
This would seem to be no great trick: just sell the same number of units at
double earlier prices and, assuming profit margins remain unchanged, profits
also must double.
But, crucially, to bring that about, both businesses probably would have to
double their nominal investment in net tangible assets, since that is the kind

of economic requirement that inflation usually imposes on businesses, both
good and bad. A doubling of dollar sales means correspondingly more
dollars must be employed immediately in receivables and inventories.
Dollars employed in fixed assets will respond more slowly to inflation, but
probably just as surely. 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.
Remember, however, that See’s had net tangible assets of only $8 million.
So it would only have had to commit an additional $8 million to finance the
capital needs imposed by inflation. The mundane business, meanwhile, had
a burden over twice as large – a need for $18 million of additional capital.
After the dust had settled, the mundane business, now earning $4 million
annually, might still be worth the value of its tangible assets, or $36 million.
That means its owners would have gained only a dollar of nominal value for
every new dollar invested. (This is the same dollar-for-dollar result they
would have achieved if they had added money to a savings account.)
See’s, however, also earning $4 million, might be worth $50 million if
valued (as it logically would be) on the same basis as it was at the time of
our purchase. So it would have gained $25 million in nominal value while
the owners were putting up only $8 million in additional capital – over $3 of
nominal value gained for each $1 invested.

Remember, even so, that the owners of the See’s kind of business were
forced by inflation to ante up $8 million in additional capital just to stay
even in real profits. Any unleveraged business that requires some net
tangible assets to operate (and almost all do) is hurt by inflation. Businesses
needing little in the way of tangible assets simply are hurt the least.
And that fact, of course, has been hard for many people to grasp. 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.
In contrast, a disproportionate number of the great business fortunes built up
during the inflationary years arose from ownership of operations that
combined intangibles of lasting value with relatively minor requirements for
tangible assets. In such cases earnings have bounded upward in nominal
dollars, and these dollars have been largely available for the acquisition of
additional businesses. This phenomenon has been particularly evident in the
communications business. That business has required little in the way of
tangible investment – yet its franchises have endured. During inflation,
Goodwill is the gift that keeps giving.

But that statement applies, naturally, only to true economic Goodwill.
Spurious accounting Goodwill – and there is plenty of it around – is another
matter. When an overexcited management purchases a business at a silly
price, the same accounting niceties described earlier are observed. Because
it can’t go anywhere else, the silliness ends up in the Goodwill account.
Considering the lack of managerial discipline that created the account, under
such circumstances it might better be labeled "No-Will". Whatever the term,
the 40-year ritual typically is observed and the adrenalin so capitalized
remains on the books as an "asset" just as if the acquisition had been a
sensible one.

Table of Historical Inflation Rates in Percent (1914-2021)
YEAR JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC AVE
1914 2 1 1 0 2.1 1 1 3 2 1 1 1 1
1915 1 1 0 2 2 2 1 -1 -1 1 1 2 1
1916 3 4 6.1 6 5.9 6.9 6.9 7.9 9.9 10.8 11.7 12.6 7.9
1917 12.5 15.4 14.3 18.9 19.6 20.4 18.5 19.3 19.8 19.5 17.4 18.1 17.4
1918 19.7 17.5 16.7 12.7 13.3 13.1 18 18.5 18 18.5 20.7 20.4 18
1919 17.9 14.9 17.1 17.6 16.6 15 15.2 14.9 13.4 13.1 13.5 14.5 14.6
1920 17 20.4 20.1 21.6 21.9 23.7 19.5 14.7 12.4 9.9 7 2.6 15.6
1921 -1.6 -5.6 -7.1 -10.8 -14.1 -15.8 -14.9 -12.8 -12.5 -12.1 -12.1 -10.8 -10.5
1922 -11.1 -8.2 -8.7 -7.7 -5.6 -5.1 -5.1 -6.2 -5.1 -4.6 -3.4 -2.3 -6.1
1923 -0.6 -0.6 0.6 1.2 1.2 1.8 2.4 3 3.6 3.6 3 2.4 1.8
1924 3 2.4 1.8 0.6 0.6 0 -0.6 -0.6 -0.6 -0.6 -0.6 0 0
1925 0 0 1.2 1.2 1.8 2.9 3.5 4.1 3.5 2.9 4.7 3.5 2.3
1926 3.5 4.1 2.9 4.1 2.9 1.1 -1.1 -1.7 -1.1 -0.6 -1.7 -1.1 1.1
1927 -2.2 -2.8 -2.8 -3.4 -2.2 -0.6 -1.1 -1.1 -1.1 -1.1 -2.3 -2.3 -1.7
1928 -1.1 -1.7 -1.2 -1.2 -1.1 -2.8 -1.2 -0.6 0 -1.1 -0.6 -1.2 -1.7
1929 -1.2 0 -0.6 -1.2 -1.2 0 1.2 1.2 0 0.6 0.6 0.6 0
1930 0 -0.6 -0.6 0.6 -0.6 -1.8 -4 -4.6 -4 -4.6 -5.2 -6.4 -2.3
1931 -7 -7.6 -7.7 -8.8 -9.5 -10.1 -9 -8.5 -9.6 -9.7 -10.4 -9.3 -9
1932 -10.1 -10.2 -10.3 -10.3 -10.5 -9.9 -9.9 -10.6 -10.7 -10.7 -10.2 -10.3 -9.9
1933 -9.8 -9.9 -10 -9.4 -8 -6.6 -3.7 -2.2 -1.5 -0.8 0 0.8 -5.1
1934 2.3 4.7 5.6 5.6 5.6 5.5 2.3 1.5 3 2.3 2.3 1.5 3.1
1935 3 3 3 3.8 3.8 2.2 2.2 2.2 0.7 1.5 2.2 3 2.2
1936 1.5 0.7 0 -0.7 -0.7 0.7 1.5 2.2 2.2 2.2 1.4 1.4 1.5
1937 2.2 2.2 3.6 4.4 5.1 4.3 4.3 3.6 4.3 4.3 3.6 2.9 3.6
1938 0.7 0 -0.7 -0.7 -2.1 -2.1 -2.8 -2.8 -3.4 -4.1 -3.4 -2.8 -2.1
1939 -1.4 -1.4 -1.4 -2.8 -2.1 -2.1 -2.1 -2.1 0 0 0 0 -1.4
1940 -0.7 0.7 0.7 1.4 1.4 2.2 1.4 1.4 -0.7 0 0 0.7 0.7
1941 1.4 0.7 1.4 2.1 2.9 4.3 5 6.4 7.9 9.3 10 9.9 5
1942 11.3 12.1 12.7 12.6 13.2 10.9 11.6 10.7 9.3 9.2 9.1 9 10.9
1943 7.6 7 7.5 8.1 7.4 7.4 6.1 4.8 5.5 4.2 3.6 3 6.1
1944 3 3 1.2 0.6 0 0.6 1.7 2.3 1.7 1.7 1.7 2.3 1.7

1945 2.3 2.3 2.3 1.7 2.3 2.8 2.3 2.3 2.3 2.3 2.3 2.2 2.3
1946 2.2 1.7 2.8 3.4 3.4 3.3 9.4 11.6 12.7 14.9 17.7 18.1 8.3
1947 18.1 18.8 19.7 19 18.4 17.6 12.1 11.4 12.7 10.6 8.5 8.8 14.4
1948 10.2 9.3 6.8 8.7 9.1 9.5 9.9 8.9 6.5 6.1 4.8 3 8.1
1949 1.3 1.3 1.7 0.4 -0.4 -0.8 -2.9 -2.9 -2.4 -2.9 -1.7 -2.1 -1.2
1950 -2.1 -1.3 -0.8 -1.3 -0.4 -0.4 1.7 2.1 2.1 3.8 3.8 5.9 1.3
1951 8.1 9.4 9.3 9.3 9.3 8.8 7.5 6.6 7 6.5 6.9 6 7.9
1952 4.3 2.3 1.9 2.3 1.9 2.3 3.1 3.1 2.3 1.9 1.1 0.8 1.9
1953 0.4 0.8 1.1 0.8 1.1 1.1 0.4 0.7 0.7 1.1 0.7 0.7 0.8
1954 1.1 1.5 1.1 0.8 0.7 0.4 0.4 0 -0.4 -0.7 -0.4 -0.7 0.7
1955 -0.7 -0.7 -0.7 -0.4 -0.7 -0.7 -0.4 -0.4 0.4 0.4 0.4 0.4 -0.4
1956 0.4 0.4 0.4 0.7 1.1 1.9 2.2 1.9 1.9 2.2 2.2 3 1.5
1957 3 3.4 3.7 3.7 3.7 3.3 3.3 3.7 3.3 2.9 3.3 2.9 3.3
1958 3.6 3.2 3.6 3.6 3.2 2.8 2.5 2.1 2.1 2.1 2.1 1.8 2.8
1959 1.4 1 0.3 0.3 0.3 0.7 0.7 1 1.4 1.7 1.4 1.7 0.7
1960 1 1.7 1.7 1.7 1.7 1.7 1.4 1.4 1 1.4 1.4 1.4 1.7
1961 1.7 1.4 1.4 1 1 0.7 1.4 1 1.4 0.7 0.7 0.7 1
1962 0.7 1 1 1.3 1.3 1.3 1 1.3 1.3 1.3 1.3 1.3 1
1963 1.3 1 1.3 1 1 1.3 1.3 1.3 1 1.3 1.3 1.6 1.3
1964 1.6 1.6 1.3 1.3 1.3 1.3 1.3 1 1.3 1 1.3 1 1.3
1965 1 1 1.3 1.6 1.6 1.9 1.6 1.9 1.6 1.9 1.6 1.9 1.6
1966 1.9 2.6 2.6 2.9 2.9 2.5 2.8 3.5 3.5 3.8 3.8 3.5 2.9
1967 3.5 2.8 2.8 2.5 2.8 2.8 2.8 2.4 2.8 2.4 2.7 3 3.1
1968 3.6 4 3.9 3.9 3.9 4.2 4.5 4.5 4.5 4.7 4.7 4.7 4.2
1969 4.4 4.7 5.2 5.5 5.5 5.5 5.4 5.7 5.7 5.7 5.9 6.2 5.5
1970 6.2 6.1 5.8 6.1 6 6 6 5.4 5.7 5.6 5.6 5.6 5.7
1971 5.3 5 4.7 4.2 4.4 4.6 4.4 4.6 4.1 3.8 3.3 3.3 4.4
1972 3.3 3.5 3.5 3.5 3.2 2.7 2.9 2.9 3.2 3.4 3.7 3.4 3.2
1973 3.6 3.9 4.6 5.1 5.5 6 5.7 7.4 7.4 7.8 8.3 8.7 6.2
1974 9.4 10 10.4 10.1 10.7 10.9 11.5 10.9 11.9 12.1 12.2 12.3 11
1975 11.8 11.2 10.3 10.2 9.5 9.4 9.7 8.6 7.9 7.4 7.4 6.9 9.1
1976 6.7 6.3 6.1 6 6.2 6 5.4 5.7 5.5 5.5 4.9 4.9 5.8
1977 5.2 5.9 6.4 7 6.7 6.9 6.8 6.6 6.6 6.4 6.7 6.7 6.5
1978 6.8 6.4 6.6 6.5 7 7.4 7.7 7.8 8.3 8.9 8.9 9 7.6
1979 9.3 9.9 10.1 10.5 10.9 10.9 11.3 11.8 12.2 12.1 12.6 13.3 11.3

1980 13.9 14.2 14.8 14.7 14.4 14.4 13.1 12.9 12.6 12.8 12.6 12.5 13.5
1981 11.8 11.4 10.5 10 9.8 9.6 10.8 10.8 11 10.1 9.6 8.9 10.3
1982 8.4 7.6 6.8 6.5 6.7 7.1 6.4 5.9 5 5.1 4.6 3.8 6.2
1983 3.7 3.5 3.6 3.9 3.5 2.6 2.5 2.6 2.9 2.9 3.3 3.8 3.2
1984 4.2 4.6 4.8 4.6 4.2 4.2 4.2 4.3 4.3 4.3 4.1 3.9 4.3
1985 3.5 3.5 3.7 3.7 3.8 3.8 3.6 3.3 3.1 3.2 3.5 3.8 3.6
1986 3.9 3.1 2.3 1.6 1.5 1.8 1.6 1.6 1.8 1.5 1.3 1.1 1.9
1987 1.5 2.1 3 3.8 3.9 3.7 3.9 4.3 4.4 4.5 4.5 4.4 3.6
1988 4 3.9 3.9 3.9 3.9 4 4.1 4 4.2 4.2 4.2 4.4 4.1
1989 4.7 4.8 5 5.1 5.4 5.2 5 4.7 4.3 4.5 4.7 4.6 4.8
1990 5.2 5.3 5.2 4.7 4.4 4.7 4.8 5.6 6.2 6.3 6.3 6.1 5.4
1991 5.7 5.3 4.9 4.9 5 4.7 4.4 3.8 3.4 2.9 3 3.1 4.2
1992 2.6 2.8 3.2 3.2 3 3.1 3.2 3.1 3 3.2 3 2.9 3
1993 3.3 3.2 3.1 3.2 3.2 3 2.8 2.8 2.7 2.8 2.7 2.7 3
1994 2.5 2.5 2.5 2.4 2.3 2.5 2.8 2.9 3 2.6 2.7 2.7 2.6
1995 2.8 2.9 2.9 3.1 3.2 3 2.8 2.6 2.5 2.8 2.6 2.5 2.8
1996 2.7 2.7 2.8 2.9 2.9 2.8 3 2.9 3 3 3.3 3.3 3
1997 3 3 2.8 2.5 2.2 2.3 2.2 2.2 2.2 2.1 1.8 1.7 2.3
1998 1.6 1.4 1.4 1.4 1.7 1.7 1.7 1.6 1.5 1.5 1.5 1.6 1.6
1999 1.7 1.6 1.7 2.3 2.1 2 2.1 2.3 2.6 2.6 2.6 2.7 2.2
2000 2.7 3.2 3.8 3.1 3.2 3.7 3.7 3.4 3.5 3.4 3.4 3.4 3.4
2001 3.7 3.5 2.9 3.3 3.6 3.2 2.7 2.7 2.6 2.1 1.9 1.6 2.8
2002 1.1 1.1 1.5 1.6 1.2 1.1 1.5 1.8 1.5 2 2.2 2.4 1.6
2003 2.6 3 3 2.2 2.1 2.1 2.1 2.2 2.3 2 1.8 1.9 2.3
2004 1.9 1.7 1.7 2.3 3.1 3.3 3 2.7 2.5 3.2 3.5 3.3 2.7
2005 3 3 3.1 3.5 2.8 2.5 3.2 3.6 4.7 4.3 3.5 3.4 3.4
2006 4 3.6 3.4 3.5 4.2 4.3 4.1 3.8 2.1 1.3 2 2.5 3.2
2007 2.1 2.4 2.8 2.6 2.7 2.7 2.4 2 2.8 3.5 4.3 4.1 2.8
2008 4.3 4 4 3.9 4.2 5 5.6 5.4 4.9 3.7 1.1 0.1 3.8
2009 0 0.2 -0.4 -0.7 -1.3 -1.4 -2.1 -1.5 -1.3 -0.2 1.8 2.7 -0.4
2010 2.6 2.1 2.3 2.2 2 1.1 1.2 1.1 1.1 1.2 1.1 1.5 1.6
2011 1.6 2.1 2.7 3.2 3.6 3.6 3.6 3.8 3.9 3.5 3.4 3 3.2
2012 2.9 2.9 2.7 2.3 1.7 1.7 1.4 1.7 2 2.2 1.8 1.7 2.1
2013 1.6 2 1.5 1.1 1.4 1.8 2 1.5 1.2 1 1.2 1.5 1.5
2014 1.6 1.1 1.5 2 2.1 2.1 2 1.7 1.7 1.7 1.3 0.8 1.6

2015 -0.1 0 -0.1 -0.2 0 0.1 0.2 0.2 0 0.2 0.5 0.7 0.1
2016 1.4 1 0.9 1.1 1 1 0.8 1.1 1.5 1.6 1.7 2.1 1.3
2017 2.5 2.7 2.4 2.2 1.9 1.6 1.7 1.9 2.2 2 2.2 2.1 2.1
2018 2.1 2.2 2.4 2.5 2.8 2.9 2.9 2.7 2.3 2.5 2.2 1.9 2.4
2019 1.6 1.5 1.9 2 1.8 1.6 1.8 1.7 1.7 1.8 2.1 2.3 1.8
2020 2.5 2.3 1.5 0.3 0.1 0.6 1 1.3 1.4 1.2 1.2 1.4 1.2
2021 1.4 1.7 2.6 4.2

Chapter Eight: 2021, Where is the Real Rate of Price Inflation Today?
Prices of Goods and Services are rising at different rates and people have
mixed views on this issue. Coming out of the Covid-19 induced recession,
some believe that the federal stimulus and spending programs will ignite a
multi-year inflationary wave again. Others argue that price spikes in certain
sectors like lumber and building products are merely temporary and due to a
short-term lack of supply.
In my view, Price Inflation is also an attitude or attitudinal phenomenon
that spreads rapidly like fear. Once the ball of inflation starts rolling it takes
time for attitudes and behaviors to change. Who wants to lower their prices
when others are still raising their prices?
Inflation is measured using a basket of goods and services. The Covid-19
virus disrupted inflation statistics because the pandemic shutdown drove
changes in consumption patterns. These changes altered the official pace of
price growth in different goods and services.
Across the world, people stopped spending on restaurants, airfares and other
lockdown-restricted activities. As a result, some countries’ real-world
experience of inflation differed from the official rate. And, the US inflation
may have been underestimated. Spending on groceries increased 29 per cent
in March last year according to Opportunity Insights. In contrast, transport
spending declined 70 per cent in April last year. Also, a decline in

production of cars and trucks over the past year pushed up used vehicle
prices.
Some argue that reweighing items in the CPI basket is necessary to more
accurately reflect recent price changes.
Americans spent less on transport since the start of the pandemic than the
CPI weighting suggests, April’s official inflation reading, which recorded a
big jump, was probably an overestimation. As the US economy reopens and
lockdowns end, rate effects may reverse. Katharina Utermöhl, senior
economist at Allianz, said policymakers “will need to take note of this and
test alternative measurement methods to get a better sense of actual inflation
dynamics.”
Keep an open mind and try to appreciate both sides views on our U.S.
government stimulus issues. Is the current price inflation transitory or will it
be more persistent?
On May 19, 2021, Randal Quarles, the Federal Reserve’s vice chair for
supervision and regulation, said that the central bank is monitoring inflation.
The Covid-19 pandemic is an unprecedented event. Reacting too soon might
come at a cost of constraining an economic and jobs recovery. Mr. Quarles
said that officials have the tools to tamp down inflation if it remains
elevated. The Fed could dial back bond purchases or lift interest rates to
slow growth and weigh down prices.

In my view, inflation is a fear phenomenon that can spread rapidly across
many industries. Central bankers may try to slow down the rate of growth.
However, it is more difficult to lower the price of goods and services when a
fear phenomenon exists.
As of June 2, 2021, The Federal Reserve said that it plans to sell the
corporate bond portfolio it bought during the pandemic. The move
completes the central bank’s transition away from its support of that market
introduced as part of a Covid-19 relief program.
This is a signal that the economy is heating up, and it may not need as much
government stimulus. The Fed plans to start reducing the amount of bond
ETFs it holds before winding down its bond holdings by year end.
Their plan is make the sales gradual and orderly. The aim is to minimize the
potential for any adverse impact on market functioning and perceptions.
The intent is to take into account daily liquidity and trading conditions for
exchange traded funds and corporate bonds.
According to the Securities Industry and Financial Markets Association, the
overall corporate bond market is more than $10 trillion in size. The central
bank recently owned $13.8 billion in bonds and bond ETFs. While this is a
small portion of the overall total, the sales send a signal to market
participants and their perceptions.

President Joe Biden is sounding out different advice as he pursues his
economic agenda. He recently spoke with prominent critic Larry Summers
on the economy after inflation warnings. As the President proposes
significant amounts of new spending through his infrastructure and jobs
package, there are concerns about the overall impact on possible price
inflation.
Summers believes that an inflation scenario is now greater than the deflation
risks on which they were originally focused. He fears the economy may be
overheating. At the time, the government reported that consumer prices rose
4.2% in April. President Biden's $1.9 trillion Covid relief bill might
overstimulate and damage the economy by sparking excessive inflation.
Coming back from a once-in-a-century pandemic creates a heightened level
of unpredictability. Biden’s aides have so far downplayed the risk of
inflation. Their view is that the danger of spending too little to recover from
the effects of the pandemic exceed the risks of spending too much.
In 2020, the Fed introduced new facilities to offer liquidity to companies,
state and local governments, smaller businesses, and nonprofits. Those
facilities were seeded in part with money from the Treasury Department’s
Exchange Stabilization Fund. Five of those emergency facilities expired at
the end of 2020. Those are different from the central bank’s quantitative

easing efforts, where the Fed has continued to purchase $120 billion in
Treasuries and mortgage-backed securities each month.
Depending on how the U.S. economic recovery develops, the central bank is
expected to start discussing reducing the pace of those purchases later this
summer or fall.
What should value investors do? Purchase businesses that are well adapted
to an inflationary environment.
Warren Buffett said that such a 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. (2) The business
should have 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.
However, Buffett also warned us that very few businesses possess both
characteristics, and competition to buy those that do will become fierce. So,
be careful in your assessment of price and value.

Chapter Nine: 2021, Finding the Wonderful Business
Use this Innovation in Behavioral Finance.
I believe that Warren Buffett and Charlie Munger invented an investing
formula and process that is underappreciated by the business and academic
communities. This sequential filtering process is effective. These filter steps
reduce the risk of investment failure by helping us steer a better path to a
high quality bargain. Charlie Munger has spoken about the merits of having
a “pilot’s checklist.”
I think the Four Filters are an important checklist because they emphasize an
economic understanding of a business, repeat customers, ideal managers,
and a margin of safety.
Warren Buffett mentioned the Four Filters in the 2007 annual letter this way:
“Charlie and I look for companies that have a) a business we understand; b)
favorable long-term economics; c) able and trustworthy management; and d)
a sensible price tag.” These filters enhance the probability of our investment
success. They will help us in our search for intrinsic value and sensible
investment.
The Very Profitable Coca-Cola Investment Explained.
Coca Cola is a business with a differentiated and continuing competitive
advantage. Its economic moat is deep and wide. Since it has a combination
of a special brand advantage, large scale cost of production advantage, and a

global network distribution advantage, we could say that it has three moats
around its economic castle.
In 1988, Warren Buffett and Charlie Munger began buying stock in the
Coca-Cola Company for the Berkshire Hathaway portfolio. They purchased
about 7% of the company for $1.02 billion. It has turned out to be one of
Berkshire's most lucrative investments. A customer generally asks for a
Coke by name. Customers do not buy a ‘cola’.
Charlie Munger said, “The social proof phenomenon which comes right out
of psychology gives huge advantages to scale—for example, with a very
wide distribution, which of course is hard to get. One advantage of Coca-
Cola is that it's available almost everywhere in the world.”
Warren Buffett knows that commodity companies sell products or services
that can be easily copied and reproduced. In 1982, Buffett said this about
commodity companies: ‘Businesses in industries with both substantial over-
capacity and a "commodity" product (undifferentiated in any customer-
important way by factors such as performance, appearance, service support
etc) are prime candidates for profit troubles.’
Some companies obtain a continuing competitive advantage by being part of
a structure that operates as a monopoly. An example of this protected status
was Freddie Mac. The Federal Home Loan Mortgage Corporation was
established by Congress to buy, securitize mortgages, and resell them as

guaranteed mortgage pass-through certificates. Until the dynamics changed
into a mismanaged over-capacity housing bubble, this had been an earlier
profitable investment of Buffett and Berkshire Hathaway.
There are also companies that market commodity products so well that they
distinguish their commodity product from that of their competitors. These
put their own special ‘brand’ upon their product. They can achieve this by a
winning marketing mix of price, product, placement, and promotions.
From a practical point of view, business is about taking good care of your
customer and arriving at an agreeable trade. In finding the business with
enduring competitive advantage, we are finding a business that has been
tested by time and its customers. Products, Customer Satisfaction, Great
Management, and Financial Safety given by a bargain purchase are very
important.
Charlie Munger has said that “people calculate too much and think too
little.” Working together, Buffett and Munger produced a remarkable and
effective Behavioral Finance formula. And, within that fourth filter, Bargain
Price, we see Ben Graham’s three most important words in investing,
“Margin of Safety.” So, investing safety is practically insured by purchasing
high quality at a bargain price.
Inflation, Market excesses, and Government excesses will come and go.
Warren Buffett wrote that a different set of major shocks is sure to occur in

the future and that he will not try to predict these nor to profit from them.
However, if he can identify businesses similar to those he has purchased in
the past, external surprises will have little effect on long-term results. Buffett
said: “We will stick with the approach that got us here and try not to relax
our standards.”
Buffett’s teacher, Ben Graham believed that the value of analysis diminishes
as the element of chance increases. In these filters, we decrease the element
of chance and enhance our predictive probabilities. So, we should learn from
the best; and we work to develop a better network of good information and
scuttlebutt. By studying business situations rationally, we improve our
decision making skills. Using the Four Filters, we decrease the element of
chance and increase our probability of focusing and finding a high quality
bargain.
After finding high quality bargains, think about what Charlie Munger said:
"Over many decades, our usual practice is that if the stock of something we
like goes down, we buy more and more. Sometimes something happens, you
realize you're wrong, and you get out. But if you develop correct confidence
in your judgment, buy more and take advantage of stock prices."
Learn From Experience. Buffett said it like this: “After many years of
buying and supervising a great variety of businesses, Charlie and I have not
learned how to solve difficult business problems. What we have learned is to
avoid them. To the extent we have been successful, it is because we

concentrated on identifying one-foot hurdles that we could step over rather
than because we acquired any ability to clear seven-footers.”
On tech, Charlie Munger said, “Warren and I don't feel like we have any
great advantage in the high-tech sector. In fact, we feel like we're at a big
disadvantage in trying to understand the nature of technical developments in
software, computer chips or what have you. So we tend to avoid that stuff,
based on our personal inadequacies. Figure out where you have an edge -
and stay there.”
Charlie Munger said, “If we don't believe we have an advantage, we don't
play… If you're going to be an investor, you're going to make some
investments where you don't have all the experience you need. But if you
keep trying to get a little better over time, you'll start to make investments
that are virtually certain to have a good outcome. The keys are discipline,
hard work and practice. It's like playing golf -- you have to work on it."

Books by Bud Labitan
“The Four Filters Invention of Warren Buffett and Charlie Munger”
book examines each of the basic steps Buffett and Munger use in "framing
and making" an investment decision. It is a focused look into an amazing
invention within "Behavioral Finance." In my opinion, the genius of Buffett
and Munger's four filters process was to "capture all the important
stakeholders" in a four cluster process. Imagine...Products, Enduring
Customers, Managers, and Margin-of-Safety... all in one mixed "qualitative
+ quantitative" process.
“Quick Guide to the Four Investing Filters of Warren Buffett and
Charlie Munger” book is a quick guide to understanding the four investing
filters of Warren Buffett and Charlie Munger. It is a shorter version of the
previous book and is designed to improve your investment thinking. How do
you set a price for your stock purchases? In Chapter 4, I estimate an intrinsic
value (of Apple stock). First, start by trying to understand the qualities of a
first-class business. The four filters help you optimize your decision making.
Warren Buffett said it best: "An investor cannot obtain superior profits from
stocks by simply committing to a specific investment category or style. He
or she can earn them only by carefully evaluating facts and continuously
exercising discipline."

"Price To Value" is about Intelligent Speculation. It is about decision
framing and using the "Decision Filters" of Charlie Munger and Warren
Buffett. Readers benefit from this book if it stimulates better thinking into
the most important factors crucial to decision making. These decision
framing ideas can be applied across different asset classes. First, the book
presents the four investing decision filters in simplified terms. Then, it
extends these ideas by looking into the intelligent speculation ideal
described by Benjamin Graham in his tenth lecture of 1946.
“Valuations” book offered 30 sample "intrinsic value per share" business
valuations I performed in 2010. In each case the author tried to simulate an
approach that Buffett & Munger might take to valuing a business. However,
all of the growth assumptions used were my own. No consultation nor
endorsement was sought with Mr. Buffett or his business partner Mr.
Munger. The examples given are chosen for educational and illustrative
purposes. The valuation cases are estimations written in a style that
emphasizes a focus on free cash flow and the number of shares outstanding.
Readers are also encouraged to think about the business' competitive
position. In reality, these businesses may outperform or they may
underperform any of my projections. Read it and then look at how my
predictions actually turned out niine years later.

"Coach W Software" was crafted from my imaginary conversation with Mr.
Warren Buffett. The real conversation never occurred. The software
generated conversation did occur on March 5, 2011. The pseudo-A.I.
Windows software was developed by me, and it is a useful tool in reviewing
the concepts developed by Mr. Buffett, Mr. Charlie Munger, and Mr.
Benjamin Graham. An easy read, this book starts out as an imaginary
conversation filled with useful business and investing ideas generated by the
software. Value? "Coach W Software" is an experiment in positive
suggestion that delivers valuable insights to the business thinking reader. It
makes us think about how man and machine can communicate with each
other. Do certain keywords help us become better investing thinkers? The
book is structured to both enlighten and entertain. In this way it mirrors a
feel-good guide to self-hypnosis in the field of investment thinking. It is
important to point out that there is no association or endorsement from Mr.
Buffett or Berkshire Hathaway. "Coach W Software" is useful to readers
who are new to value investing, and readers who wish to review these great
business investing concepts.
“Sports & Stocks” describes ideas about investing in the stock of a winning
business. A fun read, it is written from the point of view of a sports fan.
Mixing sports talk with investing talk may stimulate your thinking about
better investing. The Goal is to find HQB, High Quality (Business) Bargain.
I present an entertaining read on how to find HQB using the sports ideas of

Offense, Defense, and Special Situations. This book includes three stock
valuation examples from 2017.
“MOATS” may be the best business book that describes the competitive
advantages of profitable businesses. MOATS describes the nature of 70
selected businesses purchased by Buffett and Munger for Berkshire
Hathaway Inc. It is a useful resource for investors, managers, students of
business. MOATS also looks at the sustainability of these competitive
advantages in each of the 70 chapters. Thanks to Professor Phani Tej
Adidam, Ph.D. Chair of the Department of Marketing and Management at
University of Nebraska at Omaha; many of his students contributed to the
research for this book. Also, thanks are extended to Richard Konrad, CFA,
Dr. Maulik Suthar, and Scott Thompson, MBA for sharing their thoughts,
analysis, and feedback.
“A Fistful of Valuations in the Style of Warren Buffett & Charlie
Munger” (Third Edition, 2015). This book offers five sample intrinsic
value per share business valuation estimations that were first performed in
2010. In each case presented, I simulated an approach that Buffett and
Munger might take to valuing a business, based on what they have written
and talked about. However, all of the growth assumptions used are my own.

No consultation or endorsement was sought with Mr. Buffett or Mr. Munger.
How is this portfolio of five businesses doing after five years? If the reader
had invested an equal amount of money in all five businesses in 2010, the
average annual return would be 42 percent by the end of 2015.

Inflation Views by the author Bud Labitan

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