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PCCA Journal|2 nd Quarter 2011 14

direct lowering of the long-term rates for bonds, as higher rates are not necessary any longer to attract the dollar invest-ment. In reality, longer-term rates rose between December 2010 and April 2011. The additional liquidity in the markets may have finally had an effect as May 2011 has finally seen a fall in these longer-term rates. The addition of $600 billion in new liquidity injected into the system will result in more money slosh-ing around with the hope it will get the economy growing at a higher rate result-ing in additional jobs to drive down the unemployment rate. We have yet to see the impact in either economic growth or widespread reduction in unemployment. What is taking place is similar to

a chemistry experiment. The Federal Reserve is going to pour a catalyst, the $600 billion dollars, into a liquid, the economy, and see what happens. We already know that this catalyst will cause a chemical reaction; we just do not know if the $600 billion is enough catalyst to cause an observable or visual reaction—higher economic growth rates and more jobs.

While the $600 billion is applied, there will be vigilant observation of the economy to see what happens. If little is observed over some time period, a decision about additional expenditures and pouring more catalyst into the economy will be made. The problem with this approach is no one can really know how much catalyst is necessary to have a visual reaction nor how long to wait to observe this reaction. There-fore, it is more likely we will get the mix wrong as there are many more wrong

answers than there are right ones. If the Federal Reserve is wrong on the too-much-catalyst side, we will experience high inflation, and if we are very wrong, potentially hyperinflation. There are nearly 20 recent examples of hyperinfla-tion over the past 50 years around the globe. 1 Several notorious devaluations are briefly described below:

Argentina 1975-1991. Suffered three rounds or printing progressively larger denomination bills finishing with a 1,000,000 pesos denomination. Three rounds of currency reform were implemented to drive down inflation. The overall impact of hyperinflation: 1 (1992) peso = 100,000,000,000 pre-1983 pesos.

Brazil 1986-1994. The base currency unit was adjusted three times conclud-ing with a currency reform and adop-tion of the real in 1994. The overall impact of hyperinflation: 1(1967) cruzeiro = one trillionth of a U.S. cent in 1994, including a single-year record of 2075.8 percent inflation.

Germany 1923. The highest denomi-nation of the German mark increased from 50,000 to 100,000,000,000,000 in a span of 15 months. A currency reform in 1923 helped stem hyper-inflation and linked the value of the currency to the U.S. dollar. 2

Israel 1971-1985. Inflation rose from 13 percent in 1971 to 111 percent in 1979, to 133 percent in 1980, 191 percent in 1983, and then to 445 per-cent in 1984, threatening to become a four-digit figure within a year or two. A 1985 currency reform, price freeze, and other measures finally stabilized the currency in 1986, reducing infla-tion to 19 percent for the year.

Yugoslavia 1989-1994. The highest denomination in 1988 was 50,000 dinars inflating to 2,000,000 dinars in 1989. Five separate currency reforms in 1990, 1992, 1993, 1994, and 1995

finally brought inflation under control. The overall impact of hyperinflation: 1 novi dinar = 1 × 1027~1.3 × 1027 pre-1990 dinars. Yugoslavia’s rate of inflation hit 5 × 1015 percent cumula-tive inflation over the time period 1 October 1993 and 24 January 1994.

What Will It Mean to Utility Contractors?

The bond markets already anticipate higher inflation rates over the long-term. Recent rises in oil and other commodity prices are precursors to a more competi-tive and volatile environment. Devalua-tion of the U.S. dollar has already started and is impacting some commodity prices. Uncertainties primarily revolved around the speed of economic recovery, growth, and employment rates in the U.S.

There are three certainties utility con-tractors will face: 1) increasing inflation in the U.S., 2) devaluation of the dollar outside of the U.S., and 3) commodity price increases. All three will punish U.S. centric firms operating in what is likely to be a slow-growth U.S. economy.

Infationary Pressure Increasing

The likelihood of the U.S. experiencing hyperinflation, defined by the Interna-tional Accounting Standards Board as greater than 25 percent annually, is low. The likelihood the U.S. will experience inflation at a rate higher than our recent history is very high. Roughly speaking, the U.S. has experienced annual inflation of less than 5 percent for essentially the last 30 years starting in the early 1980s (Exhibit 1.1). Prior to that point, the late ’70s and early ’80s, the U.S. experienced much higher inflation than this level, and for several periods it approached or exceeded 10 percent. From a current economic standpoint, all of the factors

Quantitative Easing

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A good catalyst needs to adsorb the reactant molecules strongly enough for them to react, but not so strongly that the product molecules stick more or less permanently to the surface.

BaCl

2 (aq)

+ Na

2

SO

4 (aq)

J 2 NaCl

(aq)

+ BaSO

4

(s)

Page 14 - PCCAJournal2ndQuarter2011

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