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What, if anything, should financial risk managers of banks and other corporate entities be thinking and doing right now? Will such businesses suffer in a world of persistent, unbridled inflation?

As it happens, corporations are, relative to pensioners, fairly immune to inflation. The corporate structure itself is a natural hedge. Debt liabilities will lose value during inflationary years, and that's good for the debt issuers.

To the extent that a corporate's balance sheet holds a mix of financial and non-financial assets, the fall in asset value may match or be less than the drop in debt value. Further unlike the pensioners' fixed revenue, both the revenue and the expenses of businesses tend to "float" with inflation.

Professional risk managers, therefore, need not dread the onset of inflation. The corporate risk challenge is deflation! In deflation, the debt liabilities gain value. The assets of a non-financial corporate will likely "underperform the debt" in terms of the reaction to inflation.

While banks own predominantly financial assets that nominally appreciate during deflation, the corporate loans among such assets will fall in credit quality. In addition, the "floating" aspect of income statement expenses can be sticky on the deflationary side. For example, societies tend not to accept workers' wage reductions as a reasonable consequence of deflation.

Monetary Policy Risk? Deflation! By J.M. Pimbley [source]

I have no difficulty in understanding the whole article except for the bold sentence.

When I look up underperform in the dictionaries, they all say it's an intransitive verb. But it's being used as a transitive verb here. What makes this usage justifiable here? What is the purpose of the quotation marks?

Then I remember some action verbs can act as both transitive and intransitive. Take break for example, we can say the bottle broke just now and he broke the bottle just now. I would think it's similar here. Does the sentence mean the assets make the debt underperform - or, to put it another way, the value change of the assets outstrips that of the debt? Is my understanding right?

  • Maybe the sentence says that in their reaction to a (negative) inflation the assets of a non-financial corporate issuer will gain value, but not as fast as its debt liabilities? Then the quotation marks are probably used to highlight the quaint use of the verb underperform. – CowperKettle Jun 25 '14 at 14:22
  • Nah, in case of inflation, the non-financial assets will gain in value while the financial debt will fall in value because paper money is not worth what it used to be. Thus, a non-financial corporate don't have to pay back its debt as much as before in terms of real value. @CopperKettle – Kinzle B Jun 25 '14 at 14:26
  • Thanks, Zhanlong! But could the author mean "negative inflation" here? He speaks of deflation in a preceding sentence, so maybe he meant to say "in terms of the reaction to (a negative rate of) inflation". – CowperKettle Jun 25 '14 at 14:33
  • That's what I feel a bit strange as well. That paragraph begins with deflation but ends with inflation. I would think it's bad writing. There's no "negative inflation" in economics. @CopperKettle – Kinzle B Jun 25 '14 at 14:37
  • Isn't deflation a negative inflation? The term is used, although rarely, judging by a Google Books search. books.google.ru/… – CowperKettle Jun 25 '14 at 14:46
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The assets of a non-financial corporate will likely "underperform the debt" in terms of the reaction to inflation.

Does the sentence mean the assets make the debt underperform - or, to put it another way, the value change of the assets outstrips that of the debt? Is my understanding right?

No.

There's no causal relationship between the debt and assets; it's the inflation which makes both of them change in value. They're simply measured at the same time and compared, though they will likely be strongly correlated, as they share a cause.

The debt's reaction to the inflation will be of greater magnitude than the assets', as opposed to the other way around. As specified earlier, both debt and assets lose value when exposed to inflation. The final clause, in terms of the reaction to inflation, tells us that what's "performing" is the size of the decline in value. Thus, the assets will underperform the debt means the lost amount of debt will be greater than the lost amount of assets.

This is beneficial because debt is money owed, which lowers the net worth of a business. So if the size of the debt drops more than the size of the assets, then the net worth will increase. A very simple example:

Debt  Assets  Net Worth
50    100     50

Say inflation causes assets to devalue by 1% and debt by 4%....

Debt  Assets  Net Worth
48    99      51

When I look up underperform in the dictionaries, they all say it's an intransitive verb. But it's being used as a transitive verb here. What makes this usage justifiable here?

MW contains a transitive definition. I believe (though I'm not going to bother to research, as it'd be a lengthy undertaking for me) that the transitive usage is relatively new, and a little more technical than the intransitive version. I've seen this often enough for it to be standard (though not common) in American business English, especially in a financial or investing context (as used here).

What is the purpose of the quotation marks?

They emphasize that the usage isn't standard. One doesn't typically think of debt in terms of "performing", and the same goes for the strength of a reaction. Also, underperforming is usually a bad thing, but in this case, the underperformance of the assets is beneficial. The quotation marks essentially say hey, this language is a little weird, but run with me on it; you see what I mean, right?

  • I beg to differ. It says a corporate's balance sheet holds a mix of financial and non-financial assets. In case of inflation, financial assets will fall in value while non-financial assets will gain in value. The corporate will become reluctant to sell its inventory because it excepts a higher sales price in the future. Besides, the property, plant, and land also benefit from inflation. Thus, the mix of financial assets and non-financial assets could fall, or gain, or maintain in value. That's why the author mentioned "to the extent". – Kinzle B Jun 26 '14 at 4:15
  • Sorry, it's "expects", not "excepts". – Kinzle B Jun 26 '14 at 4:22
  • I'm not sure exactly what you're disagreeing with, but I'll take a shot at responding. Underperform here is used to mean decrease by less than; note that thus any amount of gain (or a loss of lesser magnitude) underperforms a loss. Inflation causes the debt to drop more than the total assets for the reasons you've said, thus the assets underperform the debt in terms of reaction to inflation. – Esoteric Screen Name Jun 26 '14 at 6:22
  • I've been working until now. Sorry for this delayed response. It's just a minor disagreement over a particular point. Your answer are excellent. Thx for clarifying it!:-) Just one more Q: The boys are underperforming the girls at school. Does this mean the boys are performing worse than the girls? @Esoteric Screen Name – Kinzle B Jun 26 '14 at 12:48
  • No worries! Yes, the boys are underperforming the girls means that the boys are doing worse than the girls. Similarly, the stock is expected to underperform has an implied direct object of the market, meaning the stock's return will be less than the average market return (usually as measured by one of the major indexes, e.g. S&P 500). – Esoteric Screen Name Jun 26 '14 at 14:30

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