Jetrader - July/August 2008 - 23

remove certain older aircraft from their operations. However, if fuel prices continue to rise further, then carriers could begin the wholesale downsizing of their ﬂeets, perhaps in tandem with consolidation activity, which would result in a net decrease in aircraft demand during an adjustment period. While economic activity and energy prices are key drivers of aircraft valuation cycles, the role of inﬂation should also be considered by aircraft investors and is perhaps of greater long-term importance. The residual value of an aircraft is a function of the “real” future asset value and the rate of inﬂation over the given period. Falling inﬂation rates therefore depress nominal aircraft residual values below anticipated levels. The losses suffered by investors in U.S. leveraged leases that unwound during the industry’s last restructuring cycle were undoubtedly aggravated by the prior era’s trend of decelerating inﬂation. Accelerating inﬂation, on the other hand, represents a positive dynamic for aircraft as an investment class versus traditional ﬁnancial assets such as equities and bonds. If economic patterns continue to repeat in the aforementioned manner then we are likely to see a sustained period of inﬂ ationary pressure. Exhibit 2 illustrates inﬂ ation before and after its prior inﬂection point, which occurred approximately 40 years ago, and the ensuing 40-year cycle starting in 1990, leading to the observation that a continuation of the 40-year pattern forebodes signiﬁcantly rising inﬂ ation. A review of today’s economic environment serves up a similar outlook for inﬂ ation. Outsourcing of production to lower cost producing nations was one of the key forces behind decelerating inﬂ ation. However, this trend has matured and many of the countries that have become key producers of goods for the U.S. and other large developed nations are themselves experiencing accelerating inﬂ ation, in certain cases approaching or exceeding double digits; the currencies of certain of these producers are also appreciating relative to the U.S. Dollar thereby exacerbating this inﬂ ationary impact. These forces as well as increased risk premiums on capital, nominal or negative real U.S. interest rates, and increasing demand for the world’s resources from rapidly growing developing nations, collectively indicate that inﬂ ation is likely to be of far greater inﬂuence in future years than it has been in the recent past. Furthermore, the assumption that the U.S. Federal Reserve can use its monetary levels to readily curb inﬂ ation is no longer self-evident as the U.S. and many other developed economies are no longer the primary producers of their consumed goods or the primary drivers behind much of the growth in net demand for the world’s resources. Conclusion In the long-term, inﬂ ation is a key driver of aircraft residual outcomes, even though it has been less topical in recent years. The observation of a 40-year super-cycle in which inﬂ ation was at a key inﬂection point approximately 40 years ago, and a multitude of other observable factors, indicate that inﬂ ation will play a more forceful role in the future. Such an outcome should make aircraft an attractive long-term asset class versus traditional ﬁnancial assets. Exhibit 2: Inﬂation Trend over 40-Year Cycles Inflation Trend: The Consumer Price Index 40 Year Cycles (1950 1,000 - 1989; 1990 - Present) up 2.9% p.a. up 6.2% p.a. (1990 - Present) 100 up 2.2% p.a. (1969 - 1989) (1950 - 1968) 10 CPI (1950 1 - 1989) CPI (1990 - Present) While economic activity and energy prices are key drivers of aircraft valuation cycles, the role of inflation should also be considered by aircraft investors and is perhaps of greater long-term importance. Jetrader 23

Jetrader - July/August 2008

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