WILL WE SEE THE RETURN OF 1970s STAGFLATION?
Mark Lister, 15 October 2021
The 1970s was, without doubt, the greatest decade for rock music. It brought us ACDC, Aerosmith, Tom Petty, Van Halen and Motorhead, while Led Zep and the Stones came into their own.
In stark contrast, the 1970s were abysmal for investment returns.
US shares, corporates bonds and real estate all posted respectable, albeit below average, annual gains of 5-7 per cent. However, none kept pace with rampant inflation, which meant that in “real” terms, investors went backwards.
It was even worse here in New Zealand, where inflation averaged 12 per annum, outpacing the local sharemarket and completely eroding ten years’ worth of house price rises.
There weren’t many places to hide back then, with gold and commodities two of the only things that performed well. Gold surged 14-fold over the decade, and has never come remotely close to repeating those returns.
Farmland was also strong, on the back of the high commodity prices and demand for tangible assets that would be more insulated from higher inflation. US farm prices increased 13.8 per cent per annum over the period.
The 1970s was mired in “stagflation”, which is a very undesirable combination of low growth, high unemployment, and high inflation.
It’s difficult to pinpoint exactly what led to this cocktail of misery, although soaring oil prices, high government spending and wage demands from powerful trade unions all helped conspire to end the prosperity of the previous two decades.
The oil shock was probably the biggest factor. Oil producing countries cut supply in the wake of the Yom Kippur war with Israel in 1973, which saw oil prices soar from US$3.00 a barrel to four times that.
American oil production had peaked a few years earlier, and it couldn't keep up with burgeoning demand from vehicles. Rising fuel prices hit the US economy hard, leading to higher transport costs, wages, and overall prices.
During the 1960s, the US inflation rate had averaged 2.5 per cent, unemployment had fallen to as low as 3.4 per cent and interest rates remained at very benign levels.
By 1974, the inflation rate was running at ten per cent, the central bank policy interest rate was almost 13 per cent, unemployment was on its way to nine per cent, and the economy was in recession.
It was an ugly time for everyone, including investors.
New Zealand suffered a similar fate, although we were already hurting from falling wool prices and a sharp devaluation in the currency, which made imported fuel even more expensive.
We also had to contend with our major export market, Britain, joining the European Economic Community in 1973. Effectively excluding us from the British market, this saw our exports to Britain fall from 43 per cent in 1960 to less than 15 per cent two decades later.
Stagflation has found its way into the headlines again, as nervous market-watchers (as well as a few very credible economists) see some eerily similar signposts today.
We’ve just had a period of very expansionary monetary policy and government spending, the COVID-19 pandemic has caused an almighty supply shock, while signs of rising inflation are everywhere. To make matters worse, oil prices have started climbing again.
Having said that, two other key ingredients for stagflation – weak growth and high unemployment – aren’t as easy to see on the horizon.
The International Monetary Fund is forecasting global growth of 4.9 per cent in 2022, while the US is expected to enjoy a 5.2 per cent increase in economic output and an improving labour market.
Similarly, the Reserve Bank expects our unemployment rate to fall to a 12-year low of 3.8 per cent next year, on the back of a resilient economy delivering solid growth.
While some parts of the 1970s economic puzzle are in place today, there’s just as many that are missing.
We should always be mindful of risks, and willing to reassess the outlook as we get new information. However, the threat of stagflation is probably something to file under “watch this space”, rather than “time to panic”.
Keep those good tunes near the top of your Spotify playlist, but lets hope we leave the rest of the 1970s back there in the past.