Stagflation has been in the headlines in recent weeks, as the oil price shock threatens to push inflation back up while taking a big chunk out of economic activity at the same time.
The term is used to describe the highly undesirable combination of low growth, high unemployment, and high inflation.
The Reserve Bank has suggested our annual inflation rate could hit 4.2 per cent in the June quarter, while the International Monetary Fund just released a scenario that sees global inflation at 5.4 per cent and an even worse one at 6.1 per cent.
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Those are just potential outcomes, rather than predictions, but they’d go hand-in hand with a fairly bleak economic outlook.
The most well-known of previous stagflationary periods was the 1970s, a decade that was abysmal for investment returns.
US shares, corporate bonds and real estate all posted respectable, albeit below-average, annual gains of 5-7 per cent over those ten years.
However, none kept pace with rampant inflation which averaged 7.4 per cent over the decade, so in “real” terms investors went backwards.
It was even worse here in New Zealand, where inflation averaged 12 per cent per annum, outpacing the local sharemarket and eroding 10 years’ worth of house price rises.
There weren’t many places for investors to hide, 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 better insulated from higher inflation.
US farm prices increased 13.8 per cent per annum over the period.
It’s difficult to pinpoint exactly what led to this, although soaring oil prices, high government spending and wage demands from powerful trade unions all conspired to end the prosperity of the previous two decades.
The energy shock was probably the biggest factor.
Oil-producing countries cut supply in the wake of the Yom Kippur war in 1973, which saw oil prices soar from US$3 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 benign.
By 1974, the inflation rate had jumped to 10 per cent, the central bank policy interest rate was almost 13 per cent, unemployment was headed to 9 per cent and the economy was in recession.
It was a tough 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 at the time, Britain, joining the European Economic Community in 1973.
That effectively excluded us from the British market, which saw our share of exports to Britain fall from 43 per cent in 1960 to less than 15 per cent just two decades later.
To be clear, the 1970s were a unique period and we’re a long way from there today, despite soaring fuel prices and fears this will beget a broader inflation spike.
However, the current situation bears monitoring.
There are few winners from a weakening economy, especially if stubborn inflation leaves policymakers in a bind.
A central bank would typically start reducing interest rates in response to slowing activity, but if it sees price pressures on the horizon it might be forced to do the opposite.
We need to watch firms’ price-setting behaviour as well as wage demands from workers, while keeping a close eye on how central banks deal with conflicting signals.
The 1970s were great for music, groundbreaking for cinema and iconic for fashion, but let’s hope we can leave some of those economic trends in the past.
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.
Mark Lister
Investment Director
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.