Mitch on the Markets

December 28th, 2021

Are We Returning to 1970s-style Inflation?

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In 2004, The Economist ran a feature on global inflation, and on the cover of the magazine they posed the question: “Back to the 1970s?” Readers today know the U.S.1 and developed world economy did not enter a period of 1970s-style inflation in the early 2000s, and in fact the U.S. was on the verge of a decade-plus run of below average inflation.

Fast forward to today, and many are again asking the question if we’re heading for 1970s-style inflation, and at worst, a period of stagflation.

These gloomy comparisons happen a lot. I’ve been in the investment business for a long time, and I can assure readers that any time the U.S. economy has experienced above-consensus inflation for a period, the comparisons to the 1970s start coming out. Admittedly, 2021 has some interesting parallels to the 1970s – the U.S. just ended a long and troubling war (Afghanistan versus Vietnam), there is a semblance of a cold war (Soviet Union versus China and Russia), and labor shortages/supply chain issues have created some problems (some readers may remember the 1970s for its shortages).

A return to 1970s-style inflation does not necessarily make for great holiday reading. But not to worry – below I offer two key reasons 2021/22 should not encounter the same long-term inflation problems seen during the 1970s.

The first reason is oil. A key driver of inflation in the 70’s was the wild surge of oil prices, from $2 a barrel to $32 a barrel over the course of the decade. That’s a 16-fold increase, which in today’s terms, would mean oil skyrocketing from the comfortable $40 to $60 range (for argument’s sake) to at least $640 a barrel. This is unlikely.

Since the 1970s, there have been ‘supply shock prevention measures’ put in place that arguably would not allow such a massive increase over a short period of time. OPEC is one of them, and there has also been a shale boom here in the U.S. that has vaulted us to being the world’s top producer. Oil prices remain volatile, of course, but compared to the 1970s prices should largely be viewed as stable.

Consumers are also in a better position today to weather slightly higher prices. Wages are on the rise, there are more available jobs than there are people looking for work, and we spend less overall on energy – in the 1970s, for instance, gasoline made up 6% of spending, compared to 2% today.

The second key reason is the supply side of the equation. The 1970s was known for supply constraints, which gave rise to demand “chasing too few goods.” A lot has changed since then. One of the biggest factors is a surge in global trade, particularly as China has become the biggest export economy in the world. Supply of goods has not been a problem since, except for in the current moment driven by the Covid-19 pandemic. The argument for a return to 1970s inflation implies that current supply issues are set to become permanent or semi-permanent, which I do not believe to be the case. Today’s supply chain bottlenecks are not a result of a global economy unwinding, but rather a product of rolling economic closures and restrictions being met with a drastic shift in demand for goods (versus services). It’s only a matter of time, in my view, before these issues are resolved and price pressures ease.

Finally, there is the question of stagflation. For readers who are not familiar, stagflation refers to the economic condition of high inflation and low or negative growth. When inflation runs higher than growth, the ‘real’ growth rate of the economy turns negative, which of course is a bad outcome. But I think these worries focus too much on a small data set (2021’s summer months), and are not taking into account the possibility – or in my view, the likelihood – that the global economy will continue to press ahead with growth while inflation wanes over time.

Bottom Line for Investors

Any time economic conditions are flashing warnings signals – high inflation, low wage growth, weak jobs markets, etc. – the comparisons to darker economic times tend to emerge in full force. Higher- and longer-than-expected inflation today is drawing comparisons to the 1970s, when inflation was rampant and the Federal Reserve drastically engaged in a monetary tightening cycle that culminated in a 20% fed funds rate. Oil prices rose 16-fold, and supply constraints abound.

We’re not seeing these types of outcomes today – the jobs market is very tight, wages are rising, prices are rising but largely in response to too much demand bumping up against temporary supply chain issues. The Federal Reserve may raise the fed funds rate in 2022, but basically off the zero bound (not up to 20%). Point is, comparisons to times like the 1970s tend to garner a lot of attention and media buzz, but the economic conditions and fundamentals simply don’t line up.

Disclosure

1 BlackRock, November 30, 2021. https://www.blackrock.com/us/individual/insights/comparing-todays-markets-with-the-1970s

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