Jeremy Strickler
jeremy@wwmgreenville.com

This is not the 1970’s

(but there are echoes)

 

TLDR

  • Some economists are afraid of long term high inflation like we experienced in the 1970’s.
  • They believe it will take a bad recession to get inflation under control.
  • It’s hard to see through to the end of the process, given covid policy in China, the war in Ukraine, and unruly domestic politics.
  • However, we don’t see the scenario as so dire, and we expect the US to weather the storm with slowing growth or possibly a mild recession.
  • We can see reasons that people feel anxious: volatile markets, the war in Ukraine, China’s autocratic turn,  the political situation in the US.
  • However, we think the feelings are worse than the data, and everyone should remain grounded in the real world by spending time with family and friends and providing practical care to those nearest to us.

The current debate in the US markets is between two camps:

  • One group thinks that inflation is coming under control quickly, and this means that the Federal Reserve may not have to raise interest rates too much further or engineer a recession in order to get inflation under control. These people think the markets represent good value at current prices.
  • The other group believes that the federal reserve must act very decisively and that rates will need to go higher. They are very concerned that if we do not get inflation under control quickly, that higher inflation will become an imbedded assumption, a self-perpetuating condition. They believe a recession is unavoidable, and they tend to think both stock and bond prices are too high, and that economic forecasts are too rosy.

And that’s what makes a market. There are intelligent, experienced people in both camps. From our point of view, inflation is headed in the right direction with oil prices down pretty consistently over the past two months, with some retailers cutting prices, the housing market stalling, and with the prospect of some layoffs on the horizon.

We also think the market is not really discounting the possibility of rates going much higher, and so it might be a little ahead of itself at this point.

We don’t think the economy is all that bad after 2nd quarter earnings came in. If this is a recession, it’s a pretty weird one, with so many new hires and with corporate earnings mostly holding up.

There are a few reasons why we think this is not like the 1970’s, and why we should not need to engineer a Bad Recession to get inflation under control:

  • The currency is quite strong.  In the 1970’s, inflation was an oil supply problem, but inflation was very much a monetary phenomenon.
    • The Nixon shock : European countries began insisting that they be able to make good on the dollar’s gold backing, asking for gold rather than dollars in payment. This quickly became unsustainable, and the US moved off the gold standard in 1971, effectively ending the Bretton Woods paradigm. This was both necessary, and painful, because the old system subsidized American consumption, basically by making everyone buy dollars that we got to print. Good system! Hey, you win the war, you make the rules. It was good while it lasted.
    • The administration imposed tariffs on imported goods.
    • Nixon imposed wage and price controls.
    • Loose monetary policy financed large US budget deficits. The money supply grew too fast.  
    • (In this way, the current situation is an echo of the 70’s scenario. US budget deficits were too large in 2020 and 2021, much too large. The government and the Fed over-reacted to covid. However, growth and employment also recovered quickly.)
    • In the 70’s The US dollar lost about 50% of its value vs the German Deutschmark, about 37% vs the Yen, about 56% vs the Swiss Franc—you get the point.
    • If we consistently lose purchasing power in the currency, eventually we’re going to have to pay much higher interest rates to creditors to borrow money.

This is not the case today. The US Dollar is beating the pants off most assets in 2022 as we raise interest rates.

  • The banks are well capitalized now, and recently passed stress tests. This might be more a reason that this scenario is not likely a repeat of the financial crisis of 2008-2009.
  • The US has a great deal of control over energy production. This is one reason the US in a relatively better position right now than Europe, the UK, Japan or China – all the other major economic centers.

 

    • In the 1970s, US oil production began to stagnate and decline, with production peaking in November 1970 at 10,044 barrels, per the US Energy Information Administration.
    • We did not see that same level of production again until November 2017!
    • However, US oil demand grew from about 15 million barrels per day to about 19 million BPD from 1970-1980.
    • Production in the US began to grow rapidly in 2011, and we are again nearing peak production hit in 2020.
    • In 2020 and 2021, net petroleum exports and imports were almost balanced. We actually had net exports both years. We import about 3 million barrels of crude more than we produce.

 

This is a subject that gets much politicized, but energy in the US is an asset, not a liability. Oil production fell after 2020, because– if you recall –oil was ZERO dollars per barrel for parts of that year, and with zero dollar oil, banks don’t finance new wells.

 

    • Tax receipts are higher
    • Spending decreased from the Covid years
    • The budget deficit for 2022 is still a bit too high, expected to be about $1 trillion—or between 4- 5% of GDP, where we might like to see it between 2-3% of GDP.
    • The Federal Reserve bank of Dallas, doesn’t believe we’re in a recession and forecasts growth for the year, despite two mildly negative GDP quarters to start the year.

Jeremy L. Strickler, CFP®

Portfolio Manager

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