The Parallels Between Today's Economic Climate and The Great Inflation of the 1970s
Having worked on Harold Wilson’s policy unit from 1974-76 and then as an economic advisor to James Callaghan from 1976-79, he is extremely knowledgeable on the issue and offered some invaluable insights. Davies was also the Chief Economist at Goldman Sachs, Chairman of the BBC, Co-Founder of Active Partners and is now chairman of Fulcrum Asset Management. He’s also an active writer for the FT and Guardian.
Recent CPI statistics demonstrate the necessity of retiring the word ‘transitory’. The January CPI report from the UK displayed an annual increase of 5.5% and is expected to climb past 7%. While more recently, the US February CPI was up a staggering 7.9% YoY. During the 70s, the UK and US experienced massive price rises, reaching as high as 25% and 13.3% respectively. Although Davies does not think the current economic environment will result in the same inflationary spiral seen in the 70s and 80s, he described it as having “many of the same components” (one of which being the elevated energy prices).
AVERAGE CPI INFLATION (US AND UK)
The oil market in the 70s experienced a series of shocks, with the first being from 1973-74 caused by Arab oil producers imposing an embargo in response to the West showing support to Israel during the Yom Kippur War against Egypt. By the end of the embargo in March 1974, the price of oil had jumped almost 300%, with the crude price rising from $3 a barrel to $12 by 1974. From 1973-74, the average dollar per gallon of petrol increased from $0.39 to $0.59, a 51% increase. The second oil shock occurred after the 1978-79 Iranian revolution, the turmoil caused a significant decline in production of oil, triggering shortages and a surge in panic buying. Within 12 months, the price per barrel doubled to $39.50, further adding to inflationary pressures. Not only have we seen elevated oil prices throughout last year, but the geopolitical tension moving into 2022 is further exacerbating the upside risk we see in the oil market today.
AVERAGE OIL PRICE (USD PER BARREL)
The price of brent crude is currently sitting at $100 a barrel, as of March 16th. This is down from its recent peak of $128 a barrel, which was caused by the US and UK imposing embargoes on Russian oil. Oil prices have been rising since their pandemic induced lows of 2020, this has been a major contributor to inflation. Widespread vaccination rates in the largest oil consuming countries have led to a strong recovery in almost all oil products. On February 2nd, OPEC+ agreed to maintain moderate rises in oil output, even amidst pressure from major oil consuming nations to increase supply. The cartel has also been struggling to meet its supply objectives; production in December was 790,000 barrels a day below target. Years of underinvestment in Nigeria and Angola have led to the nations missing their targets by 450,000 and 250,000 b/d respectively.
BRENT CRUDE PRICE 2022 (USD PER BARREL)
Jeff Currie, Goldman Sachs’ global head of commodities research, explained that he sees underinvestment in oil production (while demand has been surging) as a large factor in driving up oil prices. Even before the embargoes on Russian oil from the UK and US, Currie saw the financial sanctions levied on Russia by the west as bullish for the commodity: “the sanctions on capital flows, particularly the banks in Russia will make it difficult to invest further, reinforcing this underinvestment thesis”. Ben Broadbent, Deputy Governor of the Bank of England, said the surge in energy prices was likely to be twice as big in 2022 as in any year in the 1970s.
WATCH: GAVYN DAVIES EXPLAINS WHY INFLATION IN 2022 ISN’T COMPARABLE TO THE 1970S
In the Money Maze Podcast episode, Davies also discussed the parallels in the large-scale expansionary fiscal policy between the two periods. During the period of 1965-73 alone, the US government spent $120bn on the Vietnam war while also expanding social welfare spending. In an attempt to maintain power, the Nixon administration pressured the Federal Reserve to lower interest rates in order to create an artificially strong economy, just in time for re-election. In 1972 the UK government floated the pound, exposing the nation to import inflationary risk (this was while the government was spending generously on policies to reduce unemployment). Monetary policy was given no targets for either the money supply or inflation; interest rates were held at levels accommodative to growth and falling unemployment. The combined forces of government spending and loose monetary conditions were a recipe for double digit inflation in the US and UK. There is concern that pandemic-induced government spending programmes and loose monetary conditions could also be sparking a period of high inflation.
Davies’ description of the recent levels of fiscal stimulus as “unprecedented” is more than warranted. Central banks have been carrying out the biggest quantitative easing programmes in history. The UK Parliament estimates the total pay-out from tackling the Covid-19 pandemic is in the range of £315bn-£410bn, while pandemic related government spending in the US is said to be as high as $3.6tn. The large-scale QE from central banks has led to massive increases in the supply of their respective currencies. For example, the Wall Street Journal reported the Fed’s aggressive asset purchasing scheme led to an additional $5.5tn in circulation over December 2019-August 2021, a 35.7% increase. During the onset of the pandemic, the cash injections which kept many businesses from closure and many employees from keeping their jobs, unarguably prevented a major recession. However, when assessing the continued asset purchasing from central banks, some economists believe the programmes are destroying the value of currencies and are creating a risk of periods of ‘stagflation’.
The recent geopolitical volatility in markets will lead a much tougher policy-making process for central banks. On the one hand, the goal of a central bank is to control inflation, and with the Russian invasion of Ukraine likely to be inflationary, interest rate rises may be needed to tame spiralling price levels. However, central banks are also concerned with economic growth and therefore are faced with a tight balancing act in which they must weigh up the risks of dovish policy leading to continued inflation, with rate hikes tipping economies into recessions.
Federal Reserve Chairman Jerome Powell announced at a press conference which followed the recent Federal Open Market Committee meeting, the that the central bank would raise interest rates by 25 basis points, the first increase since 2018. Powell also noted that the move would likely be followed by further rate hikes at subsequent meetings, the committee “anticipates that ongoing increases in the target range for the federal funds rate will be appropriate”, he said. The decision reflects the more hawkish stance the Fed is taking, Simona Mocuta, Chief Economist at State Street Global Advisors, believes the series of rate rises discussed in the statement could have adverse effects on economic growth. “I think the Fed is too aggressive here”, she told CNBC, “How the economy evolves is highly uncertain. They may not come to pass, but certainly the Fed delivered a very strong message. ... I’m still sceptical we’ll get all these rate hikes,”
The Bank of England is poised to gradually tighten monetary conditions this year. Dave Ramsden, a deputy governor of the BoE, recently spoke at the annual National Farmers’ Union conference. He said inflation can be kept under control with only a “modest tightening” of policy over the coming months. The central bank begun a passive tightening process in which they will no longer reinvest the proceeds of its government debt upon maturity.
There are many parallels between today’s economic climate and that of the 1970s. But is today’s situation as dire as the period running up to the great inflation? The counter-inflation framework which was developed in the latter part of the 20th century is considerably stronger and less vulnerable to political cycles than that of the 70s. Although many economists believe central banks have been too late in adjusting policy, they have been much quicker than in the 1970s in which the inflation threat was overlooked for many years. The inflation we will experience going into the short-medium term will probably continue be uncomfortable, however, is it unlikely we will see price rises akin to those of the 1970s.
By Ben Staunton, a member of the 2022 Money Maze Podcast Ambassador Programme. Ben is studying A-level Maths at Collingham College with the aim of reading economics at university. He is particularly interested in how technology can improve the business environment. Find him on LinkedIn here.
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