Why You Probably Don’t Need to Worry About 1970s Stagflation
TWide-lapels, disco, Watergate and wide-lapels were all part of the Seventies. Also, middle-class suburbanization and stagflation (a toxic mix of stagnant growth and high prices) are some of its most notable features. Two things were particularly indicative of stagflation. The sudden oil supply shocks after OPEC embargoed Western nations over their support for Israel following the 1973 October (Yom Kippur) War, and a U.S. Federal Reserve too slow to respond.
It seems that the Seventies have suddenly become relevant again. And not in a good manner. Due to rising oil prices and the delayed response of the Federal Reserve to inflation which has been at or above 7% for several months, many people are worried we may be heading back to the Seventies. “Stagflation,” quipped one investor among many, “is coming.” Others have concluded that the cake is, as they say, already baked: “Stagflation is here. Is Recession Next?”
The headlines and comments suggest that there is a clear answer. Perhaps. But as much of the present has echoes of what unfolded fifty years ago, we shouldn’t be so quick to draw lines between then and now. The similarities between oil, rising interest rates and slower economic growth can’t be denied. There are four factors that make up an economy, but no one economy has the same structure as the other. Today’s world is different from what it was in the 1970s. While history is a useful guide, it rarely serves as a model.
It is obvious that the case for why now is the redux of when is strong: Despite a solid 2021, economic growth in the U.S. (GDP), looks weak during the first month of the year. Consumer budgets will be hit hard by rising fuel and gas prices, which can also impact the company’s profitability. For companies that grew during the epidemic, the prospect of rising interest rates has caused a severe stock market correction. The west’s economic retaliation for Russia’s invasion of Ukraine is adding another layer to the global instability.
It adds uncertainty to the situation, and it casts doubt on many notions of how the world works. Although Russian naked aggression does not contradict its previous behavior, Western countries reacted with economic sanctions against Russia. This was largely unprecedented in modern times.
Russia is vulnerable to severe economic recession that could wipe out 25% of its GDP. However, this economic retaliation will likely plunge Russia into an economic crisis. Russia’s GDP ranks 11th in the world. Most of its oil production is concentrated there, making it less than Texas, home to five times as many people. Russia is the world’s largest exporter of oil, with 7,000,000 barrels per day. However, the U.S. only imports about 600,000.
During gas shortages in Long Beach (California), vehicles line up to get gasoline at a service station.
Getty Images/Bob Riha, Jr.
In the 1970s, however, OPEC controlled nearly 60% of the world oil supply, compared to Russia’s 10% today, and the 1973 embargo saw the price of oil QuartupleIt took only a few weeks to increase, as opposed to the 25% gain in the past weeks following the Ukraine invasion. In 1973-1974 the energy shock, which was followed by supply shocks over the following years, were orders of magnitude more than what Russia represents today.
Although Russia’s economy will be severely affected by Western sanctions, the impact of Western economic sanctions on Russia is not as severe as the global embargo against OPEC in 1970s.
These commodities trader markets are naturally volatile given the abrupt disruptions, as well as lack of clarity over duration and impact. But that volatility is likely to fade once the world adjusts (outside of close to 100 million barrels worldwide) to the loss of oil from Russia. Although it will take longer to recover from the losses of Russian nickel and wheat, natural gas will be less severe than expected. However, the last four weeks have shown that the adverse effects are not as serious as we thought. Both equity and commodity markets stabilized last week after weeks of volatility. Oil dropped below $100 per barrel, and equities recorded their highest week since 2020. There may be more volatility in the future, but this suggests that markets can deal with worse-case scenarios for the moment and have ruled them out.
The intensity of inflation has rattled many, but even today’s elevated levels are mild compared to the stagflation years. From the mid-1970s to 1980, inflation was in double-digits. It reached 14.5% during the 1980 summer. For all 2021, the annual U.S. inflation rate was 4.7%. This has been increasing in the last few months with monthly readings above 7% but still far below the levels of the stagflation decades. The unemployment rate was higher back then than it is now. Interest rates reached double-digits with 30-year mortgages reaching 11.2% at the end 1979. This made even moderately priced houses difficult to buy for middle class families.
These numbers could rapidly shift and begin to resemble the 1970s. Certainly. However, the relative strength not only of the U.S. but also major European economies speaks against this. Since COIVD-19, governments have injected trillions into the economy. This has resulted in consumers with less debt and higher incomes. But inflation continues to degrade those gains. Today’s COVID spending has resulted in governments having more debt than ever. However, rates are still historically low. In fact, they remain incredibly low. That means that the interest required to service this debt is lower than in the 1980s.
Ukraine has a profound effect on the market mood and affects people’s perceptions of the future. But the tragic events in Ukraine are not enough to cause an economic crisis elsewhere. Although the Russian economic collapse was unexpected, the relative insignificance of Russia as an economic power has allowed Western companies and nations to respond with such force.
Economically, things could get even worse. These risks are more apparent now. This is why we feel that the Seventies may return. However, there is still a lot of work to do before reality becomes the Seventies. Even though it is getting worse, we can be certain that disco and leisure suits will remain in the past.
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