There is no correct answer to this question - other than that before 1973, none of it! - as it is impossible to separate out effects of the two oil shocks from the underlying structurally higher inflation that related to the mid-60s fiscal and monetary policy error. So, here is a back of the envelope calculation.
But first, why is this question important?
Because, if you listen to governments, you'll believe that the recent sharp rise in inflation is due to covid-related private sector bottlenecks that will soon ease. This is only partly true (isn't this the case with most government communications?)
The more worrying cause is the massive fiscal stimulus of the last two years - some relating to covid, some to Biden - that has yet to be withdrawn/neutralised. As you'll see below, there are parallels with the mid 60s, when fiscal policy error led to high inflation for more than 15 years, exacerbated by two oil shocks. If we can accept there is indeed a parallel, then isolate the effect of the fiscal policy error, we might have a better idea of what the next 10-15 years will look like (spoiler alert: it's not looking great).
The above chart is of the US inflation rate from 1965 to the present day. While inflation rates elsewhere will of course have been different, many countries will have shown a similar pattern, namely of inflation having started to rise in the mid-60s then spiking during the two oil shocks. In other words, the US serves as a good proxy for the purposes of this analysis.
I have placed a dotted line in the chart representing what might have happened to inflation without the two oil shocks. Why did I put the line here?
We know that...
the falling inflation in 1970/71 was due to the 1969/70 recession rather than a fall in the underlying structurally higher inflation that was taking hold from 1965 to 1969;
after the first oil shock, inflation fell to around 6%, an indication that underlying structural inflation was still around;
structurally high inflation sticks around until it is stamped out by monetary authorities. This happened in 1979 when The Fed finally got serious.
So...
From the dotted line of hypothetical year-on-year inflation rates I can back out an underlying consumer price index (CPI). I can then calculate the difference between the actual CPI and the hypothetical CPI, which I know for the purposes of my calculation represents the effect of non-oil shock factors (i.e. policy error) on inflation. From this, I can then also calculate the effect of oil shock factors.
The answer?
43% of the increase in the CPI between 1965 and 1981 was due to the two oil shocks, 57% to other factors (relating to policy error that began in the mid-60s).
I could have drawn the dotted line a bit higher (i.e. attributed less of the inflation to the oil shocks) but I wanted to be conservative. Either way, the majority of the high inflation of the period from 1965 to 1981 was due to fiscal and monetary policy error of the mid 1960s which led to it becoming entrenched (structural) for over a decade.
How can this help us with what is happening today?
Although Inflation has been rising much faster in recent months than it did in 1965-69, a recession (yes, it's coming) would likely cause inflation to fall cyclically. This may well bring long bond yields down: they have already fallen from their highs.
However, if the underlying structural inflation forces relating to the massive fiscal stimulus of the last 2 years - this may prove in time to have been policy error - are still there, any such decline will prove temporary.
There are no such things as straight lines in the world of investing. Negative feedback loops are everywhere. As someone said, the best cure for inflation is...inflation (of the cyclical variety, that is). As mentioned, bond yields are already off their highs and may in the short-ish term fall a fair bit further.
In other words, there may be another chance to position for the bond bear market which, if the experience of half a century ago is anything to go by, could last another decade. Or more.
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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