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Winter of '69

Updated: Aug 3, 2022

"I see little sign of such honesty and humility today which is concerning to say the least."

I shall continue to write about inflation. In relation to both economic growth and financial markets it is and always will be the most important factor. And right now it is a problem.

Recently I came across this paper written in December 1969 by Norman Bowsher at the St Louis Fed, titled 1969 - Battle Against Inflation. There is much we can take away from the paper with respect to the current high inflation.

Some will argue that economies are very different today compared with 50 years ago, so there is little we can learn from such analyses. There are indeed many differences, but they are superficial not fundamental. Moreover, the similarities between inflation, fiscal policy, monetary policy and financial markets back then and now are striking.

The first half of the 60s were benign from an economic perspective. US government expenditures were kept in check and monetary conditions were neither expansive nor restrictive. The inflation rate from 1961-64 averaged just over 1%. Then, things changed.

The paper notes that:

Despite the strong and balanced economic expansion without excesses during the early Sixties, some policy advisers held theories which indicated that the state of the budget was highly depressing to total spending, production, and employment. After a substantial delay, taxes were cut in early 1964, with the objective of keeping the country moving by eliminating the alleged actual or potential “fiscal drag.”

From 1965-1969, government expenditure increased at a rate of 11% per annum. The inflation rate in 1964 had been 1.2%. By 1969 it was 5%.

Fiscal and monetary policies were tightened in 1968 and 1969 which caused a recession in late 1969 and early 1970. Inflation peaked at 6.4% in April 1970 but then fell only gradually, reaching a low of 2.9% in August 1972. However, it did not stay low for long. By the end of 1974 it was over 12%, exacerbated by the 1973 oil crisis. It then averaged 9% for the next 7 years, a period that included another oil shock.

Many attribute the high inflation in the 70s to the two oil shocks. However, these just exacerbated inflation that was already elevated. The inflation genie had been let out of the bottle in the mid 60s and it would not get put back in until the early 80s when Paul Volker showed up on his white horse.

Fast forward...

From 2010 to 2014, government expenditures rose by 1.4% per annum, well within the increase in the capacity of the economy. Inflation during the period averaged just under 2% - widely considered the optimal, comfortable level. Despite the rapid expansion in the Fed's balance sheet in 2008 and 2009, monetary conditions were essentially benign during the period.

From 2015 to 2019, government expenditures increased by 4.3% per annum and inflation began to nudge up above 2% - the increase in government expenditure of 4.3% per annum was above the rate at which the economy's capacity was increasing and was thus inflationary, if only mildly.

Then covid struck and the fiscal weaponry was unleashed - the last two years have seen government expenditure increase at an annualised rate of 22%. While inflation initially fell as a result of the shock, it soon started to rise again, then accelarate to where we are now ie high single digits. Government expenditure in Q4 2021 was still 18% higher than it was in the same quarter two years earlier i.e. pre-covid.

Alongside the covid-related emergency spending, Biden's govenment pushed through a very expansionary budget. It is no wonder inflation has risen sharply. The Russian invasion of Ukraine has also pushed up food and energy prices which have fed through to headline numbers.

Although covid muddies the comparison with the late 60s, I suspect that without it there would still have been politically-driven fiscal excess and therefore that inflation would still have risen if not to where we are now then well above the 2% optimal level. In other words, the similarities with the 60s would have been even more apparent.

The difference compared with today is that in the late 60s, not only was the Fed able to blame publicly the federal government for its fiscal excesses but also the federal government was big enough to admit, again publicly, its mistakes. I see little sign of such honesty and humility today which is concerning to say the least.

There is plenty more interesting material in the paper which I will save for later posts.

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.

© Chimp Investor Ltd

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The similarities are indeed striking. Once significant inflationary pressures have been unleashed, only a recession can contain them. Central Banks maybe independent within the Government, but they are certainly not independent of the Government. For a Central Bank to tighten policy sufficiently to induce a deliberate recession, it requires political approval, and for that it requires society to come to the conclusion that the evils of inflation exceed the evils of unemployment. That is why concerted Central Bank action to contain the inflation of the 1970s was only instituted after the election of Thatcher and Reagan and why it took a decade of high inflation for it to be contained.

Sadly, we are nowhere near a political consensus that the…

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I hadn't thought about your point about the term "cost of living crisis" - a very good one. In that paper, one of the tools at the disposal of a central bank to fight inflation is moral suasion, emploring the public to "forego raising wages and prices". That'll go down like a lead balloon if used, as indeed it has done in recent months.

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