As prices rise across the economy, economists and investors increasingly fear a repeat of the 1970s and 1980s is underway. A Wall Street strategist says that’s the wrong comparison, with implications for politics and markets.
In his latest client outlook report, Guggenheim chief investment officer Scott Minerd says comparisons between the current inflationary environment and the Great Inflation of the 1970s and 1980s are misguided. Although the rise in inflation at that time invites comparisons with today, Minerd argues that its root causes – including the financing of the Vietnam War and the Great Society, the decoupling of the dollar from gold and an energy crisis – were a decidedly different set of circumstances. The most fitting corollary to history, says Minerd, is the post-World War II era, when inflation resulted from disruptions in manufacturing, rebounding demand for consumer goods, high levels savings and soaring monetary growth.
The distinction goes beyond historical trivialities. It’s sort of a defense of “transitional” inflation, long after most of Wall Street and the Federal Reserve dropped the term policymakers and many economists used to argue that pressure on price was the result of fleeting pandemic supply imbalances. It’s also an argument for policymakers to embrace a newfound faith in the power of markets to set prices and balance supply and demand, a faith that central bankers lost after the 2007-08 financial crisis.
Returning to the post-war period, Minerd says the monetary policy takeaway from the 1946-48 episode is that much of the imbalance in supply and demand was caused by the virtual shutdown of production. durable consumer goods, much like what happened at the start of the pandemic. About a year after the end of the war, the consumer price index reached a rate of 3.1% year-on-year and peaked 9 months later at 20.1%. He says this spike followed a period of explosive growth in the monetary base – essentially all currencies in circulation and on bank balance sheets – as well as rapid growth in the Fed’s balance sheet, which grew 300% from $6.2 billion in 1942 to $24.5 billion in 1945. (Since the start of the pandemic, the amount of securities on the Fed’s balance sheet has increased by 100%.)
“The rise in the monetary base and the Fed’s wartime balance sheet was predictable, much like the growth in the money supply and [quantitative easing, or large-scale asset purchases] during the current pandemic response,” says Minerd.
In the post-war 1940s, pent-up demand diminished and supply returned as prices rose and stimulated production. Minerd points to a key overlooked factor in the workings of market forces: In 1947, the Fed ended the wartime peg to short-term Treasury bill rates, leaving markets to determine those rates. This was possible, he says, because the Fed’s postwar monetary policy prescriptions focused on the supply of money and credit, as opposed to the price of money and credit. As a result, the yield curve flattened and credit conditions tightened. A brief, mild recession followed, from November 1948 to October 1949. Stocks entered a brief bear market but resumed their rise in mid-1949.
Policymakers today would be wise to revert to post-war monetary policy, Minerd says, unlike attempts to contain inflation in the 1970s that focused on targeting short-term rates. Instead, he says, they should focus on limiting credit creation by controlling the Fed’s balance sheet and the money supply.
With the Fed’s tightening cycle underway, Minerd says the risk of a severe economic slowdown, as well as increased market volatility and a potential financial crisis, is high given record high debt levels. companies, high stock market valuations and soaring prices for real estate and speculative assets. A “rational and disciplined approach adhering to monetary orthodoxy” as in the 1940s would reduce the risk of policy error this time while avoiding the inflationary spiral of the 1970s, he says.
Write to Lisa Beilfuss at [email protected]