Shortages, Stagflation and Monetary System Shocks
How Todays Market Mirrors that of the 1970-1982 Bear Market and How to Position Capital in a Highly Inflationary Environment
Introduction
“We are looking to see quite clear restraint in the bargaining process because otherwise, it will get out of control…I’m not saying nobody gets a pay rise, don’t get me wrong, but I think, what I’m saying is, we do need to see restraint in pay bargaining.” – Bank of England Governor Andrew Bailey February 4th, 2022
“I am today ordering a freeze on all prices and wages throughout the United States” – President Richard Nixon August 15th, 1971
As a child I used to have uncomfortably vivid dreams. I dreamt of any and all things that felt so real to me in my dream that even a slight variation of the same experience in reality gave me an uncomfortable feeling of Déjà vu. I remember as a kid furiously searching the internet to figure out if it was commonplace for dreams and reality to overlap in such a tangible way. Though these were merely the curiosities of a child I find myself in a similar situation today as it relates to financial markets. I am a historian by trade and as a result have gone into depth on many periods of American and World history both in my time as an investment professional and for the decade leading up to my current ventures.
As any prudent investor might do when trying to get a handle of where we are in markets, a look to the past is a good place to start. I began by comparing the facts on the ground today in real time and asking questions like, when else have markets behaved like today? What was the result? What industries were hindered? Which were advantaged? Finding useful answers to these questions can be instructive for navigating the major macro forces that overhang global markets at any and all times.
What I found has given me one of the strangest feelings of déjà vu that I have not experienced since I was a boy. The market today is so eerily similar to the set up of the 1970s that it simply cannot be ignored. The overlap between the political realities of trade and the fight for Federal Reserve independence clashing with the desires of the sitting President, the stickiness of inflation and the price controls used to temper it, the shortages rising in a number of inelastic and critical commodities that drive prosperity in our modern society, all the way down to the day to day narrative of investor sentiment and one decision buyers.
If we believe, as Mark Twain famously espoused, that history has a tendency to rhyme, the overlap between the 1970s and today cannot be chalked up to mere coincidence and investors would be wise to tread cautiously. If one stops to think about why historical realities so often remerge throughout time, the main culprit is thousands of years of human adaptation centered around survival first and societal cohesion second. It makes sense through a biological lens that we would share similar experiences with our ancestors from only a few decades ago. If our innate fear of the dark remains as engrained today as it was a thousand years ago, and we know how poor financial memory happens to be in humans, would it not be possible that we could contrive a scenario where the facts of the 1970s reappear a mere 40 years later?
While it is fun for academic purposes to understand the facts of past market crashes and sound the alarm for the sake of drama, in order to add investment value for you, our readers, we will provide you with concrete examples that we hope will allow you to protect and grow your families wealth in what is shaping up to be precarious times. The main themes we will cover are those of Inflation, Monetary Systems & Trade, Oil & Commodity Markets and overlap in Stock Market Sentiment. We hope that in reading this rather provocative piece that rather than frightening or disturbing our readers, this instead empowers a pivot toward independent, rational decision making as opposed to the broader markets solution of focusing on only the next tree in front of them rather than the vast forest rapidly changing into a cliff before our eyes.
Inflation
“The greatest danger in times of turbulence is not the turbulence; it is to act with yesterday’s logic.”- Arthur Burns Fed Chairman
1970s
The decade of 1970-1980 will forever be associated with cataclysmic inflation and eventual stagflation. In order to understand the inflationary pressures that overwhelmed the US in the decade it is important to understand Arthur Burns who was the Chairman of the Federal Reserve. It was a consensus opinion in Burn’s years of service that keeping 4% unemployment was the main focus of the Fed and that to keep inflation at say, 2% was not a job to be done by the Fed and monetary policy alone but instead should be done in conjunction with “incomes policy” which was just a fancy word for price controls.
To posit that the Fed of Burns day and the Fed of today have the same goals is to miss the cultural and political nuance between the two periods. It was Burn’s belief that monetary policy would be influenced through the credit markets and also held the belief that inflation was not simply a monetary phenomenon but that many outside influences like unions and large corporations with monopoly power could drive inflationary pressures. When inflation rose by double digits in 1973 Burn’s blamed “special factors” or transitory phenomena like poor harvests increasing food prices or restrictions on oil production growth from the declining US conventional industry as the culprits. The issue with Burn’s view is that in the following year when these inflationary pressures were further exacerbated he had to change the blame to a new one-off event which were government deficits that were actually smaller in 1974 than 1973 but to justify Burn’s belief he juiced the figures by adding in government-sponsored lending programs to make deficits look larger than they were.
Inflationary was not transitory or a “one-off” then, just as it was not in the post Covid-19 world much to the chagrin of fiscal system thought leaders around the world. The fact was then as it is now that inflationary pressures are structural and though isolated incidents might bring out the need for price increases, it takes years of underinvestment and increasing demand that is often glossed over with an eventual shock to “wake” the market up to the “overnight” deficit.
Underpinning Burn’s belief in the structural forces of inflation dated back to the 1930s Great Depression and the rush from the government to become involved in the day-to-day happenings of the US citizenry. Burn’s explains that Americans historically had a deep faith in the concept of progress that was underpinned by the belief in self-sufficiency and that while it was prudent to prepare for hard times, that this fell to the individual level with the government being a peripheral entity in the eyes of most Americans. Individualism was shattered, Burn’s contends in the 1930-1940s when unemployment rose to a quarter of the labor force and moral stamina declined, New Deal Federal Government interventionism through programs like public construction projects helped pull the country from the depths of the Depression. The argument from Burn’s is that this was never reversed, and that government intervention has grown too much in the years that followed – an opinion we do not disagree with.
Stagflation