Are We Doomed to Repeat the Economy of the 1970s?

American History

The Economy of the 1970s

2022 began disconcertingly similar to 1970, so are we doomed to repeat the era of disco, stagflation, and a flailing stock market?

For investors with an eye toward the coming decade of the 1970s, there were blue skies on the horizon. American ingenuity and technological prowess, with the help of a brilliant German rocket scientist by the name of Werner von Braun, had just pulled off one of the greatest achievements in the history of mankind: landing humans on a world outside of Earth.

Unemployment was sitting at 3.5% (near where it is now), and the economic engine of the world was notching impressive rates of growth, as measured by US GDP.

Millions of Americans were also flocking to an investment vehicle known as the mutual fund: baskets of (generally) stocks packaged together for easy purchase. While the 401(k) company plan wouldn’t come onto the scene until 1978, money was still flooding into equities as we entered the new decade. Nascent investors were about to get a hard lesson in risk management.

Warning: spoiler alert coming. On 31 December 1969, the Dow Jones Industrial Average finished out the decade of the 1960s at a level of 800. On 31 December 1979, the Dow closed the trading session at 839. An entire decade, and the DJIA had gained all of 39 points! Who could have possibly seen that coming?

Instead of one cataclysmic event, it was a toxic mix of poor fiscal decisions, an easy money policy, and geopolitical turmoil which caused the lost decade.

The cost of living soared in the ‘70s while wages and the stock market flatlined

Dependence on unstable regions to fill energy needs

According to the US Energy Information Administration, a barrel of crude cost just under $3 in 1970. At that time, oil production in the US was peaking around 10 million barrels per day (BPD). Despite that impressive production rate, global demand among non-communist nations had more than doubled in the previous decade, from 19 million BPD to over 40 million BPD, with a Middle East-based group known as OPEC controlling some 55% of the world’s proven reserves. Oil prices remained relatively stable, however, until a military incursion in late 1973 sparked the first major global oil crisis.

On 06 October 1973, during the Jewish holy day of atonement known as Yom Kippur, Egyptian forces attacked Israel from across the Suez Canal while Syrian troops simultaneously invaded the Golan Heights region—an area it had lost during the Third Arab Israeli War in 1967. The attack was cheered on by the other OPEC nation-states. With the help of the United States, however, Israel—led by the most capable General Ariel Sharon—quickly regrouped and took the offensive. By November, a ceasefire had been called. As punishment for supporting Israel, OPEC initiated an oil embargo against the United States, Canada, the United Kingdom, Japan, and the Netherlands. The confusion caused massive gas lines and shortages of fuel in the United States, as well as a quadrupling of oil prices. By the end of the embargo in March of 1974, oil was selling for around $12 per barrel.

Energy prices were a major component of the runaway inflation which epitomized the decade. Americans were suddenly spending an inordinate amount of their income to simply fuel their vehicles, with little left over for discretionary spending and savings. This had a deleterious effect on the American psyche, further reinforcing the decade of gloom.

We have certainly experienced a massive increase in the price of oil and gas over the past few years. The average price at the pump for one gallon of gas more than doubled between the start of 2021 and June of 2022, rising from $2.33 to $5.11 in eighteen months. But that is a far cry from the tenfold increase witnessed in the ‘70s. Furthermore, the United States is now the leading producer of oil and natural gas in the world. Sadly, our refining capabilities are sorely lacking, but the idea of OPEC holding us hostage once again is fanciful—despite the organization’s recent decision to cut production by two million BPD.

Not so much in Europe. To get a feel for what it was like in the United States during the first oil embargo, look no further than Europe’s current energy crisis. An over-reliance on a mercurial madman for oil and gas has created a quite similar condition, with Europeans suddenly paying as much as ten times more to cool their homes as last year. As bad as it was on the continent this past summer, expect it to be worse this winter. Arrogance tends to mute the lessons of the past.

Stagflation

Quite ironically, President Richard Nixon’s 1971 measures to prioritize US economic and jobs growth, and to stem the tide of inflation, led to a wretched condition known as stagflation: a persistently high rate of inflation combined with high unemployment and a stagnant economy. In essence, his government controls only exacerbated the very conditions he was trying to quell.

The three pillars of Nixon’s New Economic Policy were noble: create better jobs in the US, staunch the rising cost of living, and defend the US dollar from global speculators. The goals may have been noble, but the medicine was poisonous.

Tax cuts, which can certainly spur economic activity, also generally lead to higher inflation. To counter this, the president ordered a 90-day freeze on prices and wages—the first wage-price freeze since World War II. Following the 90-day period, increases would have to be approved by a “Pay Board” and a "Price Commission.”

Putting an artificial lid on natural processes can have disastrous results—a lesson communist China still refuses to learn. Nixon’s actions to stem inflation by decree ended up causing scarcity—producers reduced supply and shipped more of their goods to Canada, and shoppers increased demand by gobbling up groceries at the capped prices. This scheme was an unmitigated disaster.

The floating dollar and the WIN debacle

As if wage and price controls weren’t enough, Richard Nixon also ended the gold standard which had been enacted under the Bretton Woods Agreement. Now that the US dollar was no longer pegged to the price of gold (at $35 per ounce), the convertibility of US dollars held by the central banks of foreign into gold was halted. This led to a major devaluation of the dollar as holders rushed for the exits. Ultimately, the greenback dropped in value by one-third over the course of the decade.

With respect to the dollar, there is little comparison between the 1970s and 2022. The dollar, which now finds itself at parity with the euro, is sitting at its strongest levels in two decades thanks to a healthier (than the rest of the world) economy and a Fed intent on controlling inflation with higher rates. While this makes US goods more expensive for foreign buyers, it makes foreign goods—and travel—cheaper for Americans.

Arrogance tends to mute the lessons of the past.

By December of 1974, just four months after Gerald Ford assumed the presidency, inflation in the United States had hit 12.34%. He declared inflation “public enemy number one,” and unveiled a new program called Whip Inflation Now, or WIN.

The cornerstone of WIN was a grassroots appeal for every American to put more away in savings and purchase fewer discretionary items. The new president also pushed for $16 billion in tax cuts to spur economic activity, worked with congress to increase defense spending, and signed ERISA (the Employee Retirement Income Security Act of 1974) into law to encourage workers to save more through company retirement plans.

As one could imagine, Ford’s opponents jumped on the rather hokey name of his program and lambasted his simplistic approach to a complex problem. For all of the lampooning, however, one fact stands out: When Gerald Ford assumed office the rate of inflation in the US was over 12%; by the time Jimmy Carter took over, it was sitting below 5%.

Keynes, a second oil shock, and the Fed

John Maynard Keynes was a British economist of the early 20th century. His theory of macroeconomics, with its emphasis on heavy government intervention, dominated the political landscape of the 1970s and most certainly helped to form the lost decade.

Keynesian economics advocates as much government spending as is needed to spur economic activity, debts and deficits be damned. Although Nixon and Carter, the bookend presidents of the decade, were of different parties, both adopted Keynes’ heavy-handed approach of government control.

When Nixon delinked the dollar from gold, massive deficits would be the inevitable result. If the government could print money with reckless abandon, it is simply a matter of time before runaway inflation enters the scene.

Fiscal responsibility seemed virtually nonexistent in the 1970s—a trend which has continued to the current day. With the US suddenly running perennial deficits, the national debt nearly tripled over the ten-year span.

In addition to a ham-handed government approach, a second oil shock was brought about by the 1978-79 Iranian Revolution. While the relatively small drop in the global oil supply didn’t warrant the move, crude prices more than doubled—from $15 to $37 per barrel— between January of 1979 and February of 1980. Of course, the revolution also gave rise to the 444-day nightmare for 52 American hostages held captive in Tehran. In many ways, this horrendous event fittingly capped the dark decade just passed.

Arguably, the most astute move Jimmy Carter made in the battle against persistent inflation came in July of 1979 with his nomination of Paul A. Volcker to serve as the 12th Chairman of the Federal Reserve. Serving under two presidents (Reagan renominated him in the summer of 1983), Volcker attacked inflation like none of his eleven predecessors.

The treatment was painful: he began a tightening cycle that didn’t stop until the US economy had undergone two recessions (in 1981 and 1982) and the federal funds rate had hit an astronomical 22%! In the end, his bold gambit worked; when Volcker left office in 1987, inflation had been tamed to a 3.4% rate.

Through the prism of the 1970s, the tantrums being thrown over the specter of a possible 5% terminal fed funds rate seem ludicrous. We could control neither the oil shocks of the 1970s nor the global pandemic and geopolitical instability of this decade. We can, however, avoid a repeat of the economically bleak ‘70s by having the courage to do what is needed on a fiscal and monetary level. The current Fed chief seems committed, but do we, as Americans, have the stomach for it?