While the surge in energy prices has some likening the inflationary environment to the 1970s-80s, some observers think the postwar period is a better comparison. Here, pricey per-gallon costs on gasoline at Chicago station.
Scott Olson/Getty Images
As prices across the economy rise, economists and investors are increasingly worried a repeat of the 1970s and 1980s is under way. One Wall Street strategist says it’s the wrong comparison, with implications for policy and markets.
In his latest outlook report for clients, Guggenheim chief investment officer Scott Minerd argues that comparisons of today’s inflationary environment to the Great Inflation of the ’70s and ’80s are off base. While the rise in inflation during that era does invite comparisons to today, Minerd says its root causes—including funding the Vietnam War and the Great Society, delinking the dollar from gold, and an energy crisis—were a decidedly different set of circumstances. The more appropriate corollary from history, says Minerd, is the post-World War II era, where inflation resulted from manufacturing disruptions, rebounding demand for consumer goods, high levels of savings, and soaring money growth.
The distinction is about more than historical trivia. It’s something of a defense of “transitory” inflation, well after most of Wall Street and the Federal Reserve abandoned the term policy makers and many economists had used to argue that pricing pressure was the result of fleeting pandemic supply imbalances. It’s also an argument for policy makers to adopt a newfound faith in the power of markets to set prices and balance supply and demand, a faith Minerd says central bankers lost after the financial crisis of 2007-08.
Going back to the post-WWII era, Minerd says the monetary policy takeaway from the 1946-48 episode is that much of the supply-demand imbalance was caused by the virtual cessation of production of consumer durables, not unlike what happened at the onset of the pandemic. About a year after the war ended, the consumer price index was running at a 3.1% year-over-year rate and peaked 9 months later at 20.1%. He says that spike followed a period of explosive growth in the monetary base—essentially all currency 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 grown 100%.)
“The rise in the monetary base and the Fed’s balance sheet during wartime was to be expected, not unlike the growth in money supply and [quantitative easing, or large-scale asset purchases] during the present-day pandemic response,” Minerd says.
In the postwar 1940s, pent-up demand subsided and supply returned as prices rose and spurred production. Minerd points to one overlooked key factor in market forces working: The Fed in 1947 ended wartime peg on the short-term rates of Treasury bills, letting markets determine those rates. That was possible, he says, because the monetary policy prescriptions of the postwar Fed were 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 and mild recession followed, from November 1948 to October 1949. Stocks entered a brief bear market but resumed their rise in mid-1949.
Policy makers today would be wise to look back to post-WWII monetary policy, Minerd says, in contrast with attempts to contain inflation in the 1970s that were focused on targeting short-term rates. Instead, he says, they should focus on limiting credit creation through controlling the Fed balance sheet and the money supply.
With the Fed’s tightening cycle now under way, Minerd says the risk of a serious economic downturn, along with heightened market volatility and a potential financial crisis, is high given record corporate leverage, high stock valuations and surging prices in real estate and speculative assets. A “rational and disciplined approach adhering to monetary orthodoxy” a la the 1940s would reduce the risk of a policy error this time while avoiding the inflation spiral of the 1970s, he says.
Write to Lisa Beilfuss at [email protected]
