Worse Than 1973

Worse Than 1973

March 6, 2008

(this appeared in the Daily Reckoning on March 6, 2008)


When I tell people that the present situation resembles the 1970s, they immediately think of July 1979, when Jimmy Carter gave his famous “malaise” speech on national TV. The stock market had been dead for six years, and blue chip U.S. stocks had price-earnings multiples in the single digits. The CPI was rising at double-digit rates, and interest rates were galloping higher to keep up.

“It’s not that bad,” people say today. But I’m not thinking of 1979, I’m thinking of 1973. And it’s true, it’s “not that bad.” It’s worse.

Where are we on the dollar devaluation timeline today, compared to the 1970s? In the 1950s and 1960s, the dollar was pegged to gold at $35/oz. In the 1980s and 1990s, the dollar floated, but its value stayed fairly stable around $350/oz. In 1971, the dollar’s link to gold was destroyed, and the dollar devaluation began. In May of 1973, it hit $95/oz for the first time. This roughly equivalent to where we are today, having gone from $350/oz. to about $950/oz. When Jimmy Carter was making his speech, the dollar was in its last great collapse, to a nadir of 1/850th oz. of gold just seven months later. The equivalent today would be a move to $8,500/oz. of gold.

The S&P 500 peaked in January 1973, so mid-May 1973 was about five months after the peak. This was the start of the horrible 1973-1974 bear market. The S&P 500 most recently peaked in October 2007, so mid-March 2008 is about five months after that peak.

However, we seem to have diverged quite a bit from the 1973 script. Arthur Burns, the Fed’s Chairman in 1973, might be nicknamed “Easy Art” today for his efforts to get the economy going again in 1971. His cheap-money, low interest-rate policies started the trend of 1970s devaluation. However, by May 1973, he was already getting nervous. Commodity prices were soaring, and the dollar’s value kept sinking against gold. The economy was roaring. The Fed funds rate ended 1972 around 5.3%, but by May 1973 it was already up to 7.84%. In July 1973, it averaged 10.40%. It was primarily this increase in interest rates – an effort by a hawkish Fed to stop the devaluation trend – that led to the breakdown of the stock market. Combined with the inflation, the economy crumbled soon after.

It is safe to say that the Fed will not be at 10%+ in a couple months. The ECB was recently termed “ultra-hawkish” in the U.K.’s Telegraph newspaper, for a policy of keeping a 4.0% rate unchanged. Today’s breakdown in credit markets, caused by a lending binge that did not exist in the early 1970s, has effectively eliminated any chance of serious inflation-fighting activity.

Ah, the bulls say, but certainly that is a positive, no? The Fed is expected to cut rates further. The two-year U.S. Treasury bill yields less than 2.0%. The deteriorating economy is expected to put a lid on inflation.

But in economics, two wrongs don’t make a right. With Ben Bernanke pouring gasoline on the dollar pyre in an effort to warm up “frozen” debt markets, the inflation in coming years may well exceed that of the 1970s. People may look back on the 11.2% increase in the official CPI in July 1979, from a year earlier, and laugh that such a wimpy figure could be considered “malaise.” On top of that, the credit breakdown and housing collapse will do whatever additional damage they have left to do. Most people didn’t even have credit cards in the early 1970s, much less a debit card that makes withdrawals from 401(k) plans.

The Fed’s lower interest rates haven’t helped the situation much. But then, today’s problems were not caused by rates that were too high. Were lower rates ever really the point? The dollar’s slide may not be just an unfortunate side effect, but the real goal of the Fed’s easy policy. You could argue that, today or in the 1930s, a devaluation would have made debts easier to pay back, by inflating workers’ salaries and other prices. Ben Bernanke himself has made this argument, in a coy way. Unfortunately, the Fed is finding that today’s credit-collapse recession is indeed “putting a lid on inflation” – namely a rise in wages – while inflation of household expenses continues unabated. The resulting squeeze on household budgets has made debt service even more unlikely. Whoops!
If there’s a lesson to be learned from the 1970s, it is that even a hawkish Fed and 10%+ interest rates are not a reliable solution to currency decline. Neither Easy Art nor Hawkish Art produced a healthy economy. The real problem, in the 1970s, was that the dollar left its golden anchor. The real problem, today, is that it never went back.

The credit collapse recession is grabbing all the headlines now, but in six years, when Barack Obama appears on TV wearing a sweater, with a new batch of government solutions to the $600/barrel oil price, will we even care? By that time, I think people will be ready to do what should have been done many years ag repeg the dollar to gold. No more of this floating currency, inflation/devaluation, Fed manipulation nonsense.