Continued . . . Recession of 1970: Duration: 11 mos. GDP Decline: 0.6%. Peak Unemployment: 6.1%. 10yr T-Note Beg 7.65% / End 6.84%.
The Fed’s inflation battle worked for the first half of the 1960s. From 1960 to 1965 America’s annual inflation rate averaged 1.32%. Then Congress began to pay down the deficit accrued during the Vietnam War (fiscal tightening). Fiscal tightening (i.e., reduced government spending) means there would be less money in circulation, and what there was would, naturally, cost more to borrow.
Higher interest rates may check incipient inflation, but at the cost of greater unemployment. This is clear in the chart below showing the inflection years of 1969 and 1970. Inflation started this dance in 1969 (increase of 150 basis points year over year). Unemployment and Interest Rates lagged Inflation by one calendar year. In 1970 Unemployment (up 2.6% year over year), and the Beginning of Year 10-year Treasury shot up 175 basis points over the BOY 1969 rate. Inflation went from 6.2% (1969) to 5.6% (1970) to 3.3% (1971), showing the efficacy of the increased interest rate of 1970.
|Year||Unemployment %||10 Yr T-Note %||Inflation %|
Caution to Reader: The chart above is for illustrative purposes. Past performance is no guarantee of future results.
After raising interest rates to deal with inflation, the Fed lowered rates to address unemployment (compare 1970 T-Note rate to 1971 and 1972) and unemployment fell 80 basis points (6.0% minus 5.2%). The unemployment issue resolved. Takeaway: We’ve seen this movie many times: the economy seeks equilibrium. If interest rates are too low, disequilibrium is expressed through inflation: if rates are too high, it is expressed through unemployment rates. For the Fed, it’s a dreadful balancing act. In the Recession of 1970, interest rates required a relatively minor net adjustment of 81 basis points.
After dealing with inflation, the Fed lowered rates (see 1970 T-Note) and unemployment fell 80 basis points (1971 rate less 1972). The unemployment issue resolved. Takeaway: We’ve seen this movie many times: the economy seeks equilibrium. If interest rates are too low, disequilibrium is expressed through inflation: if rates are too high, it is expressed through unemployment rates. For the Fed, it’s a dreadful balancing act. In the Recession of 1970, interest rates required a relatively minor net adjustment of 81 basis points.
Recession of 1973-75: Duration: 16 mos. GDP Decline: 3%. Peak Unemployment: 8.6%. 10yr T-Note Beg 6.73% / End 7.73%.
Based on duration and peak unemployment, this was the deepest economic slump since the Great Depression. It affected more people than any recession since 1938.
The Recession of 1973-75 was the worst possible intersection of two related events: (1) wage / price controls (a political event) exacerbated by (2) a loss of discretionary income (an economic event).
Wage & Price Controls: Executive Order 11615, signed by President Richard M. Nixon on August 15, 1971, placed a 90 day freeze on prices and wages. Following the freeze, wages would have to be approved by a “Pay Board” and prices by a “Price Commission”. The idea was to conveniently lift controls after the 1972 election (which, it turned out, Nixon won by a landslide over George McGovern).
The critical difference between a market based economy (ours, for the most part) and a diktat economy (theirs, for the most part) is pricing feedback from the marketplace. Nixon’s wage and price controls removed pricing information from the discussion. This was a huge disservice to a nominally capitalist economy. Prices were no longer decided by the intersection of supply and demand, but by some apparatchik on a folding chair behind a metal desk. Although initially popular with the electorate, Executive Order 11615 was an economic decision made by a politician hungry for reelection, the worst of all possible beginnings. As noted, it removed pricing feedback from the marketplace, a typical consequence of which is the misallocation of goods and / or services. And, sure enough, things the consumer did not want became abundant and desired objects were no longer to be found.
Discretionary Income: This was the time of the first Oil Embargo. It is oil, its products and by-products – not alimony – that is the lifeblood of an advanced economy. Without oil, the fastest a person can travel on land is at the speed of his horse. Without oil, inland agricultural markets would be necessarily localized, as the farms would have to be close enough to the population centers so products could be delivered by horse and cart and then sold before spoiled. Forget about fresh fruits or vegetables in winter. Without oil, no delicate work could be done after sunset. Petroleum changed all those things and more besides.
In one way or another, the cost of petroleum affects every corner of a modern economy. In 1972 the population of the US was 213,000,000. Before the embargo, the United States imported 811,135,000 barrels of oil (42 gallons per bbl) at a price (Jan, 1973) of $21.72 / bbl. On average, each American consumed the equivalent of 3.8 barrels of oil at an annual cost to of $82.54 in 1973 dollars.
Notwithstanding the oil embargo, by 1975 our annual imports (mostly from non- OPEC sources, but including some OPEC oil delivered through cut-outs) rose to 1,498,181,000 barrels at a price (Jan, 1975) of $52.17 / bbl.
To place this in perspective, our national oil bill went from $1.76 billion (1972) to $7.8 billion (1975) in three years.
That had a disastrous effect on discretionary income: America lost $6 billion dollars. It was a huge economic haircut. Sending all those petrodollars to OPEC had the same effect as a sudden and precipitous increase in interest rates. When you go to your purse expecting to find $6 billion and it’s gone missing it makes no difference who took it, OPEC or the Department of the Treasury: you no longer have it. Less discretionary income means a lower Gross Domestic Product followed by higher unemployment and thence directly to recession.
Executive Order 11615 and OPEC combined into a dog’s breakfast of inflation (things cost more) and recession (fewer people had jobs). This was something previously thought impossible, but it happened. A new word had to be coined: stagflation.
Resolving stagflation is a difficult problem. Steps normally taken to moderate inflation (customarily, increasing interest rates) serve only to worsen economic growth and increase unemployment numbers. Lowering the interest rate boosts growth and decreases unemployment, but can result in higher inflation. Pick your devil. In the end, the Fed lowered interest rates – it was a Hobson’s Choice – and it led to the runaway inflation later in the 1970s.
Takeaway: This was similar to one of Nicholas Taleb’s “black swan” events. .
Recession of 1980: Duration: 6 mos. GDP Decline: 2.2%. Peak Unemployment: 7.8%. 10yr T-Note Beg 10.80% / End 10.25%.
Inflation reached a bit over 11% and the Federal Reserve, not unsurprisingly, raised interest rates to slow money supply growth. When money supply slows so does the economy and – since employment numbers rise and fall with money supply (as reflected in interest rates) – reduced money supply causes unemployment to rise.
One of the causes of the high inflation was the Iranian Revolution of 1979-1980, which sparked a second round of oil price increases, following the increases of 1973-75.
Note: The National Bureau of Economic Research considers the 1980- 82 recessions as two separate events due to a pseudo-recovery between July, 1981, and November, 1982. That is the perspective taken here. The reader should know, however, that some reputable economists see the two recessions linked by both time and agency, and call it a single event separated by a breather.
Recession of 1981-82: Duration: 16 months. GDP Decline: 2.9%. Peak Unemployment: 10.8%. 10yr T-Note Beg 14.28% / End 10.55%.
The 1978-79 regime change in Iran overthrew its US backed government in favor of a theocracy. During this period Iran was the world’s fourth largest oil producer. The new regime exported oil at inconsistent intervals and at lower volumes, creating a shortage in the marketplace and forcing prices higher. Domestically, this caused high unemployment (“impact”) for a long time (the “extent”). Again the US was facing stagflation (a recession with simultaneously high unemployment) and the Fed responded in the manner of 1973-75: with a tighter monetary policy (tighter monetary policy: interest rates increase). The prime rate had to reach an unfathomable 20.5% (1981) before inflation imploded.
Takeaway: Twice now, in 1973-75 and 1981-82 the economy has experienced the black swan of high inflation and simultaneously high unemployment. In each case the issue was resolved by first addressing inflation. And both times it worked. Granted that N=2, but it does appear that when (if) stagflation reoccurs it is likely inflation will again be addressed before unemployment.
This article is for informational purposes only and is not intended as professional advice. Nothing in this article is presented as investment guidance. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker specializing in difficult-to-place mortgages for any kind of property.
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