Inflation – 1970s Vs 2020s – what can we learn?

The latest readings for inflation in the UK, US and Europe are 9.0%, 8.6%, and 8.1% respectively.

The last time inflation was this high in the UK, Margaret Thatcher was the Prime Minister and the likes of the Village People, Bee Gees, and The Police were number one in the charts.

Naturally, those that experienced this period (I’m not one of them) are concerned because on the face of it there seem to be many parallels between the inflationary environment of the 1970s and today.

1970s

Firstly, what is often forgotten is that inflation was already relatively high going into the 1970s. It was around 6% in both the US and UK.

In the early 1970s, following an Arab embargo on oil exports to western nations that provided support to Israel in the Yom Kippur War, oil prices increased by almost 400%. This created a global energy crisis, with shortages of oil across Europe and the US forcing governments to impose restrictions and rationing.

Higher prices created even higher levels of inflation which in turn became a drag on growth. In a policy misstep, central banks cut interest rates to help stimulate their economies and drive growth while putting concerns around inflation to the side.

As prices increased, workers demanded and received, higher wages leading to a wage-price spiral.

By the middle of the 1970s, global inflation had reached double digits and over 20% in the UK.

In the end, central banks were forced to raise rates aggressively to create a severe recession which would eventually bring inflation down to more moderate levels.

2020s

The inflationary pressures we are experiencing today are widely reported and well known. These can be largely attributed to pent-up spending and surging demand following the unlocking of the global economy, a disrupted supply chain which is unable to meet this demand, and the war in Ukraine pushing up global commodity prices.

Though the scenario of increasing inflation followed by a conflict-induced spike in oil prices might seem similar to the 1970s, there are some distinct differences today:

• Leading into this period, inflation has been significantly lower hovering between 1-3% over the last 10 years.
• Central banks have learnt their lesson and understand that a commitment to price stability is essential for good monetary policy. Though slightly slow to react, major central banks have all acted in the opening six months of this year by raising interest rates and tightening monetary policy to combat higher inflation.
• The participation of labour markets in unions has significantly reduced, lessening the bargaining power for higher wages and therefore the chance of a wage-price spiral. In the 1970s, 30% and 50% of the labour force were members of a union in the US and UK respectively, this has now decreased to 10% and 25%.
• There is further downward pressure on wages due to technological advances. These have increased productivity with robotics and artificial intelligence allowing for more automation.
• This year, oil prices have increased by 50-60%, rather than the 400% seen over a matter of months in the 1970s. Despite potential increases in oil prices, global changes in how we generate power and consumption patterns have altered significantly since the 1970s making the economic impact of any further increases in oil prices less of a concern.

What can we learn?

Though the human tendency to use past experiences to help explain what is currently going on can be useful, many take this too far and use past environments to extrapolate and predict what they expect will happen going forwards.

Ultimately, no one can be sure where inflation and the global economy are heading, and we remain open to all scenarios. However, our base case is that although inflation will be higher than the 2% we have become accustomed to, it will moderate towards the end of 2022 and the beginning of 2023. We think this because:

• We are already seeing prices of raw commodities in metals, lumber and some food roll over and fall. Core inflation (which excludes energy and food) has already slowed.
• Central banks have already tightened monetary policy and will continue to do so throughout the remainder of this year. Financial conditions overall have tightened which will be a drag on growth and therefore demand.
• More recent lockdowns in China have been lifted which should allow major supply chains to come back online and help meet demand.
• Large retailers (especially in the US) have amassed excess stock and inventories which will need to be shifted through discounting and lowering prices.
• We are yet to see convincing evidence of a wage-price spiral despite a tight labour market.
• And finally, savings built up during the pandemic from lack of activity and stimulus cheques have normalised which puts a cap on future demand.

We must be very careful to say, “this time is different” and are aware that although history doesn’t repeat itself, it often rhymes.

Therefore, we always reflect our views in portfolios in a balanced manner. So, though we expect higher inflation to be less persistent, we still hold assets within our strategies which will do well if we are wrong and higher inflation does stick around for longer.

In an environment where the range of outcomes is so wide, diversification and sensible portfolio management is the key to successful investing.

Written by Jonty Brooks

General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.