- Stagflation is a period of combined high inflation and unemployment with weak economic growth.
- Gold was a clear winner during the 1970s stagflation period, followed by Commodities and REITs.
- There are some similarities in today’s environment compared to the 1970s stagflation period, but a stagflation is not yet to come in the present circumstance.
Stagflation in the 1970s
What is Stagflation?
Stagflation is the coexistence of high inflation, and a high unemployment rate, with a slow, stagnated, or even negative economic growth. Economists have defined two periods as stagflation in the 70s: 1974 - 1975 and 1978 - 1982.
Cause of Stagflation in the 1970s:
Economy: The U.S economy started to fade by the end of the 1960s (Post-World War II) due to several reasons:
- The U.S was facing greater international competitions
- The loss of manufacturing jobs
- A massive Vietnam war fiscal expenditure occurred
The Nixon Shock: in 1971, the president Richard Nixon took a series of actions aiming to achieve better employment and economic condition in hope of pushing down the inflation and protecting the US dollars to combat the great depression. The series of actions include
- A 90-day freeze on wages and prices
- A 10% tariff on imports
- Breaking up the linkage between Dollar and gold
Oil Embargo: On Oct 19th, 1973, the 12 OPEC members agreed to establish an embargo against the U.S because of two actions taken by the US administration:
- Nixon took off the linkage between the Dollar and gold, which caused the depreciation of Dollar value and significantly hurt Oil exporting countries as their oil contracts were priced in dollar
- The S. ordered military aid to Israel during its conflict with Egypt and Syria
Assets Performance during the Stagflation
Research from Schroders has found that gold has an average real Year-on-Year total return of 22.1%. In addition, investors pay close attention to the real interest rate in the gold market: Real interest rate = Nominal Interest - Inflation Rate. As indicated by the formula, when inflation or inflation expectations go up, the real interest rate will fall.
Another asset type which draws attention during the stagflation period was Commodities. During the 1970s, agricultural assets like farmland have appreciated. According to the US Department of Agriculture, the average price of US farmland was $137/acre in 1970 and had risen to $737/acre in 1980. However, the return has not taken into consideration the return of the crop yet. Not to mention how the price of beef has also doubled, with the corn prices nearly tripled, and wheat prices quadrupled at the same time period.
The third asset: Real Estate Investment Trust (REITs) has an average inflation-adjusted YoY return of 6.5%:
- Property prices tend to move along with the overall price environment
- Properties with a shorter-term leasing duration benefited from a high inflation environment quicker than those with a longer-term leasing duration
- REITs dividends have grown faster than inflation
Similarities between the Circumstances of 1970s and Today
High inflation: The YoY percentage change in the US consumer prices index in March is the highest since 1980s
High Oil Price: The oil price has been increasing since 2020 and has gone over $100/barrel since 2014
Supply Chain problem: A 2.5 Real Inventory-to-Sales Ratio indicates that the retail stores have enough merchandises on hand to cover two and a half months of sales
Where We Might be Heading Towards
The US economy is far away from stagnating. Research from Wells Fargo Securities shows the forecast of real GDP growth at 3% in 2023.
Unemployment: As of April 1, 2022, the unemployment rate has dropped to 3.8%. There is a gap between the supply and demand of workers in the tight labor market. For example, Walmart increased the average starting pay for truckers from $87,000 to $110,000 to attract workers. If employers continue to hire, the unemployment rate is expected to remain low. On the supply side of the workers, the wage bargain power is less compared to the 70s. Thus, the upward spiral in wages like the 1970s and 80s is less likely to occur today.
The tight labor market will keep the unemployment low, and the workers won’t be able to bargain up their pay as they did back in 1970s. According to the United States Bureau of Labor Statistics data, the shares of employees who are Union members in the private sector have fallen from nearly 20% in 1980 to 6% in 2020 (Graph 9). The oil intensity (Graph 10) – a measure of how much volume of oil is consumed per unit of gross domestic product, has declined by 56% globally. In other words, today’s economy can handle costlier crude oil without overreaching stress. According to the Fed’s new dot plot after its March policy meeting (Graph 11), officials expect to raise the fed funds rate six times this year. However, the Fed still has a long runway for tightening before the monetary policy could be considered restrictive territory. A soft landing by the Fed is more likely, which separates its behaviors from 1970s.
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