For the last several months Ron has commented “This is where I came in” or “We’ve been here before” when discussing politics/economics/central banks/financial markets. That’s not necessarily reassuring, and here’s why.
Ron started managing money in 1968, just before a lot of what “everybody knew” to be true ended. Events occurring between 1968-1974 had an impact that created the stagflation of the ‘70s and lasted until the early ‘80s.
In 1968 nobody talked about inflation. It had been low and stable at 3% for so long that “everybody knew” it wouldn’t change and wasn’t a factor in the economy. Just as “everybody knew” normal interest rates were 4 ½%, growth stocks would go up forever, and that economists/central bankers had figured out how to lick the recession/slow down part of the business cycle by printing money.
By 1974 inflation was over 10% and would peak at 13% in 1980. Interest rates were at 7 ½ %, also on their way to 13% by 1980. Stock prices got cut in half in ’73 -’74, and price-to-earnings (P/E) ratios had fallen from 17 to 7. And we were deep in the throes of “stagflation.” Stagflation is characterized by high inflation, high unemployment, and slow to negative economic growth—essentially inflation and recession AT THE SAME TIME. This was theoretically impossible and was giving those same economists and central bankers fits. And nobody talked about what “everybody knows” anymore.
In 2021 “everybody knew” that inflation was stable at less than 2%, a Zero Interest Rate Policy (ZIRP) was normal, the FANG stocks would go up forever, and the Fed could solve or prevent any crises by printing money (think Modern Monetary Theory, Quantitative Easing 1-4, “helicoptering money”, American Plan Rescue Act of 2021, Inflation Reduction Act of 2022, etc.).
Today, at the beginning of 2023, inflation is up to 7%. Interest rates are 4-5% and rising. The stock market was down 20% in 2022, with the FANG’s market values down close to 50%. We are facing a recession. And what “everybody knows” has come under scrutiny and pointed questions.
So, when Ron says this is where he came in, he is saying that 2020-2022 is a time of change just as 1968-1972 was a time of change. And asks if we are facing a decade of slow growth and high inflation just as we endured in the ‘70s. We are at a decision point in 2023 much like we were at a decision point in 1970.
To prevent a decade of pain, we think it is useful to examine the lessons learned from the prior decade of pain. Solving the stagflation problem of the ‘70s required Paul Volcker in the Fed slowing the rate of growth in the money supply to 4%, and President Reagan cutting taxes and regulations to spur growth in GDP.Both moves were seen as pure folly by the experts of the day, but after a brief recession in 1982, those changes set the stage for 30 years of high economic growth and low inflation.
As Jeff points out in his Quarterly Letter: if inflation occurs when the rate of growth in the money supply is higher than the rate of growth in goods and services (which Milton Friedman taught, and we tend to agree with), then there are two tools for controlling inflation. Shrink the money supply (monetary policy) or grow GDP (fiscal policy) or both. As Ron discovered in the ‘70s it takes both, but it also took a decade of pain before consumers forced the policy makers to employ both tools.
We think the current inflation is coming from the huge amounts of money dumped into the system since 2008. The money supply has increased by close to $10 Trillion WITHOUT growth in GDP (which is currently $25 trillion). As Jeff points out in his Quarterly Letter, the Fed is only using the monetary tool for controlling inflation by raising interest rates and shrinking the supply of money. Whether they will continue to do that if the economy goes into recession remains to be seen. And so far, there is no mention of using the fiscal tool at all.
So, Ron thinks 2022 is a lot like 1970. Change is happening, and people are reluctant to recognize these changes and adapt to them. The last time we denied what was happening it took a decade of pain to accept reality. Whether we require another decade of pain to mend our ways remains to be seen.
You should know that as money managers we have been through this (or something similar) before and while we try desperately not to predict the future, we are very busy working to use the lessons from the past to understand the present. We are here to help you get through this.
FANG is the acronym used to describe the most prominent tech companies in 2013. They included Facebook, Amazon, Netflix, and Google.
GDP (Gross Domestic Product) is the total market value of all goods and services produced within a country in a given period of time (usually a calendar year).
Price-to-Earnings (P/E) is the current price of a stock divided by the (trailing) 12 months earnings per share.
The comments made in this article are opinions and are not intended to be a forecast of future events, a guarantee of future results, nor investment advice.
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