“[I]nflation moving down gradually on a sometimes-bumpy road toward two percent. I don’t think that story has changed… [W]e didn’t excessively celebrate the good inflation readings we got in the last seven months of last year,” said Fed Chairman Jerome Powell at the latest FOMC post-meeting press conference. Such prudence is commendable, given that it might be premature for any form of celebration despite the recent favorable inflation readings.
The Great Inflation could be a flash from the past. Some readers might not have experienced the inflationary periods from the 1960s through the 1980s, characterized by three major waves. Each wave surpassed its predecessor in severity, was driven by varying causes and met with different policy responses.
The late 1960s saw inflation driven by substantial increases in government spending, fueled by the Vietnam War and President Johnson’s Great Society programs, amid strong economic growth and low unemployment that led to rising costs for labor and materials. Initially reluctant, the Fed eventually raised rates to tighten financial conditions, cooling inflation by the end of the decade and subsequently lowering rates.
The 1973 oil crisis, triggered by OPEC’s embargo, caused a sharp rise in oil prices, significantly impacting global production costs and consumer prices. With the U.S. economy experiencing stagflation, the Fed, under Arthur Burns, cautiously raised interest rates, which some criticized as too timid, allowing inflation expectations to become entrenched.
The third inflation wave, starting in the late 1970s, resulted from high government spending, a loosened monetary policy earlier in the decade and a second oil price shock, with inflation reaching as high as 19% in 1981. Under Paul Volcker’s leadership, the Fed aggressively hiked rates, pushing U.S. interest rates to nearly 15% to combat inflation. Despite triggering a severe recession, these measures successfully broke the inflation cycle and lowered inflation expectations.
History may not repeat itself exactly, but it often rhymes. For investors and traders, understanding history is crucial, as market dynamics are fundamentally driven by human psychology—specifically, fear and greed—which remain constant over time. The inflation episodes of the 60s to 80s reveal notable parallels. Each wave was either precipitated or exacerbated by supply side shocks, leading to increased production costs and prices. High government spending pushed up aggregate demand. The Fed’s response played a crucial role – doing too little, too late allowed inflation to become entrenched. Finally, inflation expectations are often a self-fulling prophecy; as businesses and consumers expect inflation to rise, they adjust their behavior accordingly, often contributing to a wage-price spiral.
Viewing the current post-pandemic macro environment through this historical lens, the Fed’s caution is understandable. The recent inflation mirrors the past, and while the peak of the initial wave seems to be behind us, the Fed is keen to avoid a premature easing that could trigger a “second wave.” Moreover, the recent uptick in commodity prices across energy, agriculture, metals and broader sectors suggests an increasing risk of a resurgence in inflation.
Given these considerations, we remain cautious about Treasury bonds, especially those at the long end, which are more sensitive to inflation expectations. Signs of inflation resurgence could prompt a sell-off in bonds and a rise in yields. The prevailing uncertainty in financial markets and global geopolitics (2024 is a historic year of elections) strongly reinforces our preference for precious metals, especially gold. It’s noteworthy to mention that during the inflationary period from the 1960s to the 1980s, gold experienced a meteoric rise from $35 to nearly $900—an almost 25-fold increase. As renowned financial writer Jim Grant eloquently stated, “Gold ought not to trade as an inflation hedge, but as an investment in monetary disorder, of which the world has plenty.“
