My mother recently said to me, 'It feels like we're going to have the Seventies all over again.' Unfortunately, I think she's right. There are many parallels to the 1970s, including excessive money creation, commodity inflation, oil shocks, geopolitical instability, and budget deficits. If we find similar economic conditions in the past, we can take steps that were successful then and apply them today.
If you were alive in 1971, you probably remember that President Nixon took America off the international gold standard. This allowed the Federal Reserve to print as much paper money as it wanted, as foreign governments could no longer redeem dollars for gold. This rapid increase in the money supply caused price inflation.
A similar reaction is occurring today. The Fed has increased M3, a measure of the money supply, by approximately 8% a year since 1995. They cut the Federal Funds rate from 6.5% in 2001 to 1% in 2003. It became very easy to get credit, which encouraged people to take out mortgages and other loans. Unfortunately, credit booms lead to oversupply of goods and services, causing stagnation in the economy.
Excessive money creation causes commodities to increase in price. The Commodities Research Board Index hit 289.33 today, a level we saw in the late 1970s. The CRB measures the cost of 17 key commodities, from silver to coffee to oil. Inevitably, commodity inflation seeps into the general economy as consumer price inflation. Although the government states that inflation is tame, I'm sure you've noticed the increases at the grocery store and gas pump this year.
The most important commodity is oil. Our economy is dependent on fossil fuels because they supply most of our heat, electricity, transportation, and even fertilizer for agriculture. Just like in the 1970s, increased demand and geopolitical instability can lead to oil sticker shock. The supply is so tight that unexpected events, like hurricanes or tsunamis, can put a serious dent in oil inventories. On top of natural phenomena, unrest in oil producing countries like Iraq, Nigeria, and Venezuela cause prices to spike. The price of crude oil futures has hovered near $50 a barrel recently, so expect energy costs to stay high.
The U.S. budget and trade deficits are even worse than in the Seventies. Simply stated, America spends more than it can afford. U.S. monetary policy since 2002 has allowed the dollar to fall in value against other currencies like the euro and yen. The Federal Reserve's theory is that dollar devaluation will make American exports cheaper, and imports more expensive. Despite the increase in the cost of imports, especially oil, our balance of trade hasn't improved. In fact, it's gotten progressively worse, and the manufacturing sector has continued to shed jobs.
I fear we are already seeing the beginning of Seventies-style stagflation, or slow economic growth with relatively high unemployment and prices. Recent mergers have caused new rounds of layoffs, and many unemployed workers have given up hope of finding a job. The Consumer Price Index only increased 3.4% last year, but it doesn't include the skyrocketing cost of health care. Wages have regressed to their 2001 level, when adjusted for inflation. The Federal Reserve continues to increase the discount rate, which hampers capital investment.
If we are replaying the Seventies, what can you do to protect your financial assets? You can invest in commodities, and stocks of companies that produce them. However, don't expect to see a substantial return right away. Prices won't really explode until the end of the bull market. For example, silver cost under $2 an ounce in 1971 and peaked at $54 in 1980.
The simplest way to protect your future is to accumulate slowly at today's low prices, and wait until values skyrocket. That's how savvy investors became wealthy in the 1970s. Unfortunately, many people become impatient in a long bull market. They trade themselves out of the market, waiting for the next pullback. If that dip never comes, they may not be able to afford to get back in. As Jim Sinclair says, you can trade 1/3 of your investments, selling strength and buying weakness, but never touch your core 2/3 position. If the bull market in commodities unexpectedly turns into a mania, you don't want to be sitting in the bleachers watching others ride.
Copyright © 2005 Jennifer Barry
