In May 1974 Fed Chairman Arthur Burns gave a commencement speech to Illinois College. The speech was titled “The Menace of Inflation”.
At this point in the 1970s the nation had been struggling with high inflation for four long years… For perspective, we have been only dealing with high and rising inflation for one year so far. His voice offers a view of what to expect in the years to come.
“The gravity of our current inflationary problem can hardly be overestimated. Except for a brief period at the end of WW2, prices in the United States have of late been rising faster than in any other peacetime period of our history. If past experience is any guide, the future of our country is in jeopardy. No country that I know of has been able to maintain widespread economic prosperity once inflation got out of hand. And the unhappy consequences are by no means solely of an economic character. If long continued, inflation at anything like the present rate would threaten the very foundations of our society.” (1)
In 1974 conditions are reminiscent of what we see today… Burns points out that “A large part of the recent upsurge in prices has been due to special conditions”. “A business-cycle boom” led to “prices of labor, materials and finished products bid up everywhere.” In addition, “Disappointing crop harvests” and “manipulation of petroleum supplies gave a dramatic push to the general price level.”
Burns also discusses the role of Federal spending and budget deficits played in the rise of inflation in 1974. “In financing this deficit, and also in meeting huge demands for businesses and consumers, tremendous pressures have been placed upon our credit mechanisms and the supply of money has grown at a rate inconsistent with price stability.” In today’s environment the Fed’s policy of “lower rates for longer” and Quantitative Easing (QE) has increased the money supply while fostering risk taking and helped inflate bubbles in several asset classes.
Burns also mentions the role increasing wages played. “The prices of virtually everything you buy have been rising and are still going up. For the typical American worker, the increase in weekly earnings during the past year, while sizable in dollars, has been wiped out by inflation. In fact, the real weekly take-home pay of the average worker is now below what it was a year ago. Moreover, the real value of accumulated savings deposits has also declined, and the pressure of rising prices on family budgets has led to a worrisome increase in delinquency rates of home mortgages and consumer loans.”
As of early June 2022, consumer savings that had built up during the COVID pandemic have been drawn down and delinquencies are starting to rise.
Inflation can also lead to liquidity problems for companies as they struggle to get financing. Burns said, “Businesses began to scramble for borrowed funds at commercial banks and in the public markets for money and capital. Our financial markets have come under severe strain. Interest rates have risen sharply; savings flows have been diverted from mortgage lending institutions; securities dealers have experienced losses; prices of common stocks have declined; the liquidity of some enterprises has been called into question; and tensions of a financial nature have spilled over into international markets.”
Burns also pointed out the consequences inflation has on social and political institutions. “We must not risk the social stresses that persistent inflation breeds… Inflation inevitably causes disillusionment and discontent. I do not believe I exaggerate in saying that the ultimate consequence of inflation could well be a significant decline of economic and political freedom for the American people.” Looking at the divisions that have developed in the United States over the past 10 years, this is sage advice.
So, what is the Fed to do in its fight against rising inflation? In 1974 the Fed raised rates substantially to try to get inflation lower. By raising rates, the theory goes, a hot economy will be forced to cool as borrowing money becomes more expensive. As the economy cools off the inflation in the economy falls as ‘fewer dollars are chasing more goods’. Burns wrote, “Troublesome though this rise of rates may be, it must for a time be tolerated. For, if monetary policy sought to prevent a rise in interest rates when credit demands were booming, money and credit would expand explosively, with devastating effects on the price level. Any such policy would in the end be futile, even as far as interest rates are concerned, because these rates would soon reflect the rise in the price level and therefore go up all the more. We must not let that happen.”
In a sense, this is where we are today because of the Fed policy of QE and easy money. Many economists argue that the Fed has waited too long to ‘take away the punch bowl’.
In early June 2022 top economist Mohamed El-Erian appeared on CBS’s program, “Face the Nation” to discuss the issue of inflation. El-Erian stated “I fear that it’s still going to get worse. We may well get to 9% at this rate.” (2)
‘El-Erian reiterated his criticism of the Federal Reserve in not responding to rising inflation earlier. “It mischaracterized what inflation is and it fell behind,” he told CBS.’
“What makes this very frustrating is it was partially avoidable,” he said. “This is going to have enormous economic, social impacts; it hits the poor particularly hard… this has huge institutional and political consequences. And most of it could have been avoided, had early actions been taken.”
‘El-Erian isn’t the only high-profile voice criticizing the Fed for not moving soon enough. Former Fed chair Ben Bernanke told CNBC in May that the central bank made a mistake in delaying its response to rising inflation.’
Like an addict, markets are addicted to ‘free money’. When ‘free money’ is removed the withdrawal the addict suffers is painful, sad and distressing. To return to healthy fundamentals, markets need to overcome their addiction.
Burns also addresses the elephant in the room… “Monetary policy alone cannot solve our stubborn inflationary problem… I do not expect that the path back to reasonable price stability can be travelled quickly. Indeed, our government will need to take numerous steps to reduce the inflationary bias of our economy. The forces of competition in labor and product markets need to be strengthened… certainly through more vigorous enforcement of anti-trust laws…”
This issue of corporate oligarchies and monopolies in today’s economy is a huge issue that has been pointed out by numerous economists. While inflation has been rising, so have corporate profits. In March 2022 the Bureau of Economic Analysis announced that corporate pretax profits surged 25% year over year to $2.81 trillion.
“CEOs can’t stop bragging on corporate earnings calls about jacking up prices on consumers to keep their profits soaring—and today’s annual profit data shows just how well their inflation strategy is working,” progressive thinktank Groundwork Collaborative’s executive director Lindsay Owens said. “These megacorporations are cashing in and getting richer, and consumers are paying the price.” (3)
The economy has less competition and is dominated by large corporations. Such corporations exert a disproportional amount of influence on market prices. This benefits corporations and hurts consumers.
Burns offers some realistic advice: “But if inflation cannot be ended quickly, neither can it be eliminated without cost. Some industries will inevitably operate for a time at lower rates of production than they would prefer. Government cannot—and should not—try to compensate fully for all such occurrences. Such a policy would involve negating with one hand what is being attempted with the other.” As we have seen in modern America, corporate bailouts have a cost, especially in how businesses measure and deal with risks. Increased risk taking creates longer term issues because it misallocates capital.
Burns’ conclusion is sobering… “There is no easy way out of the inflationary morass into which we have allowed ourselves to sink through negligence and imperfect vision.”
As I mentioned this speech was given in 1974. As exhausted and frustrated in dealing with inflation as Burns and the nation was at that point, they had yet another eight years of high inflation to come…
By the start of the 1980s and the appointment of Paul Voelker as Fed Chairman, the nation was ready for a different course of action. In the early eighties Voelker raised interest rates to double digit levels causing two deep recessions, but in the end drove down inflation.
At the spring 2022 NABE (National Association of Business Economists) meeting where Fed Chairman Powell spoke, he invoked the memory and tools Voelker used to defeat inflation. While the Fed only raised rates 50bp in May, a hotter than expected inflation print in June caused the Fed to raise rates by 75bp.
The question for markets and consumers is how committed Powell is to being ‘Voelker-like’; ie raising rates while the economy falls into a painful recession in order to lower inflation.
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