How the Great Inflation Happened in the 1970s

It’s the 1970s and the stock market is in a mess. In 20 months, it has fallen by nearly 50%, and in the past ten years, almost no one wants to have anything to do with stocks.Weak economic growth led to an increase in unemployment, which eventually reached double digits.

The loose monetary policy of the U.S. Central Bank — aimed at creating full employment in the early 1970s — also led to high inflation. The central bank (once under different leadership) later changed its policy and raised interest rates to around 20%-a figure that was once considered usury.For industries that are sensitive to interest rates, such as housing and automobiles, rising interest rates can bring disasters. With interest rates soaring, many people cannot afford new cars and houses because they cannot afford them.

Key points

  • When the prices of goods and services in the economy suddenly rise, eroding the purchasing power of savings, there will be periods of rapid inflation.
  • In the 1970s, there was the highest inflation rate in modern American history, and interest rates rose to nearly 20%.
  • Central bank policies, the abandonment of the golden window, Keynesian economic policies and market psychology have all contributed to the high inflation of this decade.

Interest rate casualties

This is the terrible story of the Great Inflation in the 1970s. It started in the late 1972 and ended in the early 1980s.Wharton Professor Jeremy Siegel in his book “Long-term Stocks: A Guide to Long-Term Growth” (1994) called it “the biggest failure of post-war US macroeconomic policy.”

The huge inflation was blamed on oil prices, currency speculators, greedy businessmen and greedy union leaders. However, it is clear that a monetary policy that finances huge budget deficits and is supported by political leaders is the reason. This confusion proves what Milton Friedman said in his book “Money Pranks: Plots in Currency History: Inflation is Always a Monetary Phenomenon.”The ensuing huge inflation and economic recession destroyed many businesses and harmed countless individuals. Interestingly, John Connery, the secretary of the Treasury appointed by Nixon, who had not received formal economics training, later declared bankruptcy.

However, these exceptionally bad economic periods are preceded by periods of economic prosperity or seeming prosperity. Many Americans are in awe of the temporary low unemployment rate and strong growth in 1972. Therefore, in 1972 they absolutely re-elected their Republican chairman, Richard Nix and their Democrats; Nixon, Congress, and the Federal Reserve all ended in failure.

How and why

Nixon inherited Lyndon Johnson’s economic recession when he took office in 1969, who also contributed generously to the great society and the Vietnam War.Despite some protests, Congress and Nixon continued to fund the war and increase social welfare spending. For example, in 1972, both Congress and Nixon agreed to expand social security on a large scale—just in time for the election.

Nixon was an assumed fiscal conservative when he took office. Nevertheless, one of his advisers later classified Nixon’s economics as a “conservative with a liberal mind.”Nixon had a budget deficit, supported an income policy, and finally declared that he was a Keynesian.

John Maynard Keynes was an influential British economist in the 1930s and 1940s. He once advocated revolutionary measures: the government should use countercyclical policies in difficult times and implement deficits during recessions and depressions. Prior to Keynes, the government in a downturn would normally balance the budget and wait for the liquidation of misallocated business investments to allow market forces to bring recovery.

Another economic transformation of Nixon was the implementation of wage and price controls in 1971.Likewise, they seem to have worked in the following election year. However, later, they will contribute to double-digit inflation.Once they are removed, individuals and businesses will try to make up for lost ground.

Nixon’s deficit also made overseas dollar holders nervous. There is a run on the US dollar, and many foreigners and Americans believe that the US dollar is overvalued. Soon, they were proved to be correct. In 1971, Nixon broke the last link with gold and turned the U.S. dollar into legal tender. The U.S. dollar has depreciated, and millions of foreigners holding U.S. dollars, including Middle Eastern oil tycoons with tens of millions of petrodollars, have seen the U.S. dollar depreciate.

Winning Elections

Nonetheless, what President Nixon is most concerned about is not dollar holders or deficits, or even inflation. He is worried about another recession. He and others who are running for re-election want the economy to flourish. Nixon believes that the way to do this is to put pressure on the Federal Reserve for low interest rates.

Nixon fired Fed Chairman William McChesney Martin in early 1970 and appointed Presidential Advisor Arthur Burns as Martin’s successor. Although the Fed should be fully committed to a monetary creation policy that promotes economic growth without excessive inflation, Burns quickly learned the political facts of life. Nixon wanted cheap money: low interest rates would promote growth in the short term and make the economy appear strong when voters vote.

Because I said so!

Publicly and privately, Nixon turned the pressure on Burns. William Grader reported on Nixon in his book “The Secrets of the Temple: How the Federal Reserve Manages the Country”, saying: “If necessary, we will accept inflation, but we cannot accept unemployment.”This country ultimately possesses abundance of both. Burns and the Federal Reserve’s Open Market Committee, which determines currency creation policies, quickly provided cheap funding.

According to data from the Federal Reserve Board, between December 1971 and December 1972, the main currency creation number M1, that is, the total amount of check deposits, demand deposits, and traveler’s checks, increased from 228 billion U.S. dollars to 249 billion U.S. dollars. In contrast, Martin’s figure last year increased from 198 billion U.S. dollars to 206 billion U.S. dollars.By the end of 1972, the number of M2, which measures retail savings and small deposits, had increased even more, from US$710 billion to US$802 billion.

It worked in the short term. Nixon won 49 of the 50 states in the election. The Democratic Party convened Congress easily. The inflation rate is in the low single digits, but after the champagne of the election year is symbolically drunk, the increase in inflation has a price.

In the winter of 1972 and 1973, Burns began to worry about inflation. In 1973, the inflation rate more than doubled to 8.8%. In the latter part of this decade, it will rise to 12%. By 1980, the inflation rate was 14%. The United States is about to become the Weimar Republic? Some people actually think that Great Inflation is a good thing.

Bottom line

Before inflation returns to the low single digits, another Fed chairman and brutal monetary tightening are needed-including accepting a recession. However, at the same time, the United States will endure an unemployment rate of more than 10%. Millions of Americans were angry about the late 1970s and early 1980s.

Few people, however, remember Burns. In his memoir “Reflections of an Economic Decision Maker (1969-1978)”, he blamed the huge inflation on others without mentioning the catastrophic currency expansion. Nixon did not even mention the central bank incident in his memoirs. Many people who remember this terrible time attribute all this to Arab countries and oil pricing. Nonetheless, the Wall Street Journal said in a review of this period in January 1986, “OPEC received the credit for everything the United States has done mainly to itself.”


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