Nixon, inflation, and the high price of bad analogies

Oil shock. Prices on the rise. A menace in Russia. The US coming off of one war and supporting the under-dog in another. “The ingredients of the 1970s are already in place,” said Niall Ferguson at the Ambrosetti Forum in Italy the other week. Says, Niall:

Why shouldn’t it be as bad as the 1970s? I’m going to go out on a limb: Let’s consider the possibility that the 2020s could actually be worse than the 1970s.

But how reliable is this habit of ours of shopping around for historical analogies? Yes, these historical antecedents are important. A strong memory and understanding of the Great Depression helped Bernanke navigate 2008, but there was one thing the Great Recession was not – the Great Depression.

Yes, it’s tempting to envision Niall in bell-bottoms and a satin shirt, but maybe we should start to fill in some of the details between the headlines about inflation, market crashes and malaise in the seventies, so we can better understand where we might be going. It’s a story about America, a Federal Reserve compromised by a corrupt president, price controls and supply shocks, and it’s far more subtle than Niall’s gloss for the rapturous conference circuit.

Niall’s reference begins with the onset of a recession in November 1973 and lasted through March of 1975. The Dow had peaked in January at just over 1000 and declined twenty percent through mid-December before rallying to close the year, but the pain had only just begun. The market would grind lower to just about 590 in December of 1974. Meanwhile, the unemployment-rate low of 4.6% would almost double to 8.8% at the end of the recession. It sounds familiar, but there were also important differences.

The US economy in the 1970s was initially tipped off balance by a cozy and political relationship between Federal Reserve Chairman Arthur Burns and President Nixon. A mild recession had knocked 0.6% off of US GDP during the eleven months through November 1970. Rising unemployment on the tail end of the Eisenhower administration had derailed Nixon’s 1960 presidential campaign, so the administration was focused on reaching full employment in advance of the 1972 election, and Burns was his willing accomplice. Prior to his confirmation in 1969, Nixon chuckled to Burns, “I know there’s the myth of the autonomous Fed” before warning Burns to maintain “appearances” around his “friendship with the President,” so he shouldn’t call Nixon directly. According to Burton Abrams, writing for the Journal of Economic Perspectives, “Richard Nixon demanded and Arthur Burns supplied an expansionary monetary policy and a growing economy in the run-up to the 1972 election.” At one point, Nixon warned Burns, “this will be the last Conservative administration in Washington,“ apparently raising the possibility for him that Nixon might lose the election. The monetary stimulus supplied by Burns “helped to boost the economy in time for the 1972 election, helping to deliver Nixon’s landslide victory.” His friendship paid off.

Nixon loosed another disruption on the US economy in the run-up to the 1972 election – price controls. He announced his New Economic Plan, Executive order 11615, with the words, “The time has come for decisive action-action that will break the vicious circle of spiraling prices and costs. I am today ordering a freeze on all prices and wages throughout the United States.” Just days before, Treasury Secretary John Connally had assured him: “To the average person in this country this wage and price freeze – to him means you mean business.” These would remain in place through the election and into 1973, and it worked. Abrams writes, “with wage and price controls restraining both prices and inflationary expectations, [Burns] believed that monetary stimulus could return the economy to full employment with little inflationary cost.” The cost of Nixon’s Plan, however, would soon emerge, as the author’s table of inflation rates matched with the effective term of the price controls illustrates.

Nixon had undermined each of the dual mandates of the Fed for political ends. Price and wage controls provided the illusion of stable prices, and political pressure from Nixon, himself, encouraged Burns to maintain loose economic policy. Through the levers Nixon could control, he captured the election but according to Abrams, “the excessive aggregate demand stimulation prior to the election created serious problems for the economy that took nearly a decade to resolve.” But it was the levers he could not control that shocked a weakened financial system such that the relaxation of price controls quickly yielded to nearly 10% inflation in 1973 and almost 12% inflation in 1974.

Two supply shocks hit the US in 1972. The first to hit came to be known as the Great Grain Robbery. It was followed by the Arab Oil Embargo.

The Great Grain Robbery happened over the course of the summer of 1972. Soviet grain crops had failed, and the state was anxious to replace them. USDA Secretary Earl Butz didn’t realize the scale of their shortfall and inadvertently allowed the subsidized purchase of close to 20 million metric tons of grain through brokers – fully 25% of the US harvest coupled with a $300m subsidy from the USDA. The New York Times would later report, “Moscow’s negotiators worked so cagily that the competing grain dealers here — the Cooks, Cargills and others were apparently unaware that there were several negotiations underway simultaneously.” Wheat prices soared by more than two-thirds, to $2.50 per bushel by the end of 1972 and pushed $6 by the end of 1973.

Producers were caught in a desperate situation. The reliable equation of converting grain into protein for the market was breaking down. According to Daniel Yergin and Joseph Stanislaw, by June of 1973, “Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.” George Schultz would remark, "At least we have now convinced everyone else of the rightness of our original position that wage-price controls are not the answer.”

The Arab Oil Embargo arrived in October of 1973. In retaliation for US support of Israel in the Yom Kippur war, the Arab members of OPEC halted oil shipments to the US and decreased production overall. The price of oil quadrupled and reached a plateau at which it would remain until tripling again at the onset of the Iranian Revolution 1979. Speaking before Congress in 1974, Burns explains how fragile the US economy had become: “In the middle of 1973, wholesale prices of industrial commodities were already rising at an annual rate of more than 10 per cent; our industrial plant was operating at virtually full capacity; and many major industrial materials were in extremely short supply” (Burns, 1974).

The US economy had been acculturated to plentiful supplies of inexpensive oil with stable pricing. During Burns’ testimony, he mentions autos: “Some sectors that depend heavily on a plentiful supply of inexpensive fuel – such as the automobile industry – have had to contend with sharp declines in sales and considerable idle capacity.” Yes, cars in the 1970’s were notoriously inefficient, with average ratings of twelve miles per a gallon in 1970 (DOT), but overall, the US economy was more energy intensive than it is now, so the oil shock in 1973 and then in 1979 was substantially more disruptive.

Energy intensity helps us think about how vulnerable the overall economy to increases in energy prices. Sure, if gas prices go up, people expect to see fewer motorists on the thruway, but how about fewer hours at the factory or less fertilizer going into the ground? A less energy intensive economy is more efficient, so it can do more with less energy and is more resilient to energy price fluctuations. One way of assessing this is through analyzing energy consumption in BTUs per real dollar of GDP. In 1970, the US economy required nearly fourteen thousand BTUs per chained 2012 US dollar – an inflation adjusted index. Today, we’re close to five thousand. Sure, prices have gone up, but they won’t have nearly the same impact as what we saw in the 1970s. It’s the difference between a thunderstorm and a hurricane.

But if one thing is for certain, we know how to make things worse. In November of 1973, Nixon signed the Emergency Petroleum Allocation Act which introduced a new regime of price controls in the oil market [more]. Refineries would be eligible to buy oil at three rates – a discounted price for “Old oil,” based on wells drilled before 1973, a substantially higher price for “New oil,” and the market rate for imports. The expectation was that the Act could rely on continuous production of existing wells and incentivize the production from new wells. Naturally, that wasn’t the case. Instead, producers of “Old oil” had an incentive to keep it in the ground, which lowered production. Shortages in 1974 would lead to rationing based on odd and even license plates. Odd dates corresponded with odd license plates and vice-versa, with a free-for-all on the 31st of the month, just to even things out. Ford would try to dismantle the price controls, but it wasn’t until later that the Carter administration began to phase them out.

Niall’s right, in some ways. We have inflation. There is an energy shock and the lingering supply chain shock from the pandemic is real, but this is not the 1970s. Nixon cajoled Fed Chairman Burns into lowering interest-rates to drive full employment while he signed an executive order that introduced price-controls to hide inflation. It helped him win reelection, but it undermined US economic policy. When the Great Grain Robbery and the Arab Oil Embargo struck, the US economy was already fragile and overheating. The impact was devastating.

Inflation is here, but the conditions are different. Farmers aren’t drowning their chickens, and there’s no such thing as “Old oil” and “New oil.” The US economy is far less sensitive to price fluctuations in the energy markets, and we have a Federal Reserve Chairman who is more concerned with sound monetary policy than his friendship with the president. Don’t worry, there are still plenty of ways to screw it up, though – the policy failures of team Truss and resulting crisis in Gilts and LDI based strategies are certainly trying.