While Everyone Fears the 1930s….the 1970s May Return

MorganLeFay

Posted by Gary Alexander on 9/23/09 8:03 pm

n nearly every article on trade wars or stock market history, we hear the words “Smoot Hawley” – that infamous 1930s trade bill that turned a routine market panic into a decade-long Depression.  But so far, I haven’t seen anyone cite the 1978 fiasco called “Humphrey-Hawkins,” a prelude to three years of double-digit inflation, so please allow me to be the first author to return to…1978.
By 1977, inflation was chronic but manageable, staying under 6% in 1976 and running at 6.5% in 1977. Then, the CPI hit 7.6% in 1978.  To contain this monster, Senator Hubert Humphrey and Rep. Gus Hawkins drafted an audacious bill that mandated cutting inflation to 3% and the jobless rate to 4%.  Like King Canute of old, President Carter signed this mandate into law on October 27, 1978 – commanding all bad numbers to stop rising and start falling! The numbers rebelled:
Click on chart to expand or print

Inflation reached double-digits and stayed there for three painful years because the Federal Reserve chairman of the time (G. William Miller) had no clue how to stop inflation.  That’s because he, like his predecessors and most future Fed Chairmen, were too busy fighting the demons of 1930 to pay much attention to the risk of chronic or runaway price inflation.
Meet our Six Consecutive Depression-Scarred Fed Chairmen
Author Caroline Bird (born 1915) wrote a book, “Invisible Scars,” about the internal pain caused by the Great Depression. Anyone in her generation (or with parents that age) knows what she’s talking about. These scars have dominated Fed policy for 60+ years.  First, the two Fed chairmen who served from 1951 to 1978 were born in 1904 and 1905, so they suffered during the 1930s depression as adults, fully conscious of the emotional and economic scars that decade created.
• William McChesney Martin, who served longer than any other Fed chairman (19 years, 1951-1970) was painfully conscious of the Great Depression. In my first magazine article as a young journalist (1970), I quoted at length his dismal valedictory address, in which he warned of a coming depression in the early 1970s, citing all the parallels with 1929.

• His successor, Arthur Burns (Fed Chairman, 1970-78) was equally scarred by the 1930s deflation, so Burns fueled the economy with more liquidity whenever his three Presidents (Nixon, Ford and Carter) asked the pliant chairman for an economic shot in the arm.

• The next three Fed chairmen, G. William Miller (serving just 17 months, 1978-79), Paul Volcker (in office 1979-1987) and Alan Greenspan (serving 1987-2006) were all born in the mid-1920s, so they experienced the Depression as lads, old enough to feel the pain.  

• Current Fed chairman Ben Bernanke was born in 1953, but he spent his entire adult life studying the 1930s economy, so he may as well have lived through it.  He is now doing everything possible to avoid another 1930s deflation, at the risk of fueling more inflation.
Even though Paul Volcker instituted some short-term deflationary medicine in 1980-82, in a successful attempt to kill inflation, all six of our post-1950 Fed chairmen were conscious of their requirement to fuel liquidity when needed – after the Cuban missile crisis, after the 1973 oil shock, after the 1987 crash, in the S&L crisis, after the tech stock crash, after 9/11 and since then.
The Flood of New Fuel in Late 2008 May Spark a Fire Soon
In the three months following the collapse of Lehman Brothers on September 15, 2008, the U.S. monetary base doubled, rising from $850 billion to $1.7 trillion, a more rapid monetary increase than any time in U.S. history. During that brief time, bank reserves multiplied by a factor of 13.
Taking a longer-term look, in the two years since the first blow-up of the secondary mortgage market on August 8, 2007, the Fed’s balance sheet ballooned from $902 billion to $2.3 trillion.  
Economist Art Laffer wrote about this in the Wall Street Journal this week (September 22): “The 1930s has become the sole object lesson for today’s monetary policy. Over the past 12 months, the Federal Reserve has increased the monetary base (bank reserves plus currency in circulation) by well over 100%....All this has been done to avoid a liquidity crisis and a repeat of the mistakes that led to the Great Depression.” (He also cited a brief period of inflation in the mid-1930s.)
The late Milton Friedman said “inflation is always and everywhere a monetary phenomenon.” His favorite textbook definition of inflation was MV = PQ, where M is Money in circulation and V is Velocity (how fast that money is spent).  The result is P (Prices) times Q (real value). An English-language translation is “Too much money chasing too few goods.” But velocity, represented by the verb “chasing” in this formula, is currently absent, as consumers are still reticent to spend.
Where Will Inflation Break Out First?
So far, we’re only seeing commodity price inflation, not consumer price inflation. The August Producer Price Index (PPI), released last week, rose 1.7% (a 22.4% annual rate), more than double the consensus forecast of 0.8%.  (Gasoline rose 23% and fuel oil rose 21%.) But the Consumer Price Index (CPI) rose a more modest 0.4% (4.9% a year), 0.1% above expectations.  
Despite monthly blips like this, inflation has been muted so far this year.  Banks are sitting on most of their liquidity, while corporate coffers are overflowing with nervous cash, earning zero interest.  The Consumer Price Index will likely remain throttled by a depressed housing market, since the “renter’s equivalent” of home ownership costs accounts for about 40% of the CPI.
Still, inflation will break out somewhere – even if only in asset (stock market) prices and in key commodities. To stem general inflation, Fed officials have told us they will “mop up” their excess liquidity as soon as prosperity returns – before inflation gains a foothold – but how will they do that? Raising short-term rates or choking off liquidity could cause a double-dip recession.  Will the Fed be allowed to fuel a new recession in a Congressional election year in 2010?  I think not.
In the last two recessions, which were nowhere near as severe as this one, “the Fed was slow to extinguish the extra dollars it had printed,” according to James Grant in the October Reasonmagazine inflation debate. Grant predicts the Fed “will vanquish deflation by creating a new inflation,” since higher inflation is a politically acceptable risk, the lesser of two monetary evils.

行云流水

good post

dividend_growth

对经历过30年代的人，70年代算个屁！