Current Inflation and Its Resemblance to the 70s

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11 months ago

Inflation is just the increase in general prices. This is the increase in the cost of living. A small amount of inflation, of increase in prices, of around 2% is in general beneficial as it incentivizes people to “move” their money, to invest it. This influx of investment money then allows companies to fund their plans and, eventually, grow, create more and better jobs and repay those investors in the form of dividends.

However, when inflation is too high it can become dangerous for the economy. High inflation significantly increases costs for companies which they will have to pass those extra costs to customers in the form of higher prices which can reduce their demand. This reduction in demand leads to less sales, reduction in jobs as companies don’t need so many employees which leads again to smaller demand as unemployment increases which, eventually, can lead to an economic crisis and recession.

The current environment reminds of what happened in the 70s. During the 50s and 60s we enjoyed a long period of cheap fuel and high growth with contained inflation around 1%-2% a year. Then in 1973 the price of oil multiplied as producers increased prices as a retaliatory measure for the US and western countries support of Israel during the Yom Kippur war. This created a huge increase in petrol (and energy) prices and huge increase in inflation. Most of the same story repeated in 1979. Because of these oil crises, inflation in the late 70s and early 80s reached 13.5% in the US and almost 25% in the UK which led to high unemployment (unemployment rates mostly doubled in a year) and significant recessions. Does all this sound familiar?

Today we are already facing high inflation rates in developed economies like we haven’t seen in decades (8%-9%) and economic growth is slowing down significantly. However, unemployment remains low in most developed economies.

Governments and monetary officials are already reacting to try to contain inflation growth; Central banks are already increasing interest rates. This generates a reduction in economic growth as it increases the cost of borrowing for both companies (less investment) and consumers (less consumption). In this way, the Fed, Bank of England, Swiss National Bank, etc. are already increasing interest rates. Some of them, like the Fed, very aggressively. However, this can also trigger a recession. Achieving the balance between reducing inflation and avoiding a recession is key (and very difficult!).

A significant increase in, essentially, oil and gas production would reduce inflationary pressures dramatically as energy prices in general would be reduced and that translates into less costs for (almost) any other item and service we use in the economy.

However, oil, gas and energy prices are not the whole story. Cereals (wheat, barley, etc.) and fertilizers are also heavily impacted in the current geopolitical environment as Russia and Ukraine are top worldwide exporters. These commodities are also putting pressure on food items (both for human and animal consumption) and this translates into higher inflation levels.

Are we then cursed to repeat the story of the 70s? Not necessarily. First of all, and this is important, monetary policy officials and governments know what happened in the 70s and what worked and what didn’t back then and are already reacting to control inflation. That’s a huge advantage already. On the other hand, debt levels are significantly higher now than they were in the 70s due to economic support provided by governments during the COVID pandemic.

It’s a very tricky exercise of balances but, at least, we have been in a very similar situation before!

 

This article is NOT financial advice, just a monkey typing stuff.

Pic Source: Freepik

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