High prices prompt 1970s comparisons
Other economic factors make repeat unlikely
By William Sluis
Tribune staff reporter
Published May 6, 2006
The stock market is at or near its all-time high. Gold is topping levels not seen in 25 years. Oil is above $70 a barrel. Housing prices are through the roof.
It isn't often that such a collection of indicators are all at or near their summits at the same time.
Economists, pondering the significance, see a fascinating and potentially dangerous historical parallel: the painful 1970s.
"There is a whiff of the `70s in the air, but it doesn't appear to be a case of deja vu all over again," said economist Brian Wesbury. "Although we are not likely to repeat those old problems, it's not entirely impossible."
The earlier era was a time when gasoline lines snaked around corners into filling stations and home prices zoomed beyond reach of the typical household. Gold skyrocketed above $800 an ounce in 1980 and interest rates hit the stratosphere.
The good times ended when the Federal Reserve, shocked by roaring inflation, sent interest rates to double digits. Lending for a home mortgage jumped to near 14 percent and the economy slumped into a 1982 recession that was the worst in any of our lifetimes.
But that was nearly a quarter-century ago, and few analysts are willing to say the scenario will repeat.
Even so, they worry that all aspects of commodity costs have been soaring skyward.
Many analysts blame a too-long period of low interest rates, which were held at Great Depression levels as the world economy stumbled along in the wake of the dot-com stock market collapse of Year 2000 and World Trade Center terrorist attacks the following year.
During an inflationary boom, not only do copper, oil, steel and precious metals rise as a group, they are joined by prices for land and homes. A widespread mentality of scarcity sets in.
Currently, shortages of commodities are becoming worrisome, partly because the economies of China and India are sucking in basic materials to produce the world's computers, household items and trinkets.
The question becomes: When does the boom mentality start to show cracks? When does a break appear in a sky's-the-limit attitude? Which part of the enormous economic edifice of prosperity will be the first to fall?
For now, the most suspect portion of the equation is real estate. At root, property is a commodity. And on Friday, luxury home builder Toll Brothers Inc., a leading builder of $700,000 homes, said that signed contracts fell 29 percent in its second fiscal quarter. It cut its full-year home deliveries forecast.
Wall Street, however, took little notice, and investors bid its shares higher.
Chicago economist Robert Dederick says there are major differences between the current situation and the nation's mood three decades ago.
"In those days, expectations of inflation began building, and there was far less faith that the Federal Reserve could bring prices under control," said Dederick, of RGD Economics.
Additionally, he said, workers in the 1970s went to bosses demanding raises--and got them. Labor unions were far more powerful than they are today. "There was a generally accepted view that if prices went up, wages would need to go up, too."
At the time, the economy faced little foreign competition, unlike today, when most products compete globally, Dederick said. Currently, businesses are having a tough time raising prices, as many are forced to swallow higher prices for fuel and metals.
While personal incomes are rising, there are no signs that weekly pay is zooming out of control. Many workers hold temporary positions. Entire industries, notably the airlines and domestic carmakers, continue to press for wage concessions and lower benefits. And, for good or ill, millions of undocumented workers are helping to hold wages down.
To keep inflation expectations firmly in check, Dederick expects the Fed to raise short-term interest rates on Wednesday, the 16th uptick in less than two years. The central bank's short-term barometer would rise to a flat 5 percent.
A concern is that were the central bank to squeeze credit too hard it would cut off consumer spending, taking the steam out of the economy's primary engine of growth.
Problems of the 1970s that haven't been repeated are rising levels of government regulation and spending, as well as higher taxes, said Wesbury, of First Trust Advisors in Lisle. "Today, government spending has gone up dramatically and the Fed has shown an expansive monetary policy--but nothing like the case 30 years ago," he said.
Mopping up excess monetary liquidity has become a commitment of central banks in all parts of the globe, said economist Lynn Reaser, of Bank of America's investment strategies group in Boston.
"There is a much greater commitment by all of the world's governments to keep inflation under control," she said. In recent months, inflation in this country has been running at less than a 3 1/2 percent annual rate, Reaser added.
For the stock market, a boom mentality means ever rising profits. After 15 quarters in a row in which corporate earnings have jumped by double digits, traders remain bullish, with few calling for caution.
"Investor sentiment remains subdued, valuations are reasonable and, in some sectors, are compelling," said Chicago investment manager Marshall Front of Front Barnett Associates.
Critics complain that a huge bulge of the profits hailed by investors is coming from producers of commodities, notably the oil companies. Some members of Congress, noting multibillion-dollar additions to the bottom line, have gone so far as to push for legislation aimed at petroleum price gouging, while admitting that they have no clear definition of what that means.
But economist Dederick said the current surge in petroleum prices "is nothing like the oil shock of the 1970s. That one was far more dramatic."
Although many Americans may hate the oil companies or blame them for buying feeder stock from foreign dictators, most have learned to live with high fuel prices, at least for now.
Those who believe the commodity boom will continue note that high prices are being stoked by hedge funds and other vast pools of money resembling mutual funds, which play the markets for petroleum, metals and gold, using money that has been accumulated by the wealthy and folks saving for retirement.
Economist Reaser says money pouring into such funds "represents a shift by investors into a different asset class. Some of them have taken money out of housing."
Until those investment pools suffer a severe setback, they will exert pressures to keep prices from falling.
In sum, economists say, while '70s-style inflation is unlikely to reappear, they are basing that view on expectations that activity will slow before the end of this year. If, instead, it builds further momentum, it will be time to reassess.
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