Frank Thoughts: The Last Time
Frank Boland
March 09, 2023

The last time inflation and interest rates started to rise simultaneously was 58 years ago. Then, as now, it had its genesis from too much government spending. The process was euphemistically called “Guns and Butter.” “Guns” represented the expense of the Vietnam War and “Butter” was the euphemism for the then newly introduced welfare structure in 1965. Little has changed. Currently, entitlement programs are still a growing massive part of the federal budget (49%), and we are currently in a proxy war with Russia and possibly China. “The more things change, the more they stay the same” wrote the French writer Jean-Baptiste Alphonse Karr in the 19th century.

The then new 20th century inflation surge caused enormous disruption in our country. OPEC’s creation resulted in massive gasoline lines by the early 1970s. Prices for everything went up dramatically as inflation was driven inexorably higher. The financial industry was devastated by it. Major brokerage firms went out of business. Banks were limited on mortgage lending because Regulation Q capped the amount of interest that could be paid on passbooks at 4%. Fidelity Investments started a money market fund in 1971 which yielded more by owning treasuries. This disintermediation for banks was a bonus for Fidelities’ survival in what would become the secular bear market of 1973-1974.

The seminal change of that 17-year inflationary experience was the appointment of 6’7” Paul Volker as Fed Chairman in 1979. Forty-four years ago, such height was extraordinary! His mere presence suggested a primal no-nonsense bearing. In fact, that was his message. It was unique to the prior 12 years of Federal Reserve behavior in dealing with the unrelenting inflation.  Starting in 1965 the Federal Reserve raised Fed funds four times from 4% to as high as 12% only to return each time back to 4%! Paul Volker - in three and a half years – raised Fed Funds from 10% to 20%. End of inflation.    

Despite that experience, Wall Street today talks about what, and when, the “terminal” rate will happen. It’s as though the recent bear market was a temporary inconvenience before we can get back to the 12-year period of 0% interest rates. Forgotten – or not recognized – is that period was unique in 5,000 years of civilization. Perhaps that’s because the average age of an investment professional is 55 and they were young children during the “Volker” experience. Therefore, they do not realize more importantly than the “terminal” rate is the length of time Fed funds are held at that rate.

In the 70s inflation impacted our whole social structure. After WW ll fathers went to work and women stayed home raising children. This was captured culturally with television shows such as Leave it to Beaver, Father Knows Best and Ozzie and Harriet. As inflation surged in the late 60s through the 70s, women felt they had to join the workforce. One paycheck was not enough for raising a family. Then Diners Club credit cards were replaced by cards carrying revolving debt; a practice that continues. Thus began the dissolution of Norman Rockwell’s ideal family. Now we have half the budget of the government going for “transfer” payments and a culture of movie superheroes from comic books.  

Inflation’s greatest toll is always social, but it comes back to monetary policy. The Fed has over 300 economists with PhDs who have tried for years to create a mathematical science out of what should be behavioral economics. Powell was given bad advice by them for the continuation of 0% interest rates. The good news is that he is NOT an economist and has said rates “will be higher for longer.” We suspect the 2017 Nobel winner of behavioral economics, Professor Richard Thaler, would agree.

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