A question has haunted the aftermath of the Great Recession: where is all the inflation? If the Federal Reserve is going to spike the money supply most massively in the context of minimal economic growth, as it has since 2008, it would seem that a severe price inflation must ensue. Yet the consumer price index has grown at merely 1.5% for the past five years.
Back in the “stagflation” era, the 1970s and early 1980s, and cued up by President Nixon’s taking the dollar off gold in 1971, the Federal Reserve printed money like never before. Inflation duly roared. From 1971 to 1981, the CPI leapt a phenomenal 125%, 8%-plus per annum. And in the nine years after the 1973 peak, economic growth averaged less than 2% per year.
Economic stagnation plus Fed activism equals stagflation: we saw it all thirty-five years ago. What gives these days? Why only half of the stagflation bargain?
The recent break in the gold price, in which the king commodity has completed a 20% drop since the high point of late last year, holds a clue.
In the 1970s, “inflation” was a general phenomenon, one of whose manifestations was an increase in that pet statistic of the government’s, the CPI. However, the main way that investors responded to the Fed blowouts of the era was not to bid up consumer prices or anything like that, but to get their holdings out of asset classes that brought dollar returns.
Typically this meant plowing money into commodities, land, and other scarce if useless things (such as fine art), on the assumption that investment vehicles definitively limited in supply would hold their value in the context of dollar weakness. It mattered little that, for example, gold (up 23-fold in these years) promised no income stream. Income streams from real enterprises were nil anyway in the context of negligible economic growth and a tax code un-indexed for inflation.
The magnitude of the shift—from financial assets and claims on future income, into inert kinds of assets—amounted to something on the order of $10 trillion by the early 1980s. The reason that there was stagnation in the economy was that investors had pulled an immense amount of capital out of productive uses, as they waited for the super-loose monetary policy to pass. Stagflation was technically complete without any reference to the CPI.
The CPI explosion of the time was an epiphenomenon. It was largely the function of now-obsolete trade union contracts and corporate structure. The workforce was still substantially unionized at the time, and Big Labor found it useful to tolerate if not encourage inflation and negotiate “cost-of-living adjustments” with their employers. It made workers feel that you had to join a union. Otherwise you wouldn’t have the clout to negotiate a COLA.
The Fortune 500, in turn, found that an increasing CPI made it easy to squeeze suppliers. The clamor for “price control,” as Robert Bartley of the Wall Street Journal explained in editorials that won him the Pulitzer Prize in 1980, enabled big companies like General Motors to order their supply chain to hold the line on prices or else. Soon these little guys would sell out to GM on the cheap.
Stagflation at last passed from the scene in the early 1980s, thanks to Ronald Reagan’s tax cuts that made investments in financial assets profitable, along with the Fed’s targeting of the gold price in monetary policy. There was such an investment scramble that a slew of upstarts from McCaw Cellular to FedEx to Wal-Mart upended the Fortune 500, while labor unions found it difficult to prove their relevance in the context of twenty million new jobs.
In the present day, there is no institutional support for that one manifestation of inflation—big leaps in the CPI—even in the context of a dissolute Fed. Labor unions have passed from the scene, and big companies know they have to stay focused on operations or risk getting overtaken by the latest startup.
But even in the 1970s, movement in the CPI was secondary. The primary effect of the U.S.’s undermining of the dollar was the flight of capital to non-productive uses that served as devaluation hedges.
This is precisely what we got in our own era when gold tripled as the Fed responded to the Great Recession. From 2008 to 2012, we had stagflation without one historically contingent objectification of the inflation part: movement in the CPI.
Yet now with the serious drop in gold, coupled as it has been by a bull run in stocks, it appears that investors are peeking out of their inflation hedges in the hope that profits and returns in a reliable currency will be available in the future.
This has coincided with the federal budget sequester, public criticism from the Fed’s own governors of quantitative easing, and a big-government lame-duck president’s losses in signature legislative battles. Maybe, that is, we will have tax cuts and stable money, if not a chastened public sector, in the future. The more that this prospect becomes clear, the more gold will fall, stocks will rise, and growth, opportunity, and jobs will return.
Books on the topic discussed in this essay may be found in The Imaginative Conservative Bookstore. Originally published at Forbes.com the essay is reprinted here with gracious permission of Brian Domitrovic.