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When I talk to serious, successful investors, few ask, “Do you think the central banks will raise rates two or three times by a quarter-point before the end of the year?” or “Do you think inflation will hit 3% in the next year?” They are more likely to ask things like, “What are the chances that interest rates and/or inflation will get back up to the peaks of the 1970s/1980s?”
That is a much more important question. A quarter-point change in interest rates or inflation is a fluctuation. A return to the peaks of the 1970s/1980s would be a disaster.
No one can predict the future, of course. The easy way out on the question would be to say, “Oh no, that could never happen again.” But the productive way to address a question like this is to look at those earlier decades and to try to figure out what was special about them.
It seems to me that in the years prior to those decades, three specific political/economic factors worked together to unlock a lot of pent-up demand for money, goods and services, and funnel it into a narrow timeframe where it could have great impact. These factors helped spur the rise in interest rates and inflation that followed.
The first factor was that, during four decades between the early 1930s and the early 1970s, the U.S. managed to fix the price of gold at around $35 U.S. per oz.
Greenback became a world currency in three crucial periods
This helped set up the U.S. dollar as something of a world currency during three crucial, historic periods: the 1930s depression, World War II and the post-war boom. The role of world-currency issuer let the U.S. expand its money supply without burdening itself with a heavy load of domestic inflation — not burdening itself right away, that is. But eventually the $35 gold peg gave way, like a dam that bursts when the force of a rising river becomes too much. The breaching of that $35 barrier helped set off a worldwide wave of inflation, as the value of the U.S. dollar withered in relation to the value of gold.
The second factor was the control by Western governments and countries over the price of Mideast oil.
Thanks partly to that control, oil prices stayed low from the end of World War II till the early 1970s, despite vast increases in oil demand, in time with growth of the auto industry. This source of cheap oil brought many economic benefits to the West. Rising auto production produced jobs. Oil refining and marketing also expanded, as rising numbers of ever-larger cars hit the road. Along with profits for oil companies and growth in oil-related jobs, all this resulted in much higher oil-based tax revenues, which helped pay for construction of vast highway networks.
This arrangement also aided the less-developed oil-producing countries, of course, but the West gained much more. In 1960, five oil producers (Venezuela, Iran, Iraq, Saudi Arabia and Kuwait) formed OPEC (the Organization of the Petroleum Exporting Countries) to get a larger cut of their oil wealth for themselves. It took time for them to gain the upper hand. In the second half of the 1970s, however, world oil prices shot up more than five-fold.
Oil prices have stayed highly volatile ever since. Even at their lowest levels, however, they have been far above pre-OPEC lows. This, like the rise in gold prices, helped spur inflation around the world.
Entry of the baby boom generation
The third factor was the mass entry of the baby-boom generation into adult life, starting in the late 1960s.
The boomers’ entry into the workforce held back increases in productivity, since businesses had to take time to train the newcomers. The newly employed boomers soon began the customary sequence of marrying, having kids and borrowing money to buy houses. The combination — growth in consumers plus lagging productivity — helped push up inflation and interest rates in a variety of ways.
Looked at this way, the 1970s/1980s seemed sure to suffer high inflation and high interest rates, which lingered for the next couple of decades. Today, however, we don’t face any special factors with this kind of potential for spurring big increases in inflation and interest rates.
The central banks of the world are now ending their decade-long experiment with artificially depressed interest rates. The end of this experiment will put slight upward pressure on interest rates and inflation. Today, however, special technological and political factors are working together to moderate future increases in inflation and interest rates.
Improving technology
Improving technology is already pushing up productivity around the world. This will tend to expand goods and services available, and thus hold down inflation. Capital investment is now speeding up, due to a move toward less onerous tax and regulatory policies. In fact, today’s capital spenders can benefit from a backlog of technological advances that were developed in recent years, but less-than-widely implemented due to the more onerous tax and regulatory policies of a few years ago.
As I regularly point out, however, nobody can predict the future. When people try to do that, fear often colours their predictions. That’s what I think is happening today. This spurs investors to put excess weight on upcoming fluctuations in interest and inflation, as well as on possible outcomes of current trade talks. Excess fear tends to create investment opportunities, though it can take time to profit from them.
I still think now is a good time to hold a Successful Investor-style portfolio of high-quality stocks, spread out across most if not all of the five main economic sectors, with limited if any exposure to stocks in the broker/media limelight.
My sole caveat is that the stock market will remain volatile, as always. So you should only invest in it with funds you can keep in it for three years or more.
Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was first published on May 15, 2018 and has been republished on the Hub with permission.
