Lately, I’ve gotten quite a bit of 70s (1970s) deja vu. Yes, I’m old enough to vividly remember the 70s as I crossed the decade as a teenager, graduating high school and almost, college.
If one has my memories, the 70s were pretty turbulent times, analogous to now. In 1973, Israel and the Arab (Egypt and Syria) world began a war in October…similar to this weekend. The timeframe is nearly identical – over the Yom Kippur holiday (hence that war was known as the Yom KIppur war). The 1973 war lasted 19 days. The U.S. engagement in Vietnam had just ended.
The U.S. economy in the 1970s felt very much like the economy of today. Inflation was high and thus, commodity prices were as well (food, energy, etc.). Similar to now, inflation was driven by rising petroleum prices, very much influenced by politics and war in the Middle East (OPEC cut oil production then, just as now).
President Nixon inherited Vietnam war debt as well as the mounting debt from social welfare programs created during the Johnson presidency (the Great Society programs). Medicare and Medicaid (Titles 18 and 19) were born in the 1960s. Debt levels rose to levels not seen since WW II.
In 1973, the budget deficit was $14.3 billion. With the rapid rise in the price of petroleum products due to the OPEC-engineered shortage of 1973, inflation increased dramatically. Monetary policy was tightened to fight inflation, but interest rates hit new highs and the deficit reached $59 billion by 1980.
By 1980 total federal debt had jumped to $914 billion, an increase of $532 billion since 1970. (Sales of Savings Bonds continued to increase but could not keep pace with the increase in the total debt. At the end of the decade, the total of $72.7 billion in Savings Bonds and Notes was only 8% of the public debt.). A great read on inflation, causes and results, during the 1970s is available here: 1970s Inflation
As the 1980s began, inflation (CPI) was running at 14% with core inflation (less food and energy) not that far behind. Mortgage interest rates were in the mid-teens (regionally varied). At the peak in 1981 (October), mortgage rates reached 18.6%. By the end of the 1980s, rates were down to approximately 10%.
The 1980s also saw the Federal Reserve take extreme monetary policy action to curb inflation. At the start of the 80s (January), the Fed Funds rate was 14%. By December of 1980, the Fed had moved the rate to 19-20%.
Rates began drifting downward quickly, falling first to a target range of 13-14 percent on Nov. 2, 1982, then down to 11.5-12 percent on July 20, 1982. After some oscillation, interest rates haven’t eclipsed 10 percent since November 1984. The “effective” fed funds rate averaged at 9.97 percent during this 10-year period.
Fast forward to today, and the title of the post, as I look at the economy today and the parallels to the 1970s and 1980s, I wonder how this economy will transition. Yes, times are different, but the parallels are striking. Oil prices were rising pre-Hamas and Hezzbolah attacks on Israel over the weekend. War in the middle east inevitably raises oil prices, especially if supply is disrupted in the Persian Gulf.
Like the 1970s, the U.S. government has ratcheted-up spending. COVID and entitlements and other government handouts have added nearly $8 trillion in additional debt/deficit since 2019 (pre-pandemic). Both political parties share responsibility for this spree. And, as Friedman (Milton) told all, government spending unconnected from any productive outcome (GDP growth, investment, etc.) is inflationary.
The greater the amount of government debt the economy bears, the more private investment capital is diminished by increasing taxation and/or spending cuts to cover the rising cost of interest payments to service the debt. The cycle can become insidious, especially if government spending continues at a rate faster than GDP growth.
Is there an end where the levels of government debt and deficit spending become unsustainable? A recent publication by the Penn-Wharton Center (their budget model) indicates that the end period is about 20 years from now…conservatively so. That is alarming. Much of the driver energy to that “cliff” (Thelma and Louise come to mind) are deficit financing (a greater share of the Federal budget) and entitlement programs such as Medicare and Social Security. The Penn-Wharton report is available here: When+Does+Federal+Debt+Reach+Unsustainable+Levels_231006_174503
From the report….
- The U.S. “public debt outstanding” of $33.2 trillion often cited by media is largely misleading, as it includes $6.8 trillion that the federal government “owes itself” due to trust fund and other accounting. The economics profession has long focused on “debt held by the public”, currently equal to about 98 percent of GDP at $26.3 trillion, for assessing its effects on the economy.
- We estimate that the U.S. debt held by the public cannot exceed about 200 percent of GDP even under today’s generally favorable market conditions. Larger ratios in countries like Japan, for example, are not relevant for the United States, because Japan has a much larger household saving rate, which more-than absorbs the larger government debt.
- Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation). Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.
- This time frame is the “best case” scenario for the United States, under markets conditions where
participants believe that corrective fiscal actions will happen ahead of time. If, instead, they started to believe otherwise, debt dynamics would make the time window for corrective action even shorter.
As we are in political season right now (and for the next year or so), the issue of the economy will be front and center. I’m hoping the candidates will address the above points from Penn Wharton, especially the drivers such as spending and entitlements. Medicare as I have written is unsustainable as it is configured, requiring a complete overhaul of funding, coverage, and bureaucratic policies. Social Security has a bit more life but it too, requires reforms. Frankly, most of government needs major overhaul if we are going to avoid the pain of the 70s and most of the 80s. We should have learned from then…
To my Israeli readers and my Jewish friends and readers, baruch hashem. May there be peace….