In the last year or so, the biggest worry raised in our conversations with clients has been a return to higher inflation. It’s an economic bogeyman and people have long memories about its impact. When I was living in West Germany, in the 1980s, people still had concerns about a return of the hyperinflation of the 1920s and, in the UK, our concern is that we will see a return to the economic conditions of the 1970s and 1980s.
The first thing to remember is that inflation is a backward looking measure. It measures changes in the price of goods and services which have already occurred. This may seem like an obvious thing to say, but news reporting usually suggests otherwise – bad news sells! But, importantly, if you have retired and you aren’t feeling the pinch, you can give yourself and your retirement plan a pat on the back; prices have gone up by 5.5% over the last year, and your retirement plan has coped.
I have been taking a look at what happened economically back in the 1970s, to see if what happened then might give us a guide to what might happen today.
There are some similarities. In the 1960s, there had been a long period of economic growth, with high employment levels, but without rising wages; as there has been for the last ten years or so. In the 1970s, this was followed by an oil price shock and a sharp rise in inflation. It all sounds very similar to today’s economic conditions. In the 1970s, inflation reached a peak of 27%, interest rates hit 17%, the stockmarket lost 70% of its value and we had two recessions. A repeat of the 1970s doesn’t sound good, even if Arsenal do win the Double again.
But, the similarities are easily outweighed by the differences.
- The oil price shock of the 1970s was of a totally different magnitude to that which we have recently experienced. The oil price went from about $3.50 per barrel to almost $37 during the 1970s. So far, we have experienced a rise of “only” 50% in the oil price; a 1970s style rise in the oil price would mean that you would be paying about £15 per litre for petrol.
- Interest rates are far lower now than they were at the start of the 1970s, even after the recent rises.
- Central banks have “quantitative tightening” as a device they can use (this is the opposite of “quantitative easing” and effectively takes money out of the economy, which should help to combat inflation). The idea that the Bank of England might own, buy and sell government bonds had occurred to nobody.
- Western economies are more energy efficient than they were back then; to create one unit of economic growth now, we need to consume a lot less than 50% of the energy than we did in the 1970s. Putting it another way, energy is much less important to the economy now than it was then.
- There has been a reduction in the share of the energy market taken up by oil and natural gas. Innovation often follows a crisis. The 1970s oil shocks were followed by a decline in the percentage of the energy market taken up by oil – a shock in the oil and natural gas markets might be the impetus that the alternatives need.
The FTSE All Share Index started to lose value at the start of May 1972 and it took about six years to recover its value. During those six years, the companies in the FTSE All Share Index continued to pay an income in the form of dividends. And in the 1980s, the value of the index increased by 430%!
The history of the 1970s (and, for that matter, the economic history of just about any other period) tells us that there are two essential ingredients in the recipe for investment success – diversification and patience. Removing either of these ingredients could leave a bad taste in your mouth (I’m suddenly reminded of Vesta curry!).
Philip Wise | firstname.lastname@example.org
Managing Director and Chartered Financial Planner