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10 March 2023

Worse than the 1970s

Our economic situation is clearly different from the 1970s, with its oil price shocks, trade union barons, and incompetent central bankers.

It is worse.

I see three striking parallels between the 1970s and today, but one crucial difference that swings the balance.

The first, and most obvious parallel, is the rise in inflation after a series of price shocks, and the way central banks are reacting to this. In the UK, for example, the first oil crisis in 1973 led to a rise in inflation to 23% by 1975. It come down in the following two years, but by less than what economists had expected. With the second oil price shock that started in 1978, inflation rose again. The Bank of England, and other central banks worldwide, started to cut interest rates too early.

Today, core inflation in the UK, the US and the euro area is between 5.6-5.8%. The base rates in all of these countries is well below the level of inflation, just as it was in the 1970s. Again, central bankers are sending signals that the worst may be over. Andrew Bailey, the governor of the Bank, has been signalling that we are close to the end of the rate rise cycle. So did the governor of the Bank of France recently. This is more or less what was happening in the 1970.

The second parallel is the deterioration of public finances. After the frugal 1950s and 1960s, governments in the 1970s started to use fiscal policy actively to counteract the sequential crises. The UK had its sovereign debt crisis and an IMF bail-out in 1976. US fiscal deficits rose strongly under the presidency of Jimmy Carter.

It is exactly what western government did almost 50 years later, during the pandemic and then again after Russia’s invasion of Ukraine. Much of the stimulus spending was bankrolled by central banks through quantitative easing. The US passed a total of $5 trillion dollar in stimulus during that period. During the lockdown, western governments everywhere bankrolled companies and subsidised wages. After the rise in energy prices, they did it again, helping people and companies to pay their energy bills.

Modern fiscal policy operates under the guiding principle that we must do whatever it takes - an expression that describes the mindset of the last decade better than most. It was not always like that. Before the 1970s, the world laboured under hard budget constraints. There was stuff they just could not do. The US went to the moon in the 1960s, but it started to neglect its cities. When we get hit by a pandemic and a war, life goes on as though nothing has happened.

The third parallel is a global policy regime shift. Between 1945 and the early 1970s, the western world plus Japan and Australia had locked themselves into a system of semi-fixed exchange rates, in which the US dollar served as an anchor. Known as the Bretton-Woods system, it ensured a long period of economic and financial stability. But like all exchange rate system regimes, this one, too, broke down because economies diverged over the years.

Our regime shift today is not about exchange rates, but global trading relations. I wrote in a previous column about the break-down of one-world-globalisation into two halves. Geopolitics intruded. We still trade with one another, but where we shift our trade and investments towards countries on our side of the divide. Off-shoring is now friend-shoring.

Here the parallels end. What is different this time is that what comes next will be less benign that the Thatcherism and the Reaganism that came after the 1970s. I recall that, as a student back in those days, the radicalism of Thatcher in particular seemed extreme. It looks less scary from today’s perspective, and less scary than what might hit us now.

Thatcherism was part of a global shift in macroeconomic policy priorities towards free markets and deregulation. If was the result of an intense economic debate. There is nothing like this today. Just witness the absurd economic policy priorities of the two main parties in the UK. The prime minister promises to reduce inflation, and the opposition leader wants to outgrow the rest of the G7 industrial countries. Germany’s finance minister wants the EU to revert to the old pre-pandemic fiscal rules. I see the same paucity of ideas in other European countries too. The political centre, left or right, has nothing to offer but empty slogans.

Italy is the country that went down this road earlier and further than others. Over the last 25 years dissatisfied Italian voters tried parties of the centre-left and the centre-right, interlaced with periods of technocratic governments. Since 2018 they have been turning to anti-establishment parties, like Beppe Grillo’s Five Star, Matteo Salvini’s Lega and Giorgia Meloni’s Brothers of Italy. That search will continue until they find someone who delivers. Maybe it is Meloni, but I doubt that it will be a politician from the centre.

Whatever comes next, I would expect it to be more repressive and authoritarian, and in particular less supra-national. Brexit has been the most extreme example of the latter trend, but the era of European integration is past its prime in other places too. I also expect future political majorities be less enamoured with free markets and institutional arrangements like independent central banks.

So yes, it probably will be worse than the 1970s. There were options left back then that are no longer available. Nothing is ever certain, but another age of extremes is more likely in my view than the fairy tale of capitalism reforming itself.

It is not what capitalism does.

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