What happened in the 70’s?

In a word, stagflation. We had to suffer through rising prices, and a poor economy with high unemployment, both at the same time.

Up until that time, such a thing was not thought to be possible. The theory was, rising prices is a sign of demand. If people are demanding all kinds of stuff, then business should be great, and unemployment should be low.

In certain economic circles, blame is placed on the government. Prices aren’t rising because we are demanding more stuff; they are rising because the government is printing too much money. On a broader scale, it is said, the government was debasing the money, which made it unattractive for foreign governments to sit on all the dollars we were sending them. So they started demanding gold instead. When we ran out of gold, we took ourselves off the gold standard and told everyone to choke it down.

Here’s the problem: the government does not actually print money. You do. The government does not.

When you put something on your credit card, you are creating money out of thin air. That’s what “credit” means; you’re spending money you haven’t made yet. You might think Visa or Mastercard has that money sitting in a bank somewhere, waiting for you to use it. If you think that, you would be sadly mistaken. If you put $1000 on a credit card, Visa or Mastercard needs to have about $100 on hand somewhere. As for the rest, they figure you’re good for it. Another way of looking at it is, if you deposit $1000 at the bank, they are going to turn right around and lend $900 of that to someone else. We started the day with $1000 in circulation, and finished the day with $1900 in circulation. The difference is inflation; or in other words, an increase in the supply of money.

The government, on the other hand, can’t just make up money. Somebody has to give it to them. Back in the 60’s and 70’s, it was borrowing it from you. Remember when your grandma gave you a savings bond for your birthday? And how pissed you were when you found out you couldn’t buy candy with it? True, your grandma and Uncle Sam both felt the Vietnam war was a better use of your money than candy. But that doesn’t make it inflationary.

The real problem back then was the balance of payments. We were buying more stuff than we were making. That’s not called “trade,” it’s called “running a tab.”

Say you’re the government of Saudi Arabia, sitting on a bunch of dollars you people sent them to put gas in their cars. What are you gonna do with the money?

In the years immediately after WWII, they hung on to it. They needed dollars to buy stuff. Because we were the only ones making stuff. Once Japan and other countries dug out from under the rubble, and started making stuff themselves, the Saudi’s didn’t need dollars as much as they did before. So they traded them in.

The agreement following WWII was, you could trade your dollars for gold anytime you wanted to. So that’s what they did.

Problem is, we started running out of gold. Because we were running a tab, remember. The other problem was, it appears we were printing up too many dollars. Every time you took out a loan to buy a car, you were printing money. Every time you filled up the tank on your credit card, you were printing money. To the extent we were dealing with inflation, it was because the Saudis and other countries were sending all that money right back to us.

The answer was three-fold.

First, we closed the gold window. Meaning, we decided that no, we weren’t going to trade dollars for gold anymore.

Second, we convinced the Saudis to stop sending us our money back, and to invest that money instead.

Finally, we realized we had to deal with all those extra dollars floating around the country. So eventually (beginning during the Carter administration) we quit lending money quite so much. The Fed started selling bonds like crazy, and every time they made a sale, they destroyed the money they received. That had the combined effect of reducing the supply of money in circulation, and driving the cost of debt through the roof. Credit card interest, for example, approached loan-sharky levels of 20% or more. Flip side is, your cash dollar went further.

That stung a little, but it got us on the track we are today. Where we can borrow as much as we want, and stick it to the other guy. Today, the “other guy” is more likely to be Japan or China than Saudi Arabia, but the same principle applies.

Cool thing is, they typically use most of that money to buy treasury bonds, which allows the government to spend all kinds of money on Medicare and healthcare and such. Weird system, but note how the government is still not printing money. Before about 1985, your grandma gave em the money. Now, the Chinese are giving them them the money, and a lot of it.

The only question is, who is gonna give the government money if the Chinese stop doing it? If the Fed gives them the money, that will be inflationary. Until that time, don’t be hating on your grandma, or your government.

Now. Why were prices rising in the 70’s?

In general, prices rise when there are too many dollars chasing around a limited supply of stuff.

Note, the dollars you intend to spend on a particular item can come from one of several sources:

1. Money you could have spent on something else.
2. Money you might otherwise have just hung on to.
3. Money you might otherwise have invested.
4. Money you borrowed.

If you put enough money in play, you’ll bid up the price of something. And inflation does allow you to do that. But that’s not the most intersting part of the question. Because regardless of where you got the money from, prices can’t stay high for long. Eventually some clever entrepreneur is going to get in on the action. The interesting question typically boils down to supply. What are the constraints on production? Why can’t they just ramp up the assembly line?

In the 70’s, there was at least one big constraint on production. The Saudis evidently didn’t feel like they were getting what they should for a barrel of oil, so they cut production on purpose. And at one point, when they were really pissed, they stopped shipping oil to us. (I forget what they were pissed about, but recall they were furious about something.)

It’s also an interesting question, what were we doing with our own productivity? Were we really working as hard and as smart as we could? I remember domestic auto manufacturers back then were dinosaurs, we were spending a bunch of money on union perks but I don’t remember us doing anything innovative in the engineering department. Which might be part of the reason we lost so much money to Japanese auto manufacturers. I remember when a high school friend bought a Honda, which back then was a tiny, rickety little car. We laughed at her. Look who’s laughing now, eh?

The labor market was flooded with boomers back then, which had the effect of keeping wages low.

I think it’s possible that the combination of low wages, and easy credit, made it easy for zombie companies to get by with marginal business plans. Not exactly a formula for productivity.

The upshot of it all is, we were just doing a crappy job. We got away with a lot because we were the only game in town after WWII — every other factory in the world had been bombed into oblivion — and I think maybe we just started believing our own doohockey.

And we still do. We are still really adept at running up our own credit cards. Not quite so good at making stuff people want to buy. True, we make money, which is in high demand. Up until recently there’s been an insatiable demand for dollars out there, and by association dollar-denominated debt. So, there’s finance. Information, or in other words big tech. Also we make really dope tanks and fighter jets, which we can sell or lease (essentially). And we can use some of those tanks and jets to defend the monetary regime, which supports demand for dollars out there. Great work if you can get it, I suppose.

Beyond that, our economy is 80% service-based. Looking at it from my perspective, that’s great for the healthcare industry, and it’s good whether you consume healthcare, or provide it. I’m sure it’s great for other industries as well. Entertainment. Football. Fashion. Higher education. I can think of several.

But eventually, I think, we are going to have to face reality. Eventually we need to figure out how to make stuff, and sell it. That was the lesson we might have could have learned in 1971. But, with the exception of information technology, haven’t yet.