Forget the debt limit debate, which is likely to be solved. The greater danger lies in a geopolitical event like we experienced in the 1970s. History does not repeat but it does rhyme, and so we can look back at the last great inflationary period to gain insight. Hopefully there will not be a market upset, but it is better to be prepared now than blindsided in the future. Things that have never happened before happen all the time.
As the 1960s ended, Richard Nixon was President, Henry Kissinger was his Secretary of State, and Mohammad Reza Shah Pahlavi was the Shah of Iran. The Cold War between the United States and the Soviet Union was in full bloom and Iran was the US’s strongest ally in the Middle East, and so military bases had been established in that country. The Shah, for his part, was fixated on rebuilding the Persian Empire, and his greatest tool was oil. We now know, since documents were recently declassified1, that Nixon and Kissinger used shady backchannels to cement their political relationship with the Shah and hide their intentions from the American public.1
Kissinger and Nixon facilitated deals between US arms manufacturers and Iran for the purchase of military equipment. Iran was essentially trading oil for guns. During the late 1960s and into the 1970s, the Nixon administration continued to get away with their underhanded dealings for several years. Every year the Shah upped his purchasing desires, but by 1972, he wanted so much equipment that he needed to raise the price of oil by 25% to afford it.
Kissinger and Nixon balked at that, for the United States had been undergoing a bout of inflation. The Federal Reserve Chairman William McChesney Martin had raised interest rates and the United States was beginning to experience the beginnings of a recession. Arthur Burns succeeded Martin as Chairman of the Fed, and he began to lower rates to curb the recession. Kissinger and Nixon predicted that a jump in the price of oil would strengthen inflation in the midst of a recession. So, they pushed back on the Shah.
A decade prior, in 1960, the Shah had helped to organize OPEC. It was to that organization he turned when the Nixon administration tried to stop him raising the price of oil; OPEC initiated an oil boycott, driving the price of oil from $2.90 a barrel to over $12, a 400% increase. Inflation in the US took off, but the recession continued, causing “stagflation” – inflation during a recessionary period. It would take most of the 1970s for the US economy to find equilibrium once again.
The Israeli-Arab War of 1973 launched the embargo, but we now know that it was largely the Shah of Iran who pressured OPEC to keep oil prices high.
The point is, the Fed had raised rates in the late 1960s and inflation was in retreat. Increasing rates had pushed the economy into the beginnings of a recession, and so the Fed reversed course and lowered rates to bring the economy out of recession. Then, a geopolitical event caused inflation to soar and the recession to deepen.
Today, the Federal Reserve is close to reaching the end of rate increases and inflation is subsiding, albeit slowly. If there are no unexpected geopolitical events in the next few years, the Fed will probably bring rates back down in the medium-term.
Our concern today is understanding the risk of another geopolitical event sending inflation even higher. I believe there is a greater chance of this occurring than inflation receding and the Fed lowering rates. It won’t be OPEC, but it could be China invading Taiwan, the escalation of the Russia-Ukraine War, or something completely unpredictable like a meteor or earthquake. Things that have never happened before happen all the time. After all, in 2019 would you have believed there would be a disease that would kill over 1 million Americans and spread worldwide, killing nearly 7 million.
It is best to prepare for the worst and hope for the best.
There is no place to hide during inflation. The dollar from 1960 to 1980 lost 70% of its purchasing power. What that meant was, on average, what cost $1 to buy in 1960 cost $3 to buy in 1980. In 1960, a first-class stamp was 4 cents, a Coke was 10 cents, a dozen eggs 57 cents, and a gallon of milk was 49 cents. By 1980, the first-class stamp was 15 cents, a Coke was 35 cents, a dozen eggs were 91 cents, and a gallon of milk was $2.16. Those portfolios sitting in cash had lost 70% of their practical value.
Consider than even in relatively inflation-benign times like 2000 through 2023, the purchasing power of social security has declined. While social security payments have increased 78% during that time, most things that retirees purchase shot up 141%.
For example, medical expenses increased 177%, pet services increased 190%, homeowners insurance increased 193%, Medicare increased 262%, dental services increased 275%, heating oil increased 279%, prescription drugs increased 311%, and eggs increased 332%.
The lesson to be learned for investors is that there is a way to be prepared. The stock market, as measured by the DOW, took 32 years to recover from the stagflation of the 1960s and 70s. Bond yields have still not recovered. Commodities have not recovered. Real estate has not recovered. What did well was being in a select portfolio of stocks.
$100,000 invested in McDonalds in 1966 would have grown ten-fold to $1 million by 1981. But who in 1966 really believed that a small drive-up restaurant selling 19 cent hamburgers would change the world of dining? Today, McDonalds is a household name. $100,000 invested in Arrow Electronics would have grown to over $2 million, but who would have believed a local store in Colorado which sold used radios in 1966 could expand to a billion-dollar major electrical components distribution business. But they realized the potential of the transistor and did by 1981. Advanced Micro Devices dropped from $30 per share to $10, and then began to rise to over $300 (split adjusted) by 1981. Did it really matter whether a person bought at $30 or $10 when the stock continued to rise to $1,756 (split adjusted) by 1984? Some of the stocks that did very well had down-draws of over 70% in their early days.
These are not the blue-chip names of the 1970s. They were the companies that disrupted technology, demographics, and lifestyles. We believe that to be prepared for the worst, a portfolio will probably have a variety of new companies that will again be disruptive of the 2020s and 2030s. The stocks in those companies will probably see the same volatility experienced by companies like Advanced Micro Devices in the 1970s. That volatility will probably be greater on the downside but also on the upside.
No one knows for sure what the future will hold. History does not repeat, but it rhymes. We believe what was successful in the 1970s is probably a good place to begin understanding what is happening in the 2020s.
1. Cooper, Andrew Scott. “Showdown at Doha: The Secret Oil Deal That Helped Sink the Shah of Iran.” Middle East Journal 62, no. 4 (2008): 567–91. http://www.jstor.org/stable/25482569.
2. “10 Retiree Costs That Have Risen Most Since 2000”, Think Advsior, May 10, 2023 (2023.05.10.2023 10 Retiree Costs That Have Risen Most Since 2000 _ ThinkAdvisor.pdf).