Supply shock in the making for an American stagflation   

ANTHONY KILA

Anthony Kila is a Jean Monnet professor of Strategy and Development. He is currently Institute Director at the Commonwealth Institute of Advanced and Professional Studies, CIAPS, Lagos, Nigeria. He is a regular commentator on the BBC and he works with various organisations on International Development projects across Europe, Africa and the USA. He tweets @anthonykila, and can be reached at anthonykila@ciaps.org 

Stagflation is arguably one of the most fascinating phenomena in economic cycles. It has long presented challenges for political economists to conceptualise and regulate. 

“Stagflation” is derived from the combination of two words: “stagnation” and “inflation.” It describes an economy characterised by high inflation rates, low growth, and elevated unemployment. This situation represents a tangible phenomenon that contradicts traditional economic theory, which posits a negative correlation between inflation and unemployment, as proposed by the Phillips Curve.

The term “stagflation” was introduced into our everyday lexicon by Iain Macleod, a British politician and Chancellor of the Exchequer, who, in a speech to the UK Parliament, described the British economy in these terms: “We now have the worst of both worlds — not just inflation on one side or stagnation on the other, but both together. We have a sort of ‘stagflation’ situation.” History and general education have not been very kind to Iain Macleod; his contributions to the history and economy of our world today deserve more attention and possibly greater recognition. 

A case that students of economics and policymakers should take time to study is the decade of American stagflation, which lasted from around 1970 to 1982. During that decade, inflation more than doubled, rising from 5.8 percent to 13.5 percent; economic growth was hindered by multiple recessions, decreasing from 0.2 percent to -1.8 percent; and unemployment increased from 4.9 percent to 10.8 percent.

With high inflation, rising unemployment, and stagnant wages, everyday life in the USA became characterised by daily struggles. Essential goods and services such as bread, milk, eggs, and meat grew increasingly expensive, while petrol and electricity became luxury items for many. It was not just the price; even getting petrol and diesel was a problem as there were queues at petrol stations that Americans insist on calling gas stations. Numerous households found themselves rationing their use of all forms of energy. With interest rates at over 18 percent, mortgages were out of the reach of many in the country, and many tenants were defaulting on their rents.

Businesses and investors were not spared the crisis and had to deal with high production costs and receding demands for their goods and services. Many businesses had to shut down as they also had to deal with loans with interest rates above 20 percent. Those who remained open had to lay off many of their workers. 

Economic hardship, uncertainty, and frustration led many to lose trust in the government and all previously respected orders. The decade’s anger and despondency led pop culture to produce dystopian and defiant films such as Taxi Driver (1976) and Network (1976). Situating the uncovering and management of the Watergate scandal in this context will help us better understand that event.

The causes of American stagflation can be traced to closely interrelated national and international politics, policies, and economic and social factors. General literature agrees that the main factors at the origin of the American stagflation were the oil supply shock, monetary policy of the Federal Reserve, economic policies by the Nixon Administration, budget deficit and spending, and competition from Germany and Japan. To these we need to add the collapse of the Bretton Woods accord and the expenses of the Vietnam War. 

There is a general tendency to attribute the oil supply shock as the foundation of American stagflation; however, this perspective is incorrect. A more accurate way to outline the causes of the economic downturn begins with the costs and other repercussions of the Vietnam War. American military expenditures soared during the Vietnam War, reaching a peak of £77.4 billion in 1969 (over £600 billion in today’s money). Indeed, initially, war spending boosted industries such as defence, manufacturing, and technology, generating employment in these and other sectors, which resulted in GDP growth in the early years. The economy, however, became sweltered due to this massive government spending, contributing to high inflation.

The well-known 1973 OPEC oil embargo (imposed after the Yom Kippur War) and the 1979 Iranian Revolution are two oil supply shocks that inflicted severe damage on the American (and other Western) economies, exacerbating an already dire situation. Oil prices surged from $1.8 to $11.65 in 1973 as Arab nations and others with oil imposed an embargo on the USA and several other countries, including South Africa, as a sanction against the USA for its support of Israel in the conflict. The resulting energy crisis is a shock because it caught everyone off guard. One can only imagine Americans’ conversations while queuing to purchase expensive petrol, diesel, and gas in the 1970s. 

During the decade of American stagflation, Arthur Burns, an economist, diplomat, and politician, served as the chairman of the Federal Reserve. Like many others, Burns believed that the primary cause of American inflation was the energy crisis rather than the excessive money supply. In 1970, when Arthur Burns assumed office, inflation stood at 5.8 percent; by 1974, it had reached double digits. Whilst in office, he did not tackle the issue of excessive money supply; his view was that some inflation could be tolerated to preserve employment rates. He attempted to stimulate the economy with low interest rates, but the situation backfired. 

In August 1971, confronted with a bad economic cycle, the then American president, Richard Nixon, announced some drastic decisions. His plans and announcements aimed to reduce inflation, combat unemployment, and defend the US dollar against speculators. To achieve these goals, Nixon imposed tariffs on imports and froze wages and prices for 90 days to prevent further price increases. The plan, though, did not work: after the 90 days of price and wage regulation, economic chaos followed. Nixon also ended the gold standard in 1971 (the “Nixon Shock”), leading to a weaker dollar and rising import prices, fuelling inflation.

The factors that helped America emerge from the decade of stagflation were the same ones that brought her into it: closely interrelated national and international politics, policies, and economic and social factors.

The American government’s military spending increased by about 75 percent between 1964 and 1975 and by over $1 trillion from 1962 to 1973. With the end of the Vietnam War, military expenditures were also drastically reduced, reducing the heavy burden of American debt.

With Paul Volcker as Fed chairman in 1979, monetary policy changed. Interest rates aggressively rose to curb inflation, which dropped from 13.5 percent in 1980 to 3.2 percent in 1983. The price paid for this was an unavoidable recession between 1980 and 1982.

Unlike Nixon, the Reagan administration implemented supply-side policies, including extensive deregulation and tax cuts, encouraging investments and production.

The collapse of oil prices in the mid-1980s reduced business operating costs, allowing for even more investments and productive activities.

There are many lessons from the American stagflation for those willing to learn.

But all of that was over four decades ago; these days, there is a new supply shock in the making in America that is coming from the increase in the cost of consumer and capital goods. Thanks to the new tariffs conceived to make America great again, goods will likely become scarce, expensive, or both. For good measure, the government is also cutting public spending. It is easy to see why this might lead to fewer goods to buy and less money to spend. 

Join me @anthonykila, if you can, to continue these conversations. 

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