Why All Economic Booms End the Same Way

The current inflation situation reminds me of the early 1970s.

As a kid back then, I can vividly remember the rationing at our local gas station… License plates ending with odd numbers filled up one day, evens the next.

Those shortages went beyond filling up a tank of gas. I also remember experiencing food shortages when the grocery stores ran out of meat.

While the Organization of the Petroleum Exporting Countries (OPEC) embargo was a contributing factor to the shortage in oil in the U.S. at that time – and was blamed for the subsequent huge rise in inflation that dominated that decade – the real story is more complicated than that.

When it comes to economics, politics are never far away…

Before the 1972 election, budget deficits increased to fund a new Social Security program. This, along with huge pressure on the Federal Reserve (from the government) to lower interest rates, all laid the groundwork/base for a breakout in inflation.

Temporary measures to control rising inflation by imposing wage and price controls proved to be just that… temporary.

When the controls were stopped, prices and wages saw a large jump as businesses and workers tried to recover lost income.

As prices and wages skyrocketed higher, inflation got way out of check. From a rate of 3.41% in December 1972, inflation hit 12.34% just two years later in December 1974.

After subsiding briefly in the latter half of the decade, inflation peaked at just under 15% at the beginning of the 1980s (14.76% in April 1980). That’s over six years after OPEC lifted its oil embargo on the U.S. in March 1974.

Runaway inflation and high interest rates ruined a generation of business owners… It also put millions of Americans out of work.

The objective of such expansive monetary policy in the early 1970s was to try to create a business and jobs bonanza. After coming out of the recent recession (in November 1970), the last thing the government and policy makers wanted was another one.

However, it took interest rates hitting an eye-watering 20% (and higher) in 1980 and a brutal recession before inflation finally came back under control.

Of course, no two business booms are ever the same… nor are recessions. There’s always a variety of moving parts that make each of them different.

But, the one thing that ultimately brings all booms to an end is runaway inflation. That’s because high inflation is always followed by a rise in interest rates. The only question comes down to the timing.

We explored how this is currently playing out in yesterday’s essay on home construction. We also saw that with the economic data released on Wednesday, which shows that housing starts (new construction) has fallen 0.7% month over month.

That report was the lowest in six months and the third lowest over the past year. Increasingly expensive building materials like lumber and copper, plus a labor shortage, contribute to rising construction costs.

While fear of inflation might encourage new home buyers to speed up their purchase (to avoid paying more later on), ultimately if costs rise too high (and fast), they will prolong their purchase indefinitely.

Add in a double whammy of higher interest rates, and you can see how demand can soon evaporate.

That’s why I’ll continue to watch each inflation report closely, especially after the recent housing starts data.

Unless inflation (with the accompanying higher interest rates it brings) is brought under control, then that drop in demand will eventually spread to other sectors beyond home construction.

And that’s what could really bring this bull market down.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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