Inflation Trivia

Here is some useful context for central bank policy makers, Wall Street and Main Street.

Let's learn from history, not repeat it.

 

May 8, 2022 - Inflation Trivia #6  The REAL rate of interest.  

The REAL rate of interest is the nominal or headline rate adjusted for inflation.  Most economists see this is the true measure of whether monetary policy is tight (high rate) or loose/stimulative (low rate).  Many compute the REAL rate as the nominal one-year treasury rate minus trailing twelve months inflation.

Over many decades, the real rate of interest generally hovered in a 1% - 3% range.

 

During the past 70 years ending first quarter 2022, REAL interest rates at one point reached a low of NEGATIVE 7.51%. When did that occur?

  • Answer Choices:

    • a)  August 1971

    • b)  May 1980

    • c)  July 2008

    • d)  February 2022  

  • A) In August of 1971, the U.S. left the gold standard and moved to floating exchange rates.  It is also the month in which wage and price controls were implemented to fight inflation.  That month began with the one-year treasury at 5.15% and trailing twelve-month inflation of 4.62%.  The REAL rate of interest was a POSITIVE 0.53%.

  • B) In June of 1980, the Fed was ratcheting up to a 20% fed funds rates.  As late as May 1980, with inflation soaring, the REAL interest rate was a NEGATIVE 5.86%.

  • C) With the financial crisis approaching in July 2008, the REAL interest rate bottomed at NEGATIVE 3.37%.  The nominal one-year rate was 2.23% but inflation had reached an eighteen year high of 5.60%.

  • The correct answer is D.  In February 2022, the one-year treasury rate was 1.03%.  However, after adjusting for inflation of 8.54%, the effective or REAL interest rate was NEGATIVE 7.51%.  That reflected the most stimulative Federal Reserve monetary policy of the past 70 years.  Even as the central bank talks about tightening, money became even cheaper.  We await the May 11 report on the consumer price index.​  (Source:  LongtermTrends)

April 5, 2022 - Inflation Trivia #5  Inflation and Stock Prices

  

How does inflation impact stock prices?  On February 6, 1966, the Dow Jones Industrial Average closed at 995.15, It was closing in of the milestone 1000 level.  In that same month, inflation crossed above the 2.5% mark.  Except for two outlier months, inflation remained above 2.5% until Feb. 1986, twenty years later.

As measured in 1966 dollars, when did the Dow finally reach the 1000 milestone?

  • Answer Choices:

    • a)  Nov. 10 1972

    • b)  Nov. 13 1982

    • c)  Feb. 21 1986

    • d)  July 7 1995 

  • The correct answer is D.  It took almost 30 years for the Dow (in 1966 dollars) to add those next five points.

    • On July 7, 1995, the Dow closed at 4703.

    • By then, the 1966 dollar was worth only $0.21, having lost 79% of its purchasing power.

    • Thus, a basket of Dow stocks in 1995 could finally have enough value to buy the same $1,000 of goods and services that the Dow could by in 1966.

  • Even in nominal terms, the Dow didn't sustainably cross the 1000 level until Nov. 1982.

    • It briefly topped 1000 in Nov. 1972 but quickly fell back by Jan. 1973.

    • At its worst, the Dow had dropped 45% to 550 in 1974.

    • Inflation during that cycle peaked at 14.8% in March 1980.

March 9, 2022 - Inflation Trivia #4  Wage and Price Controls  

In a last-ditch effort to stop run-away inflation, Richard Nixon instituted wage and price controls on August 15, 1971. These were widely viewed as a short-term political success and a long-term economic failure leading to acute shortages of goods and services.  Per Yergin and Stanislaw's book The Commanding Heights: “Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.”  What was the rate of inflation when Nixon ordered wage and price controls.  After you enter your choice, see below

for answers and context.

  • Answer Choices (and poll results from first 1,065 responses):

    • a)  4.38%  (12%)

    • b)  6.38%  (19%)

    • c)  9.38%  (29%)

    • d)  15.38%  (40%)​  

  • Nixon's August 15 1971 Executive Order, after consultation with Fed Chairman Arthur Burns, did three things:

    • Instituted wage and price controls

    • Removed the USD's convertibility into gold

    • Set surcharges on imports

  • At the time of this last-ditch effort to control inflation, the YoY rate of inflation was 4.38%

    • The program was an economic failure and inflation rose to 12.20% by 1974.

    • Inflation peaked at 14.59% in 1980.

  • Daniel Yergin and Joseph Stanislaw explain in The Commanding Heights: The Battle for the World Economy, it was obvious that price controls didn’t work: “Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets.”

Feb 7, 2022 - Inflation Trivia #3  Back in 1965 . . .  

Paul Volcker is widely credited with raising interest rates in 1980 to break the back of inflation during the last great inflationary cycle.  Less well known is the story of the first one half percent (50 bps) rate increase (to 4.50%) fifteen years earlier in the cycle as inflation crossed the 2% level.

 

U.S. Federal Reserve Chairman William McChesney Martin infuriated President Lyndon Johnson in Dec. 1965 with that 50 bps increase.  He famously remarked that:

  • Answer Choices

    • a)  "Guns and butter" are a bad fiscal policy mix.

    • b)  It was time to take away the "punch bowl".

    • c)  "Great Society" spending should be postponed.

    • d)  Nearing 1,000, the Dow Jones average was "irrationally exuberant"

 

Fed Chair Martin coined the "punch bowl" analogy in 1955 but didn't put it in practice until this famous clash in 1965.  That 50bps rate hike was the first of many, over a fifteen year period that finally broke the back of inflation.

Jan 8, 2022 - Inflation Trivia #2  How Long Does It Last? 

 

Inflation now exceeds central bank targets of 2% YoY and the U.S. Fed is no longer referring to inflation as "transitory".  Some central bankers even suggest that inflation could extend through late 2022 and into early 2023. Here's some missing historical context.

How many months did the last great inflation of a few decades ago last?

  • Answer Choices:

    • a)  29 months

    • b)  43 months

    • c)  61 months

    • d)  198 months

  • Let's think in terms of inflation at 3% +.

    • Inflation in the U.S. (CPI-U) crept up over 3% YoY in Nov. 1967.

    • Except for two outlier months, it remained above that level every month until May 1983, 198 months later.

  • Let's think in terms of 2.5%+.

    • Inflation in the U.S. (CPI-U) crept up over 2.5% YoY in Feb. 1966.

    • Except for two outlier months, it remained above that level until Feb 1986, 240 months later.

  • Let's think in terms of 2.5%+ and ignore the outlier year of 1986.

    • Inflation in the U.S. (CPI-U) crept up over 2.5% YoY in Feb. 1966.

    • Except for two outlier months, it remained above that level until April 1994, 338 months later.

  • It spanned seven U.S. presidents:  Johnson, Nixon, Ford, Carter, Reagan, Bush Sr. and Clinton.

  • This is what the Shadow calls "perspective".

Dec 18, 2021 - Inflation Trivia #1  When Rates Peak  

(the first in what history tells us may be a long series of not-so-trivial vignettes)  

On June 15, 1981, a previously unthinkable event occurred. What was it? 

  • Answer Choices and poll results:

    • a)  U.S. leaves the gold standard (36%)

    • b)  President Nixon resigns (5%)

    • c)  Mass margin calls threatened (34%)

    • d)  U.K. banks close for one week (24%)

  • On June 15, 1981, the Fed Funds rate hit 20.61%.

  • I remember that day sitting with Bob Arnold, Merrill Lynch's treasurer.  The Fed Funds rate was about to breach New York's usury ceiling.  We were gaming out several disaster scenarios.

    • Would Fedwire shut down, since, effectively, it was a system that transferred fed funds?

    • Would investors max out their margin accounts (capped at the ceiling) and invest risk free in treasuries at a handsome spread while at the same time collapsing the entire brokerage industry?

    • Would brokerages preserve their profits by preemptively issuing margin calls, possibly taking the markets down?

    • Would someone invoke the questionable phrase "institutional exemption" and just ignore the usury laws?

    • Would the interbank lending market freeze-up and what would be the results?