Finance and Fashion – Back to the ‘70’s

There has long been empirical evidence of a relationship between the peak of an economic cycle and a high degree of garishness in clothes and home décor. Personal experience confirms this as the image of turquoise tiles and brown baths are too much to dispel from childhood memories of the 1970’s. Likewise in the clothing stakes, nothing could match my sister’s bellbottom flairs for sheer size and decorative effect. There is even a chart that shows a correlation between the length of women’s skirts and the state of the economy i.e. periods of economic decline lead to a more conservative dress sense and coverage of the body. The two factors could be an accident of statistics, or maybe the chart’s creator just needs to get out and get a life.

The 70’s were a very mixed decade. In spite of the early setback of the Beatle’s break-up, the next few years brought a significant economic boom up until the crash of ‘74. Much like today, there was ballooning growth in debt and deficits as easy monetary conditions gave the feeling that the good times would never end. Just as the decade started in a flash of colour and optimism, so it ended in drab misery with cold, candle-lit evenings resulting from strikes and power cuts. Just as we endure terrorist threats today, the 70’s saw communism thrive in a post-Imperial climate. This was created by a misplaced enthusiasm to dismantle the colonial infrastructure without a proper handover period. As we have seen in Iraq, if you don’t replace an existing system with something better, then a political vacuum sucks in malcontents from across the globe. Indeed, Iraq has now become the front line for every anti-American organization worldwide.

It is all too easy to use history selectively to support a point, by choosing the bits that agree with your hypothesis and leaving out the exceptions. However, there are some remarkable similarities going on. As with every cycle, a period of low interest rates leads to herd-like bank lending to a sector that is in a bubble and as the argument becomes more compelling, so the frenzy escalates. Banks fall over themselves to lend yet more at ever lower margins just when they should be scaling back and heading for the exit. We have seen this in previous decades (and centuries) with loans to Latin America and the UK property market to give but two examples.

On this theme, I suspect that the next problem area will be credit card lending. Personal debts are three times the inflation adjusted level of the early ‘70’s or to put it another way, the average debt in the UK and US is around 140% of post tax earnings. The last time we came anywhere near these levels was in 1987 and this should ring a few alarm bells. Unfortunately, banks are desperate to promote credit cards and this is not just because they are profitable in their own right. Another money spinner has come from repackaging the debt into floating rate instruments that are in big demand by City institutions. These institutions need a replacement for straight bonds in a rising interest rate environment such that they and other large investors will not lose their capital value and enjoy a growing rate of interest. The very institutions that are promoting debt to protect themselves (but not their retail customers) are sowing the seeds for their own destruction in a rising interest rate environment. When Karl Marx said that capitalists would sell you the rope with which to hang themselves, he was not far off the mark.

As a cheesy disk-jockey would say, it’s back to the 70’s again. Having got off to a seemingly good start, the specter of excess debt came back to haunt the economy. The financial system was over-geared just as the oil shock of 1974 hit home. Oil prices rose from $3 to $12 and industry came to a grinding halt. The domino effect on banks led to a series of failures in the second tier of the system. At the same time, the Vietnam War was drawing to a close on the other side of the world. America had already abandoned the financial discipline of the Gold Standard by 1971 which gave them a free reign to print money to finance the War. However, it is too simplistic to compare the rise in oil prices rise from $10 to $40 over the last six years; although the scale of change was similar, the rate of change has been far more gradual and when adjusted for inflation it is not as severe as the first oil shock. Nevertheless, we are likely to see much higher oil prices going forward for various reasons including, lack of tankers for delivery, decades-low stock levels, a refining infrastructure that has suffered chronic underinvestment and of course the emergence of China as a consumer in its own right.

Most economic downturns in the last 200 years have been preceded by a large build up of debt which is often, but not always, war-related. When it has grown to excess, it crowds out investment and spending as the burden of interest and capital re-payments increase. Unlike the consumer, the government has plenty of choice in what to do. They can for example put up taxes and cut public spending. Given the penchant for politicians to get re-elected, this prudent course of action is rarely carried out. As ever, the easy and initially painless choice is most often chosen. This involves printing yet more money and letting the currency devalue. Who in the US Administration cares if the Dollar weakens when only 11% of Americans hold passports? Surely the Japanese and Chinese will keep buying bonds to maintain their currency competitiveness, in spite of the fact they already own over 50% of the US debt. The perma-bulls on Wall Street will also tell you that a weaker currency is beneficial for exports – it’s just a pity that the US exports so few goods, which in any case are usually made in Asia.

After the huge costs of the Vietnam War, the US government used the oil price rise as an excuse to inflate its way out of the debt trap such that inflation surged and the Dollar wilted. Although interest rates went up, they were still below the rate of inflation so government debts evaporated but the purchasing power of consumer savings was destroyed. Similarly in the UK, I can well remember the bitter disappointment of my parents, who, as first generation NHS doctors, had worked hard and saved hard, just to see their savings wiped out by inflation rates of up to 25%. The agony came to a crisis point during the Winter of Discontent as the economy was strangled by the Unions and bodies were left unburied. A reduced working week and exchange controls culminated in an undignified bail out by the International Monetary Fund.

Flat markets are another symptom of inflationary periods such that in 1968 the Dow Jones hit 1,000 and by 1982 was still at 1,000, albeit with lots of volatility on the way. Given that stock markets on both sides of the Atlantic are unchanged over the last six years then we may likewise only be half way through a protracted side-ways market. We also saw a similar phase after the 1920’s bull market run. Interestingly, in those boom times you witnessed bursts of hedonism, drug taking and binge drinking that would put today’s youngsters to shame. During periods of economic strength, political parties are drawn into the middle ground and the differences become blurred. However, in the harsher environment of an economic downturn politics tends to polarize to the extremes of left and right. In years to come no one will ever blame themselves for profligacy and greed – it will always be someone else’s fault. It is human nature to look at blaming others and this is why extremism gained favour in the Depression.

If we can learn some lessons from the 1970’s, they can be summarized as follows;

• Avoid index tracking investments – buy value stocks and look for dividend yields
• Buy Gold – it maintains purchasing power when paper money is mass produced
• Avoid the currencies of high debt countries - the US Dollar is a prime example
• Stop borrowing - start paying down debts as interest rates rise
• The property market is not necessarily a good inflation hedge in the short term

In spite of this gloomy outlook, there is scope to be positive in the long run. The retrenchment after the chaos of the 1970’s laid the foundations for the best market and economic period of the last century. However, it is now essential to avoid losing money and concentrate on debt reduction. For those who are brave and patient, Gold is now so cheap that it will be the equivalent of buying Internet stocks ten years ago.

Toby Birch
July 2004