The No-Good Seventies

MYSTERY

In the U.S., the 1950s and early 1960s were a time of low unemployment and inflation. The American people felt that the economy would always continue to prosper and grow. But in the late 1960s, prices began to rise; and by 1970 the unemployment rate also began to climb. The 1970s turned out to be a period of economic misery for many Americans. Presidents Nixon, Ford, and Carter all tried to bring the good times back, but nothing seemed to work. What caused this bad turn of events, and how did the bad times finally end?

Prices and Unemployment Went…

Concepts Aggregate Demand- the amount of money spent on goods and

services produced in the U.S.

Cost-push inflation- a general increase in prices brought on by higher production costs.

Demand-pull inflation- a general increase in prices when demand for goods and services is greater than the country’s ability to supply.

Full Employment- a level of unemployment in which only those in transition are without work. Generally around 5-6% of the labor force.

Unemployment- anyone 16 years of age or older who is seeking paid work.

Wage-Price Spiral- a period of increasing prices pushing up wages forcing up prices.

Monetary Policy- the Federal Reserve’s powers to manipulate the money supply to influence the direction of the economy.

The Sum of the Inflation and Unemployment Rates

Causes of the Misery

In the mid-1960s, President Lyndon Johnson signed a massive body of legislation into law. Generally known as the Great Society, it included programs to fight poverty, expand education and the formation of Medicare and Medicaid.

Causes of the Misery

From July 1964 to the end of June 1965, spending on the Vietnam War totaled around $100 million. In 1966, President Johnson’s commitment increased dramatically and he requested $14 billion from Congress for the greatly expanded effort.

Causes of the Misery President Johnson

requested a 10% income tax surcharge on wealthier Americans, to pay for the expansion of government and the war, but ran into great opposition from powerful Ways and Means Chairman Wilbur Mills. A temporary tax increase was achieved in 1968 but was phased out by the end of 1969 doing little to stem inflation.

Causes of the Misery

The expansion of defense spendingand social programs began when the eeconomy was already at an unemployment rate below fullemployment. The demand for more labor forced employers to boostwages in an effort to attract thoseout of the workforce. Thisexpansion of labor costs promptedbusinesses to raise prices to coverthem. This contributed to a rapidacceleration of the price index.

Nixon Responds

On August 15, 1971 in a move widely applauded by the public and a fair number of (but by no means all) economists, President Nixon imposed wage and price controls. The 90 day freeze turned into nearly 1,000 days of measures known as Phases One, Two, Three, and Four.

The Controls Failed

Controlling Prices Created Shortages

Costs of some raw materials such as cotton were allowed to rise, but the costs of finished products made of those materials were not. So the finished goods were not made. Store shelves emptied.

Farmers discovered it cost more to raise poultry than they could recoup selling it at the controlled prices. The same thing happened with ranchers and feedlots that would lose money bringing cattle to market at the controlled prices. There were low prices for beef posted in the supermarkets, but the meat counters were empty.

The wage and price controls required some manufacturers to cut quality and retailers to cut warranties to meet the artificial prices.

All of These Factors Weaken the Dollar

The Germans and Japanese were enjoying a boom in exports.

Nixon imposed a 10% surcharge on all imports, causing U.S. prices to rise.

The U.S. was phasing out the gold standard in favor of a floating currency increasing the printing of dollars.

Money has grown increasingly more abstract - from a physical commodity,

- to a piece of paper representing a claim on a physical commodity,

- to a piece of paper of no intrinsic value,

- to an electronic entry representing a claim

on a piece of paper of no intrinsic value.

[just a Federal Reserve note]

Prelude to the “Perfect Storm”

Increased government spending

Increasing wages

Greater demand for imports

Tariffs increasing world prices

The exit from the gold standard leads to a sell off of the dollar

O.P.E.C. Hits Us Where It Hurts

On October 17, 1973, the major Middle Eastern oil suppliers cut production of petroleum by 25% and stopped shipping oil to the U.S. and European nations they believed were supporting Israel in its expansionary designs.

In the United States, the retail price of a gallon of gasoline rose from a national average of 38.5 cents in May 1973 to 55.1 cents in June 1974

Recession in 1974-75 The rapid increase in prices

led the Federal Reserve, the nation’s central bank, to raise interest rates and tighten the money supply. This led to a decline in business investment, a significant drop in the stock market, a spike in unemployment and a recession in 1974-75.

Why did the Fed choose this remedy knowing it would lead to higher

unemployment?

Persistent Inflation Further restrictions on oil

production and growing Middle East tension, culminating in the Iranian Hostage Crisis in 1979, continued to drive oil and gas prices higher through the remainder of the decade.

What was the Iranian Hostage Crisis and why did it have any bearing on U.S. gas

prices?

Anticipated Inflation

By 1978, people began to expect inflation as an unstoppable force. Americans quit saving and began borrowing to spend as much as they could. The decline in the dollar’s purchasing power hurt savers and helped borrowers.

WHY?

Gold Prices Skyrocket With a 13.5% rate of

inflation and the U.S. throttled by a group of Iranian college students, gold prices spiked to unprecedented levels in late 1979 and early 1980.

Why was gold so immediately popular?

What is the correlation with

today’s peaking gold prices?

$2000/oz. in inflation adjusted dollars

Adverse Supply Shocks[“bad news” – job losses; “bad news” – inflation]

AD AS1

PL1

Y*YR 10%

AS2

$4.25

This economy is stagnating but inflating.

Stagflation

PL2[10%]

Stagnating

Inflating

Trade-off betweenEnergy and labor costs