Back to the future: should we expect an economic recovery from the 1970s?
Some of the factors that boosted the national and global economy then seem to have parallels with today. For those who remember the 70s and early 80s, it was a time characterized by an energy crisis fermented by the oil cartel, Opec.
This resulted in the rationing of gasoline via “car-free days”, an inflationary and wage spiral accompanied by an increase in interest rates. It was a period of interventionist government policy which included freezing wages and prices in the early 1980s in an attempt to control inflation.
These economic pressures ultimately led to two significant structural changes in the New Zealand economy; the floating of the New Zealand dollar in 1985 and the introduction of the Reserve Bank Act of 1989, which shielded the Bank from direct political interference.
As Mark Twain is famous for saying, “History never repeats itself, but it often rhymes”. Although I am not an economist, I suspect that there are lessons to be learned from this period.
New Zealand’s inflation rate may have peaked this year at 7.3% per annum and may be falling, but the 1970s showed that imported inflation, combined with inflation of national salaries, is very difficult to control.
During the 1970s, the average inflation rate was just over 12% per year. As a result, $100 at the start of the 1970s only had the purchasing power of $30 at the end of the decade. Some assets provide a natural hedge against inflation while other investments perform poorly by failing to keep pace.
During the 1970s, the worst performing asset class was fixed interest (meaning both term deposits and bonds). Funds invested in fixed interest have actually lost value relative to inflation.
The best performing asset class of this decade was commodities. Commodities are the raw materials used to create the products that consumers buy. Commodities vary widely and range from grain, gold, beef to oil and natural gas.
During the 1970s, a general commodity index rose by more than 20% per year. Some stocks offer good inflation protection. Stocks of infrastructure companies (such as power companies) tend to do well because they have the ability to increase their prices with inflation and the value of their physical assets. i.e. dams and power plants, increase as inflation increases their replacement cost.
Other stocks may struggle in a high inflation environment if they are struggling to pass on their rising costs and their profit margins are under pressure.
During this decade, real estate kept pace with inflation but did not rise sharply above inflation. The current government policy and the desire to increase supply are two other factors likely to limit real estate growth for the coming period. What lessons can we apply today? :
1. Be more intentional in your investment strategy. Since the beginning of this year, equity markets have been strongly negative. For investors who have supplemented their exposure to equities with exposure to commodities, their situation improves considerably. This is just one example of an intentional, forward-looking asset allocation decision based on the changing investment environment rather than passively relying on the past environment.
2. Don’t bet on just one asset class. Although I have a vision of the future development, I could easily be wrong. This is why I strongly caution against investing in a single asset class. If you own your own business, you might be forced to do this for a while, but when you can diversify away from concentrated investment risk, you should take this step. A “double or quit” approach may be acceptable to the casino, but is not acceptable to your retirement capital.
3. The perception of security can be an illusion. In an uncertain world, it can be tempting to take less risk by avoiding investments whose principal value varies according to market conditions. The price swing that some assets experience can be uncomfortable, but that is precisely what is likely to help you weather inflation. Volatility is the price you pay for inflation protection. I note that several mortgage funds have recently stepped up their advertising with what looks like attractive yields. However, I question their ability to outperform inflation over the longer term and would point out that with rising interest rates, we are likely to enter a period of increasing mortgage defaults.
I mentioned the two economic changes, the Reserve Bank Act and our floating exchange rate, which were implemented in response to the experience of the 1970s.
Hopefully, these two changes will help ensure that the extremes of the 70s don’t fully play out in the next decade. However, you must prepare for a different environment than you have experienced in recent years.
— Peter Ashworth is a director of New Zealand Funds Management Limited and a financial adviser based in Dunedin. The opinions expressed in this column are his own and not necessarily those of his employer. His statements are available on request and free of charge.