A crisis of global integration
Even before war broke out in the Middle East, it was easy enough to make analogies to the 1970s. Inflation was running at a multi-decade high, geopolitics had been disrupted by a regional war in Eastern Europe and domestic politics in many developed economies had become startlingly polarised and fractious.
Yet investors are still sceptical of the economic parallels. Certainly, there has been no ongoing wage-price “spiral”, as real wage growth ex the 2020 bump has been flat to negative. Weak labour bargaining power due to persistent de-unionisation, globalisation, and technology is arguably still likely to keep underlying inflation anchored. Unlike the 1970s, oil prices have more support from production in the Western hemisphere, and in any case fuel spending is a much lower share of consumer wallets in the US today. Currencies unpegged from the gold standard cannot be unpegged again, limiting one avenue of shock to the financial system. Central banks maintained market credibility, as indicated by quiescent 10-year breakevens that had never gone much higher than 3% since 2020.
Here are the three 1970s parallels that persist:
First, the supply shocks we are experiencing could well be larger and more persistent than those of the 1970s. The global economy faces multi-decade, multi-trillion capital expenditure plans as far as the eye can see around the net-zero transition. We have a never-before-experienced demographic decline in working-age populations, alongside a “derisking” of US-China trade and the mammoth shift in global supply chain investment that will entail. In addition, we live in an obviously multipolar world with more fractious geopolitics than a period of disproportionate US strength in the 1970s. It is easy to see how production processes could be impaired, disrupted or run above capacity for longer than previously.
Second, financial stability risks are just as salient to central banks today, if not more so, given high debt levels, and could be a constraint to their activity going forward. The short Fed “pause” after SVB’s collapse in March 2023 does not exactly compare to the Fed pause in 1972 after the Bank of Commonwealth was bailed out (because inflation continued to fall in 2023 whereas it began to pick up in the second half of 1972). But it is not difficult to imagine how a future financial stability risk might weigh on the Fed’s ability to tackle inflation more forcefully. Domestic credit to the private non-financial sector as a percentage of US output is 60 percentage points higher than it was in 1972, and the risks to financial stability from government leverage imbalances have definitely risen, albeit from low levels
Third, like the 1970s, prices and wages exhibit a deep persistence and inflation shocks take time to resolve. As the historical data shows, wages tend to keep up with prices and prices tend to keep up with wages, adjusted for productivity, over long periods of time. The IMF concluded recently that 40% of historical inflation shock episodes across economies take longer than five years to resolve, and the remaining episodes took on average over three years. The Bundesbank’s Karl Otto Pohl once compared bringing inflation to target like putting toothpaste back in the tube.
Economic historian Charles Maier pointed out that the 1970s was one of the three systemic crises of the 20th century. They were ‘crises’, as distinct from isolated economic or political turmoil, because “all institutions seem to disappoint at the same time” and “there is a sense of profound interconnection.” Whereas Maier called the 1970s a “crisis of industrial society,” in our view the 2020s is a “crisis of global integration”.
The challenges of global and financial integration, championed in the 1980s and 1990s, have become profoundly clear.
China’s rise as global and regional power has exacerbated economic tensions with its trading partners, resulting in the current de-risking strategy. Decarbonising to net zero requires trillions of dollars of investment at global scale, both in advanced economies and especially emerging economies. Public-private coordination will be required to access new supply chains of critical minerals. Within demographics, inflation is a global process, and changes in the availability of labour in one part of the world will affect prices in other parts of the world.
In addition, the structural increase in international migration has had profound effects on the stability of several economies. Going forward, the decline in working age populations is going to exert a profound shift to business models and tax systems. Unconventional US monetary policy had to be emulated globally, and to the extent it is unwound it will also have global effects. In technological disruption, the low-rate world turbocharged a number of new applications, most recently the large language platforms.
How wary should investors be of a crisis of global integration? Historically, periods of change are periods of volatility, though not in every case a period of weakness for financial assets. Sure, the 1970s stagflation was the second-worst decade for real investment returns in the 20th century, with the worst coming from the first systemic crisis in 1910-1919. But real returns in the 1930s were somewhat positive for equities, albeit coming after negative performance in the 1920s; they were even stronger for fixed income given deflation.
In business, crises can also be periods of immense business opportunity. The 1970s was a period of great entrepreneurial vigour—Apple, Microsoft and Home Depot were all formed then. Intel developed its 8080 microprocessors in the early 1970s.
Ultimately, the only thing that is certain is we are on the road to a vastly different economy.
For more detail, please visit Ninety One’s ‘Road to 2030: What the next cycle looks like’ research findings, looking at the investment implications of an arguably fourth systemic crisis. DM/BM
By Sahil Mahtani, Strategist at Ninety One