It's the 1970s, and the stock market is a mess. It loses 40% in an 18-month period, and for close to a decade few people want anything to do with stocks. Economic growth is weak, which results in rising unemployment that eventually reaches double-digits. The easy-money policies of the American central bank, which were designed to generate full employment, by the early 1970s, also caused high inflation. The central bank, under different leadership, would later reverse its policies, raising interest rates to some 20%, a number once considered usurious. For interest-sensitive industries, such as housing and cars, rising interest rates cause a calamity. With interest rates skyrocketing, many people are priced out of new cars and homes. (Learn more in A Review Of Past Recessions.)

Interest Rate Casualties
This is the gruesome story of the great inflation of the 1970s, which began in late 1972 and didn't end until the early 1980s. In his book, "Stocks for the Long Run: A Guide for Long Term Growth" (1994), Professor Jeremy Sigel, called it "the greatest failure of American macroeconomic policy in the postwar period."

The great inflation was blamed on oil prices, currency speculators, greedy businessmen and avaricious union leaders. However, it is clear that monetary policies, which financed huge budget deficits and were supported by political leaders, were the cause. This mess was proof of what Milton Friedman said in "Money Mischief. Episodes in Monetary History" (1994): inflation is always "a monetary phenomenon." The great inflation, and the recession that followed, wrecked many businesses and hurt countless individuals. Interestingly, John Connolly, the Nixon-installed treasury secretary without formal economics training, later declared personal bankruptcy. (Read more about Friedman's contributions in Free Market Maven: Milton Friedman.)

Yet these unusually bad economic times were preceded by a period in which the economy boomed, or appeared to boom. Many Americans were awed by the temporarily low unemployment and strong growth numbers of 1972. Therefore, they overwhelmingly re-elected their Republican President Richard Nixon, and their Democratic Congress in 1972; Nixon, the Congress and the Federal Reserve failed them.

How and Why
It began in 1969 with a president facing re-election. Nixon inherited a recession from Lyndon Johnson, who had simultaneously spent generously on the Great Society and the Vietnam War. Congress, despite some protests, went along with Nixon and continued to fund the war, and increased social welfare spending. In 1972, for example, both Congress and Nixon agreed to a big expansion of Social Security just in time for the elections.

Nixon came to office as a supposed fiscal conservative. Still, one of his advisors would later classify Nixonomics as "conservative men with liberal ideas," (Stein, 1984). Nixon ran budget deficits, supported an incomes policy and eventually announced that he was a Keynesian. (Learn more about Keynes in Giants Of Finance: John Maynard Keynes.)

John Maynard Keynes was an influential British economist of the 1930s and 1940s. He had advocated revolutionary measures: governments should use countercyclical policies in hard times, running deficits in recessions and depressions. Before Keynes, governments in bad times had generally balanced budgets and waited for malinvestments to liquidate, allowing market forces to bring a recovery.

Nixon's other economic volte-face was imposing wage and price controls in 1971. Again, they seemed to work during the following election year. Later on, however, they would fuel the fires of double-digit inflation. Once they were removed, individuals and business tried to make up for lost ground.

Nixon's deficits were also making dollar-holders abroad nervous. There was a run on the dollar, which many foreigners and Americans thought was overvalued. Soon they were proved right. In 1971, Nixon broke the last link to gold, turning the American dollar into a fiat currency. The dollar was devalued, and millions of foreigners holding dollars, including Arab oil barons with tens of millions of petrodollars, saw the value of dollars slashed. (Learn more in The Gold Standard Revisited.)

Winning Elections
Still, President Nixon's primary concern was not dollar holders or deficits or even inflation. He feared another recession. He and others that were running for re-election wanted the economy to boom. The way to do that, Nixon reasoned, was to pressure the Fed for low interest rates.

Nixon fired Fed Chairman William McChesney Martin, and installed presidential counselor Arthur Burns as Martin's successor in early 1971. Although the Fed is supposed to be solely dedicated to money creation policies that promote growth without excessive inflation, Burns was quickly taught the political facts of life. Nixon wanted cheap money: low interest rates that would promote growth in the short term and make the economy seem strong as voters were casting ballots.

Because I Say So!
In public and private Nixon turned the pressure on Burns. William Greider, in his book "Secrets of the Temple: How the Federal Reserve Runs The Country" reports Nixon as saying: "We'll take inflation if necessary, but we can't take unemployment." The nation eventually had an abundance of both. Burns, and the Fed's Open Market Committee which decided on money creation policies, soon provided cheap money.

The key money creation number, M1, which is total checking deposits, demand deposits and travelers checks, went from $228 billion to 249 billion between December 1971 and December 1972, according to Federal Reserve Board numbers. As a matter of comparison, in Martin's last year, the numbers went from $198 billion to $203 billion. The amount of M2 numbers, measuring retail savings and small deposit, rose even more by the end of '72, from $710 billion to $802 billion. (Read more in Formulating Monetary Policy.)

It worked in the short term. Nixon carried 49 out of 50 states in the election. Democrats easily held Congress. Inflation was in the low single digits, but there was a price to pay in higher inflation after all the election year champagne was guzzled.

In the winter of '72/ '73, Burns was soon worried about inflation. In 1973, it more than doubled to 8.8%. Later in the decade, it would go to 12%. By 1980, inflation was 14%. Was the United States about to become a Weimar Republic? Some actually thought that the great inflation was a good thing. (For more information, read our Tutorial on Inflation.)

Conclusion
It would take another Fed chairman and a brutal policy of tight money, including the acceptance of a recession, before inflation would return to low single digits. But, in the meantime, the U.S. would endure jobless numbers that exceeded 10%. Millions of Americans were angry by the late 1970s and early 1980s.

Yet few remember Burns, who in his memoirs, "Reflections of an Economic Policy Maker (1969-1978)", blames others for the great inflation without mentioning the disastrous monetary expansion; Nixon doesn't even mention this central bank episode in his memoirs. Many people who remember this terrible era blame it all on the Arabic countries and oil pricing. Still, the Wall Street Journal, in reviewing this period in January 1986, said, "OPEC got all the credit for what the U.S. had mainly done to itself."

Related Articles
  1. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  2. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  3. Economics

    Explaining the Participation Rate

    The participation rate is the percentage of civilians who are either employed or unemployed and looking for a job.
  4. Economics

    What Qualifies as Full Employment?

    Full employment is an economic term describing a situation where all available labor resources are being utilized to their highest extent.
  5. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  6. Investing News

    Timing of the Fed Interest Rates Hike

    Until the beginning of August, Fed watchers expected the central bank to raise rates in September. However, recent news pertaining to China’s slowing economy and its devaluation of the yuan have ...
  7. Economics

    A Look at Greece’s Messy Fiscal Policy

    Investigate the muddy fiscal policy, tax problems, and inability to institute austerity that created the Greek crises in 2010 and 2015.
  8. Mutual Funds & ETFs

    ETF Analysis: JPMorgan Alerian MLP

    Take an in-depth look at the J.P.Morgan Alerian MLP fund, the largest exchange-traded note, or ETN, in the U.S. marketplace.
  9. Markets

    The Vodka Industry Keeps Growing, But Why?

    Understand what the vodka industry is and where it performs best. Learn about the growth of the industry and three reason why it continues to grow.
  10. Term

    What is the Macro Environment?

    The macro environment is the conditions existing in an economy as a whole, rather than in a single sector or region.
RELATED TERMS
  1. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  2. Cost, Insurance and Freight - CIF

    A trade term requiring the seller to arrange for the carriage ...
  3. International Monetary Fund - IMF

    An international organization created for the purpose of standardizing ...
  4. Inflation

    The rate at which the general level of prices for goods and services ...
  5. Delivered Duty Unpaid - DDU

    A transaction in international trade where the seller is responsible ...
  6. Marginable

    Definition of "marginable."
RELATED FAQS
  1. What impact does inflation and deflation have on a blue-chip stock value?

    Inflation and deflation, though opposite scenarios, are quite similar with regard to the havoc they can wreak on an investor's ... Read Full Answer >>
  2. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  3. Is Argentina a developed country?

    Argentina is not a developed country. It has one of the strongest economies in South America or Central America and ranks ... Read Full Answer >>
  4. How is the Federal Reserve audited?

    Contrary to conventional wisdom, the Federal Reserve is extensively audited. Politicians on the left and right of a populist ... Read Full Answer >>
  5. Who decides when to print money in the US?

    The U.S. Treasury decides to print money in the United States as it owns and operates printing presses. However, the Federal ... Read Full Answer >>
  6. Why do some people claim the Federal Reserve is unconstitutional?

    The U.S. Constitution does not mention the need for a central bank, nor does it explicitly grant the government the power ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!