Economic Outlook: History Repeating Itself? Rising Inflation may be On the Horizon in the Pacific Northwest

Good Afternoon …… Bag-Holders!

When I started my career as an economist in the 1970s, my boss had a cartoon posted near his desk. It showed a CEO speaking to company investors at the annual meeting. The CEO began his address: “Good afternoon bag holders — I mean shareholders!” (Back then the economy was in shambles.)

The problems started in 1965. That year, Congress and President Johnson passed a budget that boosted spending just after cutting taxes[1]. Spending grew quickly—up more than 50 percent in just five years. Tax receipts could not keep pace with it. Deficits grew. When the economy is in a recession, deficits stimulate economic growth. However, the economy was already running at full steam (very low unemployment, factories running at full tilt). There was very little growth to be had, so the deficit spending did little more than spark inflation.

Starting at 1.3 percent in 1964, inflation rose to 5.4 percent in just 5 years. The Federal Reserve predicted 2 percent inflation and continuously under-estimated it during those years.

The former Chair of the Council of Economic Advisors under Barack Obama, Christina Romer, looked back at those years and concluded that most economists in those days thought excess employment caused inflation. Their solution, she contended, was to slow the economy, let unemployment go up, and watch inflation fall. It didn’t work.[2]

When Richard Nixon became president in 1969, the old economic theory was tossed out. The new ‘solution’—a combination of wage and price controls—was instituted. It backfired. Among the repercussions of the price controls were shortages of common commercial goods such as toilet paper and sugar. To get around wage controls, companies gave employees benefits that drove up the prices of healthcare. The policy was a failure and inflation continued to rise.

In 1974, just 10 years after it all started, inflation hit 11 percent. Interest rates skyrocketed along with inflation, forcing many businesses and some governments, including New York City, to file bankruptcy petitions. Even Nixon’s Treasury Secretary eventually had to declare personal bankruptcy.[3]

This bit of history is relevant today because our economy is in a similar situation now. Our inflation rate was a modest 2.1 percent last year and the economy is screaming hot. But, we just saw a massive tax cut passed, federal spending is rising, and large deficits are projected for years to come. Add in Trump’s tariffs on imported steel, aluminum, and lumber, and higher inflation was set in motion.

The implications are serious for the Northwest because we depend on an influx of new residents to fuel construction. In no state is that more important than Idaho. Its net in-migration in 2017, as a share of population, was the highest of any state (Washington ranked 5th and Oregon 8th). Inflation matters because as inflation rises, so do interest rates—few things are as bad for moving to a new state than facing very high mortgage rates.

So what do we do about it now? Many have all been lulled into a sense of complacency that comes with years of low inflation. And we want to believe it will just continue. Even the Federal Reserve predicts inflation will be about 2 percent (the same forecast they had in the late 60s). Still, we believe the inflation picture going forward looks troubling.

Start with the fact that nationally, inflation is already over 2 percent (prices were up 2.4 percent from a year ago in March 2018).[4] If you are in the Northwest, prices have been rising faster. They were up 3.1 percent in Seattle, 3.2 percent in Boise, and 3.9 percent in Portland. If you focus on just services, especially in Portland, prices were up an astounding 5.4 percent.

While even higher inflation is not a certainty, if you are a business looking to expand, a builder hoping to construct an apartment, a person wanting to save money, a pension fund investing retiree contributions, or a government reliant on issuing bonds at reasonable rates, you should test to see how you would tolerate rising inflation. Incorporate a more sophisticated economic forecast into your plans. It will help answer questions such as, how vulnerable is my project? What would happen to it if inflation does rise over 5 percent, like it did before? Doing so could keep you from becoming a bag-holder!

 

[1] Spending was primarily for social programs and to fund the Vietnam War.

[2] Romer, C. Federal Reserve Board of St. Louis Review. March/April 2006. Pp. 177-186.

[3] https://www.nytimes.com/1987/08/01/business/real-estate-woes-force-connally-bankruptcy.html

[4] Year over year percent change in the US consumer price index as of March 2018.