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As if the survival of leisure suits and Lava lamps weren't bad enough, the '70s retro theme is now the talk of the financial markets, too. American economists are warning that stagflation--the high-inflation, low-growth scourge of the '70s--may be threatening a comeback. Inflation is rising because of record energy costs--gas prices have reached $3 a gallon in some U.S. states--which is chilling consumers. Add to that the nagging concerns over Washington's debt habit, a weak dollar, slowing growth and the future of flagship automakers, and it is perhaps inevitable that Americans who can remember the '70s would start to note the similarities. So traumatic were the effects of stagflation that historian Theodore White included it as one of three "fundamental ideas" that define modern America, alongside Johnson's Great Society and the rise of television.
The good news is that the key indicators are still way short of the '70s red zone. Economic growth is slipping toward 3 percent, but nowhere near stagnant, and inflation is nudging up past 3 percent, nowhere near the double digits of the '70s. Economists don't even agree on exactly what mix of sluggish growth and rapid price increases defines stagflation. What they're clear on is the very '70s dilemma these trends pose for the Federal Reserve Bank: if it raises rates, it dampens inflation but chokes already faltering growth. If it lowers rates, it spurs growth but also fuels inflation. "This makes life a lot harder for the Federal Reserve," says Jared Bernstein, senior economist at Washington's Economic Policy Institute. "It has to fight inflation but it also has to be mindful of the job market, the trade deficit and consumers who are not contributing to growth as they had in previous quarters."
The Fed has made its choice. Last week it hiked interest rates by a quarter of a percentage point, its eighth such increase since it began tightening monetary policy last June. "It's pretty obvious the Fed has chosen which side of the monster they'll attack first," says Anthony Chan, senior economist at JPMorgan Asset Management. "To give up now in the face of what is pretty mild inflation would not be the right thing to do."
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Even the worst-case scenario is likely a far less severe dose of stagflation than the original. Economists blame the shrinking economy and rising prices of the '70s on low productivity growth and bad policies, in particular President Lyndon Johnson's decision to finance the Vietnam war without raising taxes, followed by Nixon-era wage and price controls. Today some economists see a reminder of LBJ's "guns and butter" spending habits in the Bush administration's "deficits don't matter" approach.
The threat that deficits pose to growth has helped inspire a revival of the infamous "misery index," invented by Chicago economist Robert Barro. Tallying unemployment and inflation, the index became a barometer of '70s gloom, with its gas lines and rationing, and President Gerald Ford's failed campaign to "Whip Inflation Now." Today the misery index stands at 8.3 percent, way below the high mark of 21.7 set in the second quarter of 1980, but up from the low point of 5.9 percent recorded in 1998. What this captures is not misery, but another phenomenon America has not seen in this way before: high anxiety despite a generally strong economy. If inflation and growth were at the same levels but trending in opposite directions, we wouldn't be talking about stagflation.
While Ford's win buttons became a laughingstock in some circles, Americans eventually did whip inflation. Productivity today is rising twice as fast as it did in the '70s, which means American business can grow without adding to labor costs and raising prices. Rising foreign competition also restrains any rise in retail prices, and the decline of organized labor undercuts the power of unions to pump up wages. In the last 30 years, trade as a percentage of the U.S. economy has risen to 25 percent from 11 percent and the unionized share of the labor force has tumbled from 25 percent to 12.5 percent, according to Lehman Brothers.
Still, the ghosts won't go away. Standard & Poor's last week demoted Ford and General Motors to junk-credit status, based in part on the assumption that Americans are turning away from big SUVs and back to the small cars of the leisure-suit era. Could one of the big two be headed toward collapse, some analysts asked, like Chrysler circa 1979? Cutbacks at Ford and GM are already having a ripple effect on growth. Others warned that the Fed's rising rates will have little impact on an inflation cycle driven largely by imported oil, and issued new calls for the Bush administration to get serious about conservation, another rallying cry of the late '70s. Might be time to dust off those win buttons, just in case.
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