October 24, 2022

We see a lot of comparisons between what’s happening today and what occurred in the 1970s because it was the last time consumer price inflation was anywhere near this high. But unless you were around (and probably driving) back then, it might go unnoticed that the 1970s were also the last time we experienced a supply crunch in energy.

In response, the Federal Reserve back then spiked short-term interest rates to more than 20%. That drove the economy into a severe recession more than once, though it brought down inflation.

People worry that could happen again today. But there’s a huge difference between today and the last time we saw runaway inflation – the nearly $31 trillion national debt.

In the 1970s, federal government debt as a percentage of gross domestic product (GDP) was around 35%. Today, that figure is around 125%.

Understanding that, it seems today’s market environment has less in common with the 1970s and is more like the 1940s. Back then we saw big inflation due to supply disruptions and lots of government spending on World War II, which was heavily financed. The debt-to-GDP ratio almost hit 125% in 1946 – close to our present level.

As anyone with a credit card balance will tell you, higher interest rates become more of a concern as debt rises.

When debt is low, rising rates aren’t much of an issue because the cost to service the debt is still manageable. But when debt increases, especially to more than 100% of GDP, even a relatively small rate increase can mean big jumps in interest payments.

If that process continues, the cost of interest can throw budgets out of whack and cause severe deficits. Of course, that could bring on more government debt to cover the difference.

It’s a downward spiral, no doubt. So, if we keep going down this path, we could push ourselves into a nasty corner and eventually spin out of control.