(click on the image to view the spreadsheet in full size)
The purpose of this exercise initially was to help put into context the data and assumptions we, as financial planning practitioners use, such as assumed tax rates, interest rates and inflation when we are building financial plans. How do they compare to the past? What periods in the past matter or relate to a period we may be entering etc. The data I accumulated in the spreadsheet only goes back 53 years for a reason. It’s my opinion that one of the most significant events of the last 50 years was Nixon’s decision to make our currency nonconvertible to gold for foreigners in 1971. The implications of that decision laid the table for floating currencies world-wide with vastly expanding monetary and credit creation ability. Only incomes and inflation constrain growth of the monetary supply and asset prices now.
It’s one reason interest rates remain so low. What market force would make an interest rate bet against an entity with unlimited monetary resources, even when people know rates are artificially low. There are no bond vigilantes anymore. You’ve heard it said, “don’t fight the Fed.” Now you know why.
Lastly, The implications of the decision in 1971 also involve taxation and debt. In a prior blog on income taxation, I cited Beardsly Ruml’s assertion that the federal government is now completely free from the money market and unconstrained by any commodity to create revenue so the need for taxation is truly monetary and social though the funds may still be used for revenue. It also means debt could grow to amounts we never thought possible without an actual default (Exception: intentionally devaluing currency is often viewed as a default) on the debt or need to tax extraordinary amounts. One reason we may have seen tax rates drop and debt rise, along with very low interest rates over the last 20 years or so.
Sounds good so far, right? If there is an obvious downside to this it may be more political and social. It may mean that the government grows as a percentage of GDP spending and that means it’s influence grows on our economy. Markets are meant to be efficient to operate fairly and justly. We’ll see if there is a more “political economy” or if efficiency is impacted. Inflation is another issue, but the Federal Reserve has plenty of tools to fight that if need be.
Below is a summary of the commentary in the spreadsheet timeline, hope this helps, Jeremy:
1) Feb. 1971. US negotiates with OPEC that all oil must be quoted in US dollars. This creates a permanent and deep market for US dollars. The term Petrodollars is born.
2) Aug 1971. Facing international pressure from foreign governments exchanging the US dollar for gold because of worries about the Vietnam war, budget deficits and social spending, President Nixon unilaterally abandons dollar gold convertibility to foreign governments. Without the constraints of commodity convertibility, monetary and credit expansion is only limited by inflation concerns.
Volker becomes Fed Chairman with a mandate to tame or control inflation. In the process inflation went from a high of 13.5% in 1981 to 3.2% in 1983. He did this by raising the Fed funds rate from 11.2% to 20% . Victory over inflation would come at a steep and predicted price. A severe recession that would see unemployment rise to 10% as the cost of business rose with interest rates followed.Volker’s decisive actions partially set the table for the greatest economic expansion in history of the world over the next two decades. The 1980’s and 1990’s would see rates drop consistently fueling monetary and credit expansion without massive inflation.
1) Providian issues the first credit card that allowed people to carrying balances forward. Prior to this, credit cards had to be paid off monthly.
2) Alan Greenspan is appointed Fed Chairman. Deregulation of various financial, banking and housing government sponsored enterprises along with accommodative interest rate policy began in earnest.
3) 1987 Stock Market Crash- because stock markets became illiquid the Fed immediately stepped in and asked several large banks to loan funds to the exchanges to provide liquidity and the Fed guaranteed those loans. This plus subsequent actions by the fed initiated the term the “Greenspan Put,” meaning the Fed would bailout investors if there was a 20% decline in prices.
1) The Federal reserve raised Fed Funds rates 6 times between 1999 and 2000 to cool markets, the US stock market crashed and then the Federal reserve lowered rates to stimulate the economy. Housing sector heats up.
2) The 1999 repeal of the Glass Steagal Act- allowed banks to use insured depositories to underwrite private securities and sell them to their own customers. Underwriting standards drop and bank profits rise.
Financial Crisis- crisis in housing, causes a crisis in credit, which causes a crisis in asset prices and employment. The Central banks of the world coordinate their efforts to provide liquidity, low interest rates and purchase assets outright to create functioning markets. Asset purchases or quantitative easing (originally called the nuclear option) continue for years, but reflate asset prices.
Hope this helps!
Jeremy P. Green CFP, CTFA, CLU, CEBS, MSFS, AEP, EA
Wealth Strategist & Expert Witness Consultant
Wealth Strategist Designs