A little history lesson
As a result of my age, I first became aware of government influences on the market in the 1970’s when we had inflation accompanied by stagnant economic growth, termed “stagflation.” Three administrations (Nixon, Ford, Carter) tried various solutions with poor results until Reagan simultaneously applied the brakes to inflation (tight money policy) and the gas to the economy (low taxes).
As a finance student in 1981 I served two semesters managing TCU’s Educational Investment Fund. At the end of the spring semester, we had to leave things in order for the group to come back in the fall. We had cash balances and needed to do something with it. Credit Lyonnais (French national bank) was paying 18.5% interest for 90 day CDs in US dollars. Although inflation was still rocking along (in the neighborhood of 12%) it was hard to turn down rates like that, so we locked up our free funds for the summer and were proud of the rate we got.
That extraordinary rate was indicative of how tight the credit market was, and how much return investors required due to their continued perception of inflation risk. The tight market was a result of Reagan aggressively wringing inflation out of the market by contracting the money supply. And we went on to have a recession from that. It was tough times and it was painful. (I graduated during the peak of unemployment in May of 1982 – welcome to the job force.) Inflation did go away. The next growth cycle was not encumbered with inflation and, pushed by lower tax rates, it lasted beyond the Clinton administration and grew government revenues faster than the projections made with higher tax rates. (Thanks, Dr. Laffer!)
Our current economic climate seems precarious and the government is striving mightily to influence it for good. We have interest rates pushed down by liquidity and money forcefully flowing into the system. The government is putting capital into failing businesses and trying to protect home owners. They are more worried about stopping freefall and preventing deflation and no longer worried about inflation. In fact, inflation will solve a myriad of the perceived problems:
- reduces the cost of government debt (pay back with cheaper dollars)
- restores the value of real estate (in terms of dollars)
Since inflation usually takes between two and three years to begin to show up, they have to run the pumps a little longer before they can be sure. No worries there.
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