By Eric Peters, CIO of One River Asset Management
For nearly a century, gold had been pegged at roughly $20.67/oz. Then in 1934, FDR banned private holdings, confiscated people’s gold, and set the value at $35/oz for use in international trade/settlement. It remained anchored at that price for decades. But fiscal pressures of the Vietnam war and Johnson’s Great Society project stressed the pegged system. Johnson’s war on poverty, Medicare, Medicaid, urban renewal programs and so many others were costly. As they stressed America’s finances, the system’s circuit breakers were overwhelmed.
On August 15, 1971, Nixon abandoned the gold standard, froze wages and prices for 90-days, and imposed a 10% import surcharge. Unemployment was a painful 6.1%, inflation was 4.6% and 10yr yields were 6.58%. All sorts of unique things were happening in the world economy. They always are. Which is why no time is the same. Back then, the Bretton Woods system that had served the post-war economy so well had come under intense pressure. Aided by the Marshall Plan, the rest of the world had been rebuilt, and was starting to catch up in earnest.
Joe Biden was sworn in as a 30-year-old freshman Senator in Jan 1973. Seems like half a century ago, because it was. In the 1.5yrs between Nixon leaving the gold standard and Biden’s inauguration, the gold price jumped from $35/oz to $65/oz (in that same period, the S&P 500 rose 20%, while CPI fell from 4.6% to 3.7%). No doubt that jump in gold seemed like a big move to people. Having traded between $20/oz and $35/oz over the previous 150yrs, people were mentally tethered to historical prices. Humans struggle to process rapid change.
As fate had it, the S&P 500 peaked the month of Biden’s 1973 inauguration with 10yr bond yields at 6.46%. The price of gold and the value of stocks, which had both risen in the 1.5yrs following Nixon’s exit from the gold standard, diverged radically as inflation started to rise in earnest. CPI had started rising before the oil embargo of October 1973. It was lifted in March 1974, with oil prices having jumped from $3/barrel to nearly $12/barrel. By the end of 1974, gold hit $181/oz, the S&P 500 fell 48%, 10yr bond yields rose to 7.48%. CPI had jumped to 12.3%.
Inflation remained volatile for another decade after that. Oil prices too. Commodities in general. Gold hit $850/oz in January 1980. Bond holders got destroyed. Equity holders too. Generally speaking, agricultural commodities did reasonably well on an inflation-adjusted basis in the 1970s. But the really big winners were gold and oil, each for unique reasons, both of which were amplified by that monetary debasement. To this day, most people are mentally anchored to that experience, so that when they worry about inflation they buy gold.
There are more differences between the 1970s and the 2020s than there are similarities. Demographics, technology, global trade, union membership, consumption patterns, environmental stresses, geopolitics, and domestic politics are all different. There are substantial similarities too. But one thing is identical - this planet remains inhabited by humans. And we never change. We despise iniquity. When Biden entered politics in 1973, the rich/poor divide in America had halved since the late 1920s high. It has since doubled. Returning to those highs.
How this inflation plays out will be different from anything that has come before it. It is always so. Naturally, some aspects will resemble the past. This inflation will inevitably be volatile, such periods of price changes typically are. And in the early stages, nearly everyone will persuade themselves that it is transitory.
In the late stages, those same people will conclude that it is permanent. Throughout the process, each of us, individually, will see what we want to see, hear what we want to hear, and believe what we want to believe. Those things are always true, perhaps now more than ever. We will also find the period ahead deeply unsettling. Change is hard to process. And more things are changing now than at any time in our lives - such is today’s utterly unprecedented pace of innovation and disruption.
In such a state, it is natural to cling to our anchors:
- Our policymakers will point to the inflation metrics that they themselves have engineered in such a way to ensure stability, even if they long ago diverged from reality.
- Bond investors will look to the spreads between overnight rates and two-year bonds, five-year, ten, thirty. And despite the reality that the government has run 15% deficits for two years, funded by the Fed which simply creates the money, they will cling to the anchors that have governed the well-behaved yield curve for the course of their careers.
- Equity investors will hold tight to the relationships that anchor their value relative to bonds.
- Not a solitary investor in the mainstream will be prepared to deviate from the benchmarks to which they have anchored their careers.
And yet, all of us will begin to increasingly wonder, whether digital assets, which have no real history, no anchors, are the first to provide a glimpse of what lays beyond the horizon.