There are some striking parallels between what we are experiencing now and what happened in Britain in the early 1970s. Back then investors had nowhere to hide, and Britain was brought to its knees. The UK stock market crashed by two-thirds, inflation let rip to reach 26% and the country became literally ungovernable. Could it happen again? Fleet Street Letter readers cannot afford to be complacent.
But before I explain, let’s remind ourselves of how events unfolded in the early 1970s.
Are we about to go on the mother of all nostalgia trips?
In 1971 the Conservative Prime Minister, Edward Heath, decided to embark on a dash for economic growth. His concerns about the consequences of rising unemployment were focused on the imminent closure of the Upper Clyde Shipbuilders yards. The local Chief Constable, David McNee, warned the cabinet that violence on the scale then becoming familiar in Northern Ireland was a real possibility. In the event, the shipyards were ‘rescued’ with public money, the 1972 budget was a giveaway and money supply growth went through the roof.
Part of the reason money supply growth skyrocketed was due to a change in legislation in May 1971 known as Competition and Credit Control. The aim was to no longer ration credit but to let the price mechanism do the job. But when higher interest rates were needed to curb runaway credit growth, the Prime Minister refused to countenance them. The consequences were a massive consumer and speculative boom.
Annual broad money growth accelerated from 11% in 1970 to 14% in 1971, to then reach 22% in 1972 and 23% in 1973. Broad money balances in the financial sector shot up 75% in 1972 and 46% in 1973. So where did this money end up? Well, it spawned a boom in share prices followed by a speculative frenzy into property.
Massive housing boom… easy credit… huge increases in public spending…
The FT Industrial Ordinary Index of shares climbed by 65% in the year to May 1972. This turned out to be the peak in the equity market. Asset price buoyancy in the rest of 1972 and during 1973 was instead most marked in property. Both residential and commercial property registered enormous price increases, at a pace never recorded in UK peacetime history.
The Heath Government had hoped that the easing of monetary conditions would provoke a boom in investment in industrial plant and machinery. But the money ended up virtually everywhere else. Consumers used their new Access credit cards to buy Japanese electronics, German cars and Italian deep freezes, sending the balance of payments deeply into the red.
At the same time, a new breed of whiz kids took advantage of relaxed credit conditions and turned their talents to ‘asset redevelopment’ and property speculation. It was a new Klondyke. In the two years following May 1971, bank advances doubled, private borrowing trebled and loans to property and financial markets quadrupled. House prices increased by 70% in just two years. But the Government did not only fuel a boom with relaxed monetary conditions; it also increased public spending by massive proportions. It had grandiose plans to extend the scope of higher education, and to reorganise local government with more tiers of administrators. Planning and publicity departments proliferated and in the NHS the ratio of administrators to medical staff swelled. Employment figures increased by 200,000 in education and by 100,000 each in the health service and local government. These workers were not producing marketable goods and services, and acted as a drain on the productive sector of the economy by competing with it for manpower and burdening it with higher taxation. Sound familiar?
Oil-driven inflation ripped into the economy and the stock market crashed
Meanwhile, commodity prices soared. In the 12 months to June 1973, The Economist’s index of commodity prices rose by 76%. Inflation started to rip into the economy.
The position was becoming unsustainable. Having resisted attempts to prevent mortgage rates reaching politically undesirable levels, the Prime Minister could not hold out any longer. In July 1973, interest rates were raised from 7% to 11% in just eight days. There was a sour smell of panic in the air as boom was followed by bust. Secondary banks went under and commercial property values slumped. And there was worse to come.
Following the 1973 Yom Kippur War, OPEC curtailed the supply of oil to the West and by mid-October the price of crude had jumped from $3 to $5 a barrel. Two months later the price more than doubled to $11.65. This pushed up inflation in the UK and Heath’s incomes policy was in tatters.
The National Union of Mineworkers struck. Heath put Britain on a three-day week and went to the country in February 1974 – and lost. The Labour Government won a second general election in October 1974 and by then the FT Industrial Ordinary was little more than a third of its value in May 1972.
Meltdown could be avoided… but don’t bet your house on it
So why aren’t sharper, higher oil and commodity prices, the explosion of public sector employment and double-digit money supply growth generating serious inflationary pressures today? The reason why history is not – yet – repeating itself lies in the increased flexibility of our labour and product markets.
Back in the 1970s a combination of higher petrol and food prices and heavy recruiting in the public sector pushed up wages. Unions were stronger and managements, both in the public and private sectors, were frightened of them. Moreover, there wasn’t the influx of cheap and skilled labour from Eastern Europe as there is now to keep wage levels down.
Today, inflation in the High Street is being held in check by falls in the prices of clothing, footwear, electrical appliances and home entertainment devices following the emergence of China as a leading manufacturer. In other words, the current Government is enjoying favourable external influences that are keeping inflation in check. This good fortune might not last forever.
But it is not all luck. Although Chancellor Brown is an inveterate tinkerer, who has raised taxes too much and added to the burden of red tape, the delegation of interest rate policy decisions to an independent Bank of England has meant that really serious mistakes have been avoided. The Heath administration was completely clueless by comparison.
The UK – 13th place and falling!
But there is no cause for complacency. Underlying economic conditions are deteriorating and it is imperative that the Bank of England keeps its eye on the ball. UK economic growth in the first two quarters of this year has been a feeble 1.2% and 1.5%, respectively. CBI retail surveys reckon that conditions in the High Street are their worst for 22 years. The numbers of those claiming unemployment benefits have risen for six months in a row.
Meanwhile, the belated effects of a bloated bureaucracy and excessive red tape are starting to impinge on Britain’s international competitiveness. The World Economic Forum said that the UK had slipped to 13th in the international competitiveness league table from fourth in 1997. Our excessively complicated tax system, poor infrastructure and inadequately qualified workers are seen as the main culprits. Consequently, productivity growth was only 0.5% up on a year earlier. This is just not good enough.
At the same time inflation is beginning to rear its ugly head. This month’s inflation numbers will not be comforting reading and the word ‘stagflation’ – that unhappy combination of rising inflation and unemployment – may soon come back into vogue.
Too much cash chasing too few assets
Although Bank of England insiders are presumably mindful of the inflation threat contained in excessive money growth, they are not having it all their own way. The Old Lady might have agreed to cut rates by a quarter of 1% in August, but this was against the wishes of the Governor and three other Bank officials. If the interest rate doves have their way in future meetings, easy money will perpetuate the speculative frenzy into equities and other assets we have been seeing.
Some people have difficulty reconciling the current strong performance of the FTSE with worsening economic news at home. But international influences come into play. The UK stock market is heavily weighted in oil and mining stocks, and these companies have benefited from surging commodity prices buoyed by rampant demand from China.
It is also a case of too much money chasing too few assets – as was the case during the early 1970s share price boom. Companies are awash with cash, which is boosting dividend payments, share buybacks and takeover activity, and banks are lending money hand over fist to private equity houses.
Two investments to beat the ’70s comeback
What does this mean for your investments? Currently strong broad money growth will continue to underpin a boom in asset prices, but the order is rather the reverse of the 1970s in that equity prices have taken up the baton from residential property in delivering capital gains, and not the other way around.
Moreover, private equity players will play their part in underpinning share price increases just as the likes of John Bentley and Jim Slater did in the 1970s. We are also seeing the growth of broad money boosting the prices of works of art, antiques and other goods that are intrinsically supply constrained.
You should also continue to hold gold. The precious metal has just hit a 17-year high and the current bull market in bullion is the longest since the ‘stagflation’ years of the 1970s.
As always it will pay to select the right sectors of the equity market. Oil and mining shares will continue to thrive. Indeed, those expecting this sector to be bailed out by another near-term cut in interest rates are likely to be disappointed as the inflation numbers released next month will not be comforting.
To sum up, there are some compelling parallels between now and the 1970s, but favourable external developments, improved workings of labour and product markets and independent economic management mean that a 1970s-style meltdown may just be avoided. But this week’s collapse in the FTSE may just be the start.
Rest assured, we will ensure you know when it’s time to head for the exits. We remain hopeful that the boom in asset prices we have experienced will be brought down to earth more expertly than it was in the 1970s – but it won’t be an easy ride.
Brian Durrant is the Investment Director of The Fleet Street Letter.
P.S. If you enjoyed this article then we encourage you to sign up for The Fleet Street Letter. Get contrarian, cutting-edge analysis for sensible, long-term investments that secure you high growth and healthy dividends.