That ’70s Show?

Paul Krugman discusses some of the differences between the current credit crisis and inflationary environment and the 1970s.

Professor Krugman is correct in pointing out that today does not have the spiraling wage inflation of the 1970s. I’ll add that globalization and outsourcing has put a cap on many US wages, especially outside of technology and other high education specialties. However . . . 

While that’s better for inflation in general, the failure of workers to keep up with cost increases is worse for the overall economy. At least in terms of consumer spending, which accounts for 70% of the US economy. And, it also means that many US workers are seeing their standard of living slide. Hence, why Inflation is called the cruelest tax of all. While no one wants to see wage increases at 11%, at least keeping up with price increases would help the retail sector, the hard-pressed housing sector, durable goods purchases, and perhaps even encourage some improvement in the savings rate.

And this is before we even get to the issue of how inflation is measured. As the chart above shows, it appears we aren’t anywhere near the levels of inflation seen during the 1970s. But that’s an apples-to-oranges comparison. Since the 1970s, there have been numerous changes to the way the BLS measures inflation — and none for the better. From substitution to hedonics to the rest of the cowardly idiocy of the Boskin commission (approved by one Bill Clinton), the way CPI inflation rate is measured today is, by design, significantly lower than it was in the 1970s. And while in my opinion, the Inflation of 2003-08 isn’t as bad as the 1973-78 era — its actually much closer than the BLS data would suggest.

Further, the OpEd notes that the Fed has — at least so far — staved off a total financial meltdown through their alphabet soup of credit facilities, lending nearly a trillion dollars to banks and brokers against all sorts of sketchy collateral (I am paraphrasing). The Fed has been much more robust in their response to today’s crisis versus the 1930s — they have to be; This crisis has become far more global far quicker than the 30s, thanks to the massive distribution of some $400 trillion dollars in derivatives throughout the global financial system. Where we diverge in our opinions is that rescuing the financial sector and keeping a lid on inflation are mutually exclusive goals. The credit crisis was never one caused by high rates. The Fed certainly could have responded by bringing rates down to 3.5% or even 3% without crimping borrowing.

Fed_lending_chartSlashing rates to 2% is a proximate cause of the further weakening of the already damaged dollar — something today’s column does not mention. Indeed, its hard to discuss commodity inflation today and omit at least some mention of the weak dollar’s impact on oil and other prices. Once the dollar comes into the equation, the Fed’s contribution to its weakness must also be acknowledged.

Hence, we are engaging in a race between the weakening economy and the weakening American peso: If you can tell which will fall faster, you can place your bets on commodity prices. Will demand destruction caused by high prices happen faster than the shrinking of the yardstick that measures those prices?  Will the economy contract quicker than the dollar? I don’t know, but whoever figures that out will have unique insight into future prices. 


The Fed may have temporarily given the financial system a reprieve from its own worst excesses, but at a cost that is proving to be quite dear. Given the current account deficits and excess spending of the US government, I have little doubt that dollar weakness is not going away anytime soon. And that does not bode well for inflation prospects, regardless of short-term, price-driven demand destruction or further weakening in the economy.


A Return of That ’70s Show? 
NYT June 2, 2008

Forms of Federal Reserve Lending to Financial Institutions
Federal Reserve Bank of New York
March 2008

Embedded vs. non-embedded inflation   
NYT, May 31, 2008,  1:27 pm   

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  1. Bruce commented on Jun 2

    I would also recommend the sobering Monday column by Dr. Hussman about the lack of improvement in the banking sector today. This is a long way from over, and not a time to begin the ready, fire, aim school of investing.

    Bruce in Tennessee

  2. Doug_S commented on Jun 2

    I don’t think consumer spending is 70% of the economy. [BR: You should think again] you can only get that figure if you ignore all business spending on intermediate goods and services. [BR: Um, no]

    You have to invest in productive capacity before you can consume. There was zero spending on the Internet in 1985. After UUNET and Sprint and Cisco built a network that could connect home and business computers, people could start buying internet access and selling things on the internet.

    Before someone invested in and built the Internet computer network “twenty years of home and business “demand” for computer connectivity created no economic activity.

    And the technology to connect computers was there and the demand was there, people just did not know it. The phone companies never dreamed that people would want to use their network for anything other than voice and picturephones. Why would anyone want to connect their computers?

  3. VennData commented on Jun 2

    The beauty of all that Etch-a-Sketch(ie) CDO collateral is that big banks just hand it over to the Fed for Treasuries (the new millennium’s version of flipping the thing over and shaking it) which they can use for all sorts of financial money making enterprise(s).

    So why can’t homeowners turn their house over to the Fed? Their mortgages? Their car payments? And start with a clean slate? This is the undercurrent of today’s voter anger at the GOP establishment that they better get a handle on if they don’t want to get flipped and shaken themselves in ’08.

  4. John commented on Jun 2

    I’m not quite sure what you’re saying here BR. Basically we need some wage inflation to keep up with price inflation even if it means yet more price inflation?

  5. Barry Ritholtz commented on Jun 2


    1. Inflation, while not as high as the 1970s, is higher than reported. The Fed has taken rates much lower than need be, with the attendant inflationary results.

    2. Fighting the credit crisis and inflation are not mutually exclusive.

    3. Don’t ignore the dollar weakness as another source of inflation, (also in large part Fed casued).

  6. Al Czervic commented on Jun 2


    If I remember my Econ 101 correctly, only final goods or services are counted in the national output. So yeah, intermediate spending is ignored. The rationale would be that intermediate sales are relected in the final sale so to do otherwise would be double counting.

  7. Al Czervic commented on Jun 2

    make that…

    …reflected in the final sale

  8. David Rosenberg commented on Jun 2

    It’s truly fascinating, years after the Boskin Commission’s hedonic adjustments were introduced and a quarter century after the BLS shifted to a user cost of homeownership approach, that the pundits choose now to come out and inform everyone how distorted the CPI is. This is new? Nobody knew that today’s CPI is structured differently than it was three decades ago? And today, not five years ago, or ten years ago, we are being put on notice that the inflation rate is hugely distorted to the downside. Everybody is judging the inflation landscape strictly on what is happening in the commodity markets, yet when the CRB was sagging at between 15% and 20% annual rates with near consistency in 1998 and 1999, and the headline inflation rate was locked in a 1.5% to 2.5% band, nobody questioned why it was back then that the CPI wasn’t deflating along with the commodity complex.

    Now everyone seems to believe that because the inflation rate isn’t in double-digit terrain along with raw materials, it must be a seriously distorted index. Maybe, just maybe, we didn’t get the CPI deflation then because of the fact that domestic demand was running at a 5% clip, we were creating 300,000 net new jobs per month, the unemployment rate was 4.5% and heading lower, and unit labor costs were rising at 2-4% annualized rates. And perhaps, this is just a thought, the reason why CPI inflation is not matching the outsized surges in commodity prices is because domestic demand is flat, we are losing jobs, the unemployment rate is 5% and moving up, and unit labor costs are practically stagnant. Maybe the inflation process is a little more complex than just linking it entirely to the CRB index.

  9. Jay commented on Jun 2

    I must take issue with what is otherwise an excellent critique of Krugman’s piece: “While nobody wants to see 11% wage inflation. . . .”

    Well, that’s like saying, “while nobody wants to keep their head above water,” or “nobody wants to see investors make enough to clear losses due to inflation,” or, “nobody wants to be paid for an honest day’s work.”

    What I think you mean to say is that nobody wants to acknowledge that real wages are shrinking due to inflation. Nobody wants to admit they’re paying their employees less by keeping their wages static. Nobody wants to admit that social security payments pegged to cost of living increases should be adjusted. Nobody wants to call our government statistics what they are: pure, unadulterated BS. Nobody wants to pay the piper, but a lot of people are doing just that, and the more we shift the economic hardships to the middle class, the closer we come to systemic collapse.

  10. mark commented on Jun 2

    Has anyone done the numbers on wage growth
    vs inflation? If wages have remained
    stagnant which has been my case over the
    last 8 years, how much more does inflation
    affect me now.

    Was wage growth stagnant through the

  11. techy commented on Jun 2

    why is strong dollar good for america?

    six months back people were predicting end of the dollar if interest rate was cut, nobody wanted to buy the idea that USA is a net debtor country, and inflation is a good thing, currency depreciation is even great.

    commodity prices going sky high because of lower interest rate and loose monetory policy??…..well isnt that what is being investigated as speculation, nothing few regulation wont be able to fix.

    china has 1.5 trillion in USD but still wants to send cheap exports by not letting its currency appreciate(so that manufacturing can start again in USA) its time all those exporting countries share the burden by holding on to a depreciating reserve.

    i am looking forward to the day when dollar will become so cheap that it will make sense to produce some goods over here…

    the only issue…OPEC, so far they are behaving well…by keeping oil still traded in USD.

  12. rexl commented on Jun 2

    the united mine workers?
    i don’t think there is much net savings in wages but the people receiving the raises have changed, check public employees, lawyers, doctors, nurses, and the other usual suspects.
    and regarding the mine workers, where lots of men used to go down into the mountain to get the coal now a couple of men in a very large machine tear the top off the mountain and take the coal at their leisure.

  13. Doug_S commented on Jun 2

    Intermediate spending is not included because it would be included in the final spending on goods and services?

    So $2,000 in car repair is not counted as economic activity because it will presumable be included in the future used car sale.

  14. Mike commented on Jun 2

    We exported to the rest of the world the very jobs that forced the 70s wage spiral. So don’t look to US statistics to reflect today’s inflation. Look at the rampant wage inflation in China and India (and elsewhere) as measured by the rising price of imports (China) and services (India). What is the mechanism there? The falling dollar of course.

    My wife’s family is from India. I spoke to her cousin over the weekend — he just got back from Mumbai. He told me a new housing development is going for 1000US/sqft and that the old friends he meets back in Mumbai make more money in India than he makes here in the US. There is also the story of our good friends from San Francisco who opted to move back to India because the wage comparison is favorable and the quality of life is better there. This is not an isolated story, I’m hearing it more and more.

  15. bsneath commented on Jun 2

    We created an economy where 70% of GDP is consumption by borrowing more than we could afford & importing more than we export. Now the economy is rebalancing. To do this, the dollar will fall, imports will fall, savings will rise, inflation will rise, exports will rise.

    The only question is, will these events occur in an orderly or chaotic manner?

  16. Risk Averse Alert commented on Jun 2

    Not only is “the failure of workers to keep up with cost increases … worse for the overall economy,” it is bad juju for a precious thing called “Posterity.”

    The compromise of institutions meant to provide stability has brought our nation and the world to an extraordinarily risky point.

  17. DonKei commented on Jun 2


    Excellent piece.

    As you say, never ignore foreign currency and international commodity markets when trying to figure out domestic inflation. This is as true today as it was in the 70’s, when dollar devaluation led to the abandonment of the gold standard and ultimately a full-fledged dollar crisis in 1978.

    In my estimation, the government’s inflation policy is intended to as painlessly as possible allow the inevitable wage compression for Americans that international wage arbitrage would otherwise compel.

    It is high time we recognized that inflation/currency debasement is the covert US government policy. The reality is reflected in its attempt to lie about the true extent of dollar debasement through its tortured statistics.

    And why shouldn’t the US government want to debase its currency? Every of its several trillion dollars of liabilities become that much cheaper to pay back. If the near hyperinflationary oil markets keep up their ways, it’s likely the value of US government debt could decrease so much that the US would appear to be solvent again, like a company that marked its liabilities to market as it approaches insolvency appears to be making money. (See FASB rule 159).

  18. Andrew G commented on Jun 2

    The primary reason why the Fed acted less dramatically in the 30s is that the US was tied to the gold standard. The Fed felt they had to keep rates high in order to avoid capital outflow. So, the Fed has done exactly the right thing this time around – instead of raising rates in order to maintain a de facto ‘oil standard’, they have cut rates/provided liquidity in order to avoid a depression.

  19. ScottB commented on Jun 2

    I agree with you that lowering interest rates didn’t do anything to help with the financial meltdown. I disagree with you that the drop in the value of the dollar–and any related inflation–is a problem. The drop in the dollar is a long-overdue correction for a nation that has been running an unsustainable trade deficit. It should drop more against any number of currencies. Capital inflows have brought us cheap imports but also less domestic production. Higher import prices will help get production and consumption closer to alignment.

  20. Al Czervic commented on Jun 2


    I have little idea where and how they “draw the line”. I would guess that if you spent $2000 to fix your car, then that would be counted as the final sale of a service from the shop that fixed it to you.

  21. DL commented on Jun 2

    The bulls argue that, while we may have some economic weakness over the next several months, we’ll be off to the races again in the fourth quarter.


    The economic dominos will continue to fall for another two years, in part because of all the fed tightening that will have to occur once the election is out of the way.

  22. Sinomania! commented on Jun 2

    “There was zero spending on the Internet in 1985.” — Doug_S

    Actually the feds were making big investments in the ARPAnet or DARPAnet then and had been for almost 20 years – Cisco and UUNet’s contributions were in developing technology that connected and made productive the already considerable investment by the government in the internet’s basic foundation. I agree with what you’re saying – and what we need now in America is a new direction for productive advances – energy, alternative energy, electric cars, these are all things that should be jumpstarted now. But the USA is still geared as a war making machine.

  23. Pat G. commented on Jun 2

    “I’ll add that globalization and outsourcing has put a cap on many US wages,”

    Globalization and outsourcing benefited who? Big business. Who was responsible for passing the laws to make it happen? Big government. Get the picture?

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