By Greg Lai and Alex Hsiao, Co-Chief Investment Officers
On August 15, 1971, when inflation was about 3% at an annual rate. To control inflation, President Nixon announced he was freezing wages and prices for ninety days, raising tariffs on certain imports, and ending the direct international convertibility of the dollar. The set of policies was labeled “the Nixon Shock.” Ultimately, they failed to calm inflation because they ignored the Fed and monetary policy’s role in determining the inflation level.
Restrictions on price increases for gasoline and oil remained after the ninety-day period and eventually transformed into an effort to eliminate price “gouging” when prices rose in 1973 after the Organization of Arab Petroleum Exporting Countries imposed an embargo on oil shipments to the U.S. The controls pushed gasoline and oil prices below a market-clearing price stimulated demand for these products, and simultaneously discouraged supply. With the price controls in place, consumers in the U.S. were faced with gasoline rationing and long lines waiting at gas stations for access to gasoline.
The price controls were not effective. The price of oil rose from roughly $3.50 per barrel in 1971 to more than $12.00 per barrel in 1975. The price controls on oil remained in place through 1980 when oil prices reached more than $37.00 per barrel. Once price controls were removed, the price of oil declined to just over $14.00 per barrel in 1986.
The general price level showed a similar trajectory. From 1971 to 1981, the annual average inflation rate, as measured by changes in the Consumer Price Index, was about 8.4% per year. This inflation rate was far above the roughly 2.5% rate experienced from 1913, the year in which the Fed was established, to 1971. President Reagan ended all price controls in 1981, and from 1981 to 2020, inflation averaged 2.7% at an annual rate. After 2020, inflation rose to an average annual rate of about 5% per year as the Fed increased liquidity in response to an economic slowdown following COVID-19-related policies.
Stock market participants did not fare well in the aftermath of “The Nixon Shock.” Over the ten years from August 1971 to August 1981, the after-inflation return generated by the S&P 500 Index was -1.0% per year. Once price controls were eliminated entirely, the stock market performed much better. From August of 1981 to July of 2024, the annual after-inflation return for the market was 8.7%.
Price controls were manifestations of much more significant problems that the “Nixon Shock” did not address. Inflation in 1971 was rising as the money supply increased at a rapid rate, and the budget deficit as a percentage of GDP increased mainly because of expenditures related to the Vietnam War. The price of gold rose on the open market above the official price, and President Nixon was compelled to close the Gold Window. Once this happened, the Fed was relieved of all effective restraints on monetary policy.
The forces that destabilized the U.S. economy in the 1970s are similar to those currently existing. The Treasury is running a large deficit, the Fed will be forced to monetize part of that deficit, and inflation will remain problematic. Efforts to reduce inflation by implementing price controls will fail just as they did in the 1970s. Price controls on food will reduce supplies, rent controls will reduce the housing supply. Policymakers must be aware that inflation is everywhere and, at all times, a monetary phenomenon. Monetary policy reflects the size of the budget deficit. Until the deficit’s size is reduced, inflationary pressures will grow.
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