Key points:
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- Share markets in Australia and the US suffered long and deep 1973-4 crashes in parallel. Both featured major political crises – Nixon/Watergate in the US, and the Whitlam dismissal in Australia.
- However the main causes of the parallel share market crashes were the battle against inflation, not the political dramas. The policies of both administrations certainly worsened the inflation problem, but inflation had its roots in the mid-1960s.
- The 1970s inflation crisis trigged three seismic once-in-a-generation policy shifts, including:
- 1) in monetary policy thinking – from the Keynesian ‘Phillips-Curve’ trade-offs to Friedman’s ‘Monetarism’.
- 2) toward central bank independence and inflation targeting; and
- 3) the shift to a whole new economic orthodoxy - away from the post-War Keynesian ideas of heavy government intervention and control, welfare state, protectionism, heavy regulation, and high taxes - toward the post-1980 ideas of globalisation, deregulation, hands-off governments, free trade, lower taxes, privatisation, and individual self-relance.
- That post-1980 system gave us four decades of declining inflation and interest rates, which boosted asset markets and generated windfall investment returns. But it also resulted in rising inequality, the hollowing out of what were once high-paid, stable manufacturing jobs, casualisation of workforces, and resultant social unrest.
- That golden era of declining inflation, declining interest rates, globalisation, free-trade, hands-off government, are clearly over. Now (since the GFC and certainly since Covid), we are into a new era – with the return of inflation, big government, heavy government interference, protectionism, backlashes against immigration, nationalism.
- Today’s conditions have some similarities with the 1970s crisis – slowing growth, rising inflation, currency instability, fiat currencies lacking money supply constraints, political unrest.
- But we now have some additional factors - including big government deficits and debts, flat-lined productivity growth, casualisation/uberisation of workforces which is fostering populism, nationalism, xenophobic backlashes against immigration, and racial division.
- We also have two additional problems in tackling inflation – 1) governments’ lack of discipline on fiscal policy, and 2) lack of courage and political will on monetary policy.
- The outcomes are likely to be higher inflation and interest rates, plus lower asset market returns.
50 years on from the Whitlam dismissal
It is 50 years since the dismissal of Prime Minister Gough Whitlam – on Remembrance Day 11 November 1975. It was undoubtedly the most contentious and controversial political crisis in Australia’s post-white settlement history (or at least since the military coup in 1808. But there is no doubt that the Whitlam dismissal was the most controversial and far-reaching in the modern era).
At the time of the Whitlam dismissal, I was in high school in Tasmania (one of my twelve schools across seven States), and I have vivid memories of how it sparked unprecedented outrage within the school, across the entire community, and around the country.
After Tasmania, my next couple of high schools were in the US, where the Nixon/Watergate crisis was just as topical and controversial.
I do not take sides in the political debates surrounding these momentous and highly political events. My aim is to ignore the politics and focus on the financial implications for investment markets.
The 1973-4 crash
Today’s main chart shows the daily Australian All Ordinaries Index (green) and the Dow Jones Industrial Index of US shares (red) during the period 1972-6. Both have been re-based to 100 at the start of 1972 in order to highlight their almost identical parallel paths in the crash and then in the rebound.
The lower section of the main chart shows the main monetary policy indicator in each country in that era – the Official Short-Term Money Market rate (60 day) in Australia (green), and the Fed’s discount rate in the US (red).
Also marked in the lower section are the periods of economic recession in both countries. This highlights the fact that the share markets rebounded from the middle of economic recessions. This is the usual pattern with recessions, contrary to popular belief that recessions are bad for share markets. (In most cases, it is the fear of impending recession that causes share market sell-offs, not the actual recession itself if and when it does arrive.)
Parallel paths for share markets
The stock markets in Australia and the US both suffered relatively long and deep crashes in 1973-4.
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- In Australia the All Ords fell by -59.8% from 23 January 1972 to 30 September 1974 - worse than the October 1987 crash, but not as bad as 1929-31 crash. However, in real terms after inflation, it was our deepest ever crash at -67%.
- In the US the Dow fell by -45% from 11 January 1973 to 6 December 1974. Not as bad as 1929-32 (-89%), but still a very serious sell-off (especially in real terms after inflation).
As with almost all cycles, the Australian market followed the US market very closely through the twists and turns on the way down, and then on the way out in the recovery. This is no coincidence that the Australian market follows the US very closely. Global markets are highly interconnected, and Australia has a relatively small, open economy heavily reliant on foreign capital, so what happens on Wall Street is invariably echoed on the local market next morning.
However, there was one element of coincidence in this particular crash – both countries just happened to be going through extraordinary political crises – the unprecedented removal of President Richard Nixon in the US, and the unprecedented removal of Prime Minister Gough Whitlam in Australia.
Nixon & Whitlam
US is a Republic, where the President can be removed by Congress in certain very rare circumstances. Nixon was ‘impeached’ by the US House of Reps on three charges relating to his involvement in, and cover-up of, the break-in to the Democrat campaign headquarters at the Watergate Hotel during the 1972 election campaign. Following the impeachment charges, Nixon resigned on 9th August 1974 to avoid being formally removed from office.
On the other hand, Australia was, and still is, technically a British colony, where the King or Queen of England is also Australia’s official Head of State. Whitlam was removed by Queen Elizabeth II of England (also Queen of Australia) via her local representative, Governor-General Sir John Kerr. (Ironically, Whitlam had hand-picked Kerr and recommended him to the Queen only a year earlier, against Whitlam’s own Labor party advice!)
Starting out with the top of the boom
Nixon’s landslide re-election win (7 November 1972) and Whitlam’s landslide first election win (5 December 1972) were both in the midst of the euphoria of the late-1972 share market peak in each country, after strong rebounds from the 1970 recession in the US, and the 1970-1 mining collapse in Australia, helped along by expansionary monetary policies in both countries.
The Nixon and Whitlam election wins did not trigger or cause the long and deep share market crashes that started right after the elections.
For share markets the real battle was about inflation, not politics
The central issue in both countries, and around the world, were inflation, currency volatility following the end of the Bretton Woods US dollar/Gold Standard system, the trade-off between inflation and unemployment, and the severe credit squeezes in both countries that triggered the deepest recessions and stock market sell-offs since the 1929 crash and the 1930s depression.
Although the Nixon and Whitlam administrations contributed to the inflation problems in their respective countries, the underlying causes of inflation went back to the sustained increases in government spending from the mid-1960s on social programs and the Vietnam war, made worse by poor central bank responses to rising inflation, the OPEC oil price spike at the end of 1973, worsening current account deficits, and currency imbalances.
In Australia in particular, the inflation situation was worsened significantly by automatic quarterly indexation of award wages to inflation, the Whitlam government’s granting of above-inflation wage rises to government employees, and expansion of government jobs to try to soak up rising unemployment.
Start of the 1973-4 crash
From the highs of late 1972 with the re-election of Nixon and election of Whitlam, the long and deep share market decline was triggered by the start of policy tightening efforts in each country to tackle rising inflation (mostly monetary policy but also some fiscal measures including tariffs, quotas, taxes, exchange rates).
In Australia, the tightening started with a sudden upward 7% revaluation of the dollar on 23 December 1972, when inflation was running at 6%. In February 1973, the RBA switched its policy settings from 'Expansionary' to 'Mild Restraint'.
(In that era, the RBA’s main monetary policy tools were aimed at controlling bank lending by setting levels for how much banks could lend, at what rates, and to what industries, as well as setting deposit interest rates, ‘LGS’ ratios (the level of liquid & government securities banks were required to hold), and the dreaded ‘special account’. Market interest rates were more of an outcome than a direct policy tool, and their focus was at the long end, where the main target was the yield on government bonds. Monetary policies were set by the Treasurer, on advice from Treasury as well as the RBA often as a junior source of advice. The RBA’s role was mainly implementation and execution of the Treasurer’s policies).
In July 1973, the RBA further tightened the credit squeeze by shifting from ‘Mild Restraint’ to ‘Full Restraint’, and tariffs were cut by 25% across the board. These policy tightening measures are marked in the lower section of the main chart.
From the start of 1973 to September 1974, 90 day Bank Bills yields rose from 5.5% to 12.75% (peaking at 21% in May 1974), official short-term money market rates rose from 4% to 10.15%, and 10-year government bond yields rose from 5.7% to 9.5%. It was the most severe and sustained credit squeeze in Australia’s history.
It was also the worst bank liquidity crisis since the widespread bank collapses in 1893. There were runs on desposts in several building societies around Australia, interbank interest rates shot up to above 20%, and all of the major banks had to borrow emergency cash from the RBA's emergency deposit window to keep up with customer withdrawals and keep their doors open.
There was only one bank collapse out of the mid-1970s crisis - the Bank of Adelaide (no relation to the current 'Adelaide Bank') collapsed under a mountain of bad debts in its finance arm FCA from the early 1970s property construction boom. It was eventually rescued in 1979 by ANZ which took over the carcase and the deposits so that no retail depositors lost money. (It was a model for the much larger collapses in the early 1990s of the State Bank of Victoria and State Bank South Australia after mountains of bad debts from the late 1980s property construction lending boom. Likewise the near fatal losses from bad debts from property construction loans in Westpac's AGC and ANZ's Esanda.)
In the US, the Fed also started to raise its discount rate on 15 January 1973, when inflation was running at 4%. In all, the Fed raised the discount rate from 4.5% to 8% in fifteen months.
We can see on the left side of the main chart that the start of the share market index falls from the highs in January-February 1973 (upper section) line up with the start of policy tightening by the two central banks (lower section).
So the Australian market followed the US market down, not just because we always follow the US lead, but also because the central banks in both countries started to tighten policy at the same time – and for the same reason – rising inflation.
Rate hikes & recessions
The savage interest rate hikes in 1973-4 killed the economic booms in both countries, tipping them both into economic recession. The timing of each recession are indicated on the lower section of the main chart.
However, inflation still remained high, and unemployment was still rising (blue lines in the two smaller charts below the main chart), with widespread business closures and failures.
Inflation a larger problem in Australia
The smaller charts below the main chart show inflation and unemployment rates in each country over the same period as the main chart – start of 1972 to end of 1976. The y-axis scales on each chart are the same, in order to highlight the key differences – much higher inflation (but lower unemployment) in Australia relative to the US.
Why does Australia have higher inflation than the US?
When influential Kiwi-born economist Bill Phillips (the father of the ‘Phillips Curve’), was developing his inflation-unemployment trade-off model for Australia, he pointed out the key inflationary features he observed in the Australian system:
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- Australia’s centralised system of Awards and minimum wages,
- Centralised Arbitration Court decisions and National Wage Cases,
- Trade union power and ability to extract above-Award pay rises,
- Export prices and revenues were influential in centralised wage decisions, without reference to productivity.
- Added to this was the automatic wage indexation in the Whitlam years.
(Phillips, A, ‘Wage Changes and Unemployment in Australia 1947-1958” Economic Society of Australia and New Zealand Economic Monograph, 1959, No. 291)
Even Keynes decades earlier in his ‘General Theory’ also specifically identified Australia’s centralised wage system as an inflationary problem. (Keynes, ‘General Theory of Employment, Interest and Money’, London, Macmillan, 1936. pp. 267-9 in my 1973 edition).
Nixon-Whitlam Political crises
While the policy decisions of the Nixon and Whitlam administrations certainly influenced the direction of the inflationary and economic crises in their respective countries, their tumultuous removals from office did not change the course of share markets. In each case there was a share market reaction on the day, but both markets resumed their existing trends the following day.
By the time Nixon resigned on 9 August 1974, the US market had already been falling since January 1973 when the Fed started hiking interest rates. When Nixon finally resigned, the US share market kept falling because inflation was still rising despite eight rate hikes from 4.5% up to 8%.
Likewise, Whitlam’s dismissal on 11 November 1975 was not a turning point for the local share market either. The share market had already rebounded 45% from its low point more than a year earlier in September 1974.
Share market recoveries
In both Australia and the US, share markets rebounded from late 1974 (out of the middle of the respective recessions, as per the usual pattern in recessions). The rebounds in both markets finally ran out of steam by late 1975 – just as economies were recovering and monetary policy was being eased (also a common pattern in recession rebounds).
Australian rebound
The rebound on the Australian share market started at the beginning of October 1974 following some major collapses of property construction companies – notably Mainline and Cambridge Credit at the end of September, plus a surprise 12% devaluation of the dollar in the last week of September. This triggered the biggest ever one-day rise in the local market index of +7.3% on 25th September 1974.
The big turning point was the RBA’s sudden switch from ‘Restraint’ straight to 'Expansionary' settings at the start of October after the building society deposit runs. The Treasurer ignored Treasury advice and abandoned the fight against inflation (which was still rising) and switched the primary focus back to fighting rising unemployment.
The bank CEOs were called into an emergency meeting at the start of October and directed to rapidly expand lending volumes. LGS ratios were cut, SDR's were cut, money was released from the 'Special Accounts', and interest rates were cut. The official short-term money-market rate dropped by -1.15%, 90-day bank bills dropped by -2.15%, 90-day commercial bills dropped by -1.75%, and savings bank reserve ratios were cut to encourage mortgage lending.
These major policy switches put a rocket under share prices, even though inflation was still running at 16% at the time. Both inflation and unemployment would go on to rise into early 1975, but the easing monetary policy signals provided confidence for investors to keep buying shares, and they never looked back.
By the time Whitlam was dismissed in November the following year, the local market had been rising strongly for eleven months, through the Khemlani loans affair, Whitlam’s sacking of Treasurer Jim Cairns on 4 June 1975 (after Cairns threatened in Parliament to just keep printing more money until unemployment had been completely eliminated!), and also Whitlam’s sacking of Minister for Minerals and Energy Rex Connor on 14 October (after the ‘loans affair’ in which he tried to raise money from shady Middle Eastern sources to fund his proposed nationalisation of all mining activity in Australia).
Then, when Malcolm Fraser won the 13 December 1975 election (following Whitlam’s 11 November dismissal) by a landslide, the local share market continued on its rebound path, and continued through to September 1976 (when it hit the British pound / IMF bailout crisis).
US rebound
The US market rebound rally was kicked off by the Fed’s first rate cut on 9 December 1974 (despite inflation still running at 12.2% at the time). The US rebound rally continued through new President Gerald Ford’s two assassination attempts, and through the New York financial crisis and bailout.
Just as the start of the share market crashes in both countries started at the same time, because both central banks started policy tightening at the same time, we can also see in the middle of the main chart that start of the share market rebounds (upper section) line up with the start of policy easing by the two central banks (lower section).
Once again, the Australian market followed the US market up (just as it followed it down), not just because we always follow the US lead, but also because the two countries started to loosen monetary policy at the same time.
Major outcomes from the 1970s economic crisis
The dramatic and traumatic mid-1970s economic crisis led to at least three far-reaching policy shifts that shaped the course of economic history for several decades -
1.. Turning point in monetary policy thinking
The first turning point was in monetary policy thinking in the US, Australia, and around the world.
The post-War reconstruction boom and Bretton Woods stability produced high rates of economic growth, productivity, and jobs growth, so governments had not needed to fully test the Keynesian notion of an inflation-unemployment ‘trade-off’ – ie engineering high unemployment to bring down problematic inflation.
However, when growth slowed and inflation rose in the 1970s, the ‘trade-off’ idea was put the test and failed.
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- In the US, inflation reached 12.2% in November 1974, and unemployment reached in 9.1% in May 1975 when inflation was still 10%.
- In Australia, inflation reached 17.6% in March 1975, and unemployment reached 6.7% in February 1978 when inflation was still above 8%.
This new experience of high and rising inflation at the same time as high and rising unemployment was the final nail in the coffin for the Keynesian idea of a ‘Phillips Curve’ trade-off between inflation and unemployment, and it started the search for a new policy framework, and the outcome was a shift in thinking toward the idea of Milton Friedman’s monetary targeting, or ‘monetarism’.
Friedman -v- Robinson and the end of Keynesianism
In April 1975, two of the most influential thinkers on monetary policy visited Australia – the American libertarian Milton Friedman, and the British left-wing post-Keynesian/Kaleckian Joan Robinison.
Friedman argued that inflation was caused by excessive monetary expansion and government spending in particular, and that inflation could only be brought down by constraining the money supply – by reducing government spending and credit growth. For Friedman, it was not a choice between unemployment or inflation (the Phillips Curve ‘trade-off’), it was a choice between some unemployment now, or more unemployment later.
Robinson’s post-Keynesian view was that Keynes would never have approved of the Phillips Curve idea of inflation and unemployment co-existing in a ‘trade-off’. Instead, she argued that inflation was caused by the class-war struggle between capital (business price gouging) and labour (wage claims), and that no policy measure that increased unemployment could ever be justified.
Essentially, Friedman and Robinson used different arguments to arrive at the same conclusion - that the inflation-unemployment trade-off idea was not sound – ie you can’t buy a reduction inflation at the cost of jobs. This was consistent with the 1970s experience of seeing high and rising inflation and unemployment at the same time.
Robinson was popular within the Labor government, as would be expected, in particular with Treasurer Jim Cairns who was a staunch anti-Monetarist. Whitlam cancelled his meeting with Friedman when he heard about Friedman’s view that excessive government spending caused inflation.
After Cairns was sacked by Whitlam, the new Treasurer Bill Hayden specifically rejected the idea of using unemployment to fight inflation. In his 1975/6 budget speech on 19 August 1975 he officially declared Keynesianism dead –
“Australia is no longer living in . . . .the simple Keynesian world in which some reduction in unemployment could, apparently, always be purchased at the cost of more inflation. Today it is inflation itself which is the central policy problem. More inflation leads to more unemployment.”
A far cry from Nixon’s declaration in 1971 that “We’re all Keynesians now!”, which accompanied his ill-fated “Whip Inflation Now’ campaign.
In Australia the game was up for the Labor government. Friedman’s visit was probably the turning point for galvanising the Federal Opposition, business leaders, lobby groups, and gaining widespread public support for a shift to Monetarism to fight inflation. However, the journey was neither quick nor pain-free.
Finally killing inflation
In the US, Jimmy Carter appointed new Fed Chair Paul Volcker in 1979, and he finally killed the 1970s inflation beast in the early 1980s using severe money supply targeting that resulted in interest rates soaring to 20%. Volcker’s painful medicine cost Carter a second term (with the election of Ronald Reagan in 1980), and it also almost cost Reagan a second term.
Inflation in the US was cured but at heavy cost - deep double-dip recessions in 1980-2, widespread business failures, and unemployment rising to 10.8%. However, the US did enjoy low inflation and declining bond yields and interest rates through the 1980s.
Australia took a decade longer to conquer inflation
But Australia did not follow same path as the US (and UK). The Fraser/Lynch government was too weak in the late 1970s and early 1980s, and they did not have the stomach to fight the unions when unemployment was already running above 6% in 1980-2 (and then soared above 10% in the 1982-3 recession).
The new Hawke/Keating Labor government from March 1983 specifically rejected the harsh ‘monetarist’ medicine of money supply contraction and high interest rates used in the US/UK to kill inflation, and they adopted their ‘Accord’ process instead.
As a result, inflation in Australia remained high for the rest of the 1980s (1983-9 average of 7.6% pa in Australia versus 3.8% in the US). Unemployment also remained higher in Australia for the rest of the 1980s (1983-9 average of 8.0% versus 6.7% in the US).
It took another decade for inflation to be killed in Australia – in the deep 1990-1 ‘recession we had to have’.
For my story on that cycle, see:
2.. Central bank independence
A second major outcome from the 1970s inflation crisis was that governments admitted defeat and granted ‘independence’ to their central banks (independence within government, not independence from government).
Central bank independence, accompanied by explicit inflation targeting, was cemented in the early 1990s with New Zealand leading the way, and it led to three decades of low inflation.
3.. Transition to new economic orthodoxy
Beyond the relatively narrow and rather dry topic of monetary policy (above), a third major outcome of the 1970s inflation crisis was that it led to fundamental shift to a whole new economic orthodoxy – away from the post-War Keynesian ideas of heavy-handed government intervention and control, welfare state, protectionism, heavy regulation, and high taxes - toward the post-1980 ideas of globalisation, deregulation, hands-off governments, free trade, lower taxes, privatisation, and individual self-relance.
That post-1980 system gave us four decades of declining inflation and interest rates (three decades in Australia), which boosted asset markets and investment returns. But it also resulted in the hollowing out of what were once high-paid, stable manufacturing jobs, casualisation of workforces, rising inequality, and resultant social unrest.
Similarities with today’s conditions
(Apologies to readers for the rather dry account of monetary policy shifts over the past half century. It is not just idle curiosity – it has direct relevance to what is going on today, and it will shape the future of asset markets and investment returns in the decades ahead.)
That golden era of declining inflation, declining interest rates (which delivered high asset market returns), globalisation, free-trade, hands-off government, is clearly over. Now (since the GFC and certainly since Covid), we are into a new era – with the return of inflation, big government, heavy government interference, protectionism, re-regulation, populism, backlashes against immigration, nationalism.
Today we are facing many of the conditions that contributed to the 1970s crisis – slowing growth, rising inflation, currency instability, fiat currencies lacking money supply constraints, political unrest.
But this time we now have some additional factors that were not as problematic in the 1970s – including big government deficits and debts, flat-lined productivity growth, xenophobic backlashes against immigration, and casualisation/uberisation of workforces which is fostering populism, nationalism, and racial division.
Current monetary/fiscal policy thinking on inflation
In terms of monetary policy theory, ‘Monetarist’ money supply targeting was only used for a few years from the late 1970s to early 1980s, and governments/central banks quickly switched from targeting the quantity of money to targeting the price of money (via interest rates).
Central bank thinking has probably reverted to an ‘expectations-augmented’ Phillips Curve inflation-unemployment trade-off. The problem identified in the 1970s was that it is not actual inflation that influenced consumer and business behaviour, it was the inflationary expectations. Even when inflation has been brought down after a period of high inflation (for example in the mid-1980s US, or mid-1990s Australia, or now after the Covid stimulus inflation) it can take many years for people’s inflationary expectations to come down. Even when inflation is low, rising inflation expectations can depress spending, investment and jobs growth, undermining the inflation-unemployment trade-off as a useful policy tool.
Having said that, there is probably still a wide-spread general belief among central bankers that inflation can be brought down by raising unemployment levels (eg raising interest rates so companies cut costs, shed jobs, slow production & investment, and also to weed out the weaker less-efficient businesses and the jobs they support).
But will governments bite the bullet?
The problem is, with the rise of political fragmentation and populism, governments in the US and Australia (and probably UK and Europe) probably no longer have the courage to risk political suicide by deliberately setting out to increase unemployment as a means to slow spending, wage claims, and price inflation.
If governments and their central banks don’t act (or worse still – keep running inflationary deficits as they are now), and unwinding globalisation, subsidising inefficient, higher cost on-shore manufacturing, the outcome is likely to be sticky inflation and elevated interest rates, resulting in low business investment, low productivity growth, slow economic growth, and weak jobs creation, similar to the 1970s.
Inflation and asset market returns
As a long- term investor, and adviser to long-term investment funds/mandates, what I am most interested in is the impact of all of this on investment returns, and how to adjust asset allocations in diversified long-term portfolios that need to span decades and profound changes in economic conditions. This is my main focus.
One finding is that inflation is not good for investment returns – from any asset class (including precious metals). For my long-term study of the impact of inflation on asset class returns – see:
'Till next time . . . . safe investing!
See also:
For my most recent monthly update on local & global markets for Aussie investors: