Back to the 1970s? Inflation Outlook

by Jeremy Stark

There are a number of reasons many of us would prefer that the 1970s remain a distant memory--like disco, handle-bar mustaches, plaid sport jackets, and bell-bottoms. Lately, however, some concerns of that turbulent period have been making news again: higher oil prices, inflation, and even stagflation. What is the outlook for inflation, and what should you do about it?

Inflation was up last year; there is no doubt about it. Gasoline and home heating oil are more expensive, rents are up, and health-care costs keep rising. If you take a step back, though, the differences between now and the '70s start to emerge pretty quickly.

Not only was the inflation rate much higher then (the consumer price index rose 13.3% in 1979; in 2004, it rose 3.4%), it spread over every part of the economy. Now, prices for many consumer goods are stable, and others, like those for computers and DVD players, are falling. With all the incentives and competition among automakers, new cars are 4.3% cheaper now than they were in 1996.

The end of the Cold War created a truly global economy, and rapid advances in technology enabled construction of a worldwide communications network and a global marketplace. With few exceptions, no matter where you are in the world you can look on the Internet for the lowest price available for whatever you're trying to buy and have it shipped to your front door in days.

The same technology allows companies to find the cheapest suppliers, manage their manufacturing lines and inventories more efficiently, and make business decisions effective with the click of a mouse. Businesses can provide goods and services at lower costs, global competition makes sure they do so, and everyone gets a better deal. Globalization and the Internet combine to form a powerful deflationary force. The "productivity revolution" that enabled the U.S. economy to grow rapidly for years without initiating worrisome levels of inflation in the 1990s was real, and it is real today.

That said, there still are bottlenecks in the global economy and shortages of some resources that enable producers to raise prices when demand grows. We may not be as lucky in the 21st century inflation-wise as were the people who lived in the 19th century, when similar revolutions in communication (the telegraph and telephone) and production efficiency (the modern factory) combined with faster transportation (the steamship and railroad) to make it a much smaller--and cheaper--world. There was no inflation in the 19th century save for that caused by wars.

Nevertheless, it is reasonable to be less concerned about inflation now than we were in the 1970s, no matter what the headlines say. Remember that few members of the media are economists. When they suggest that stagflation--prices rising while economic activity slows down--is on the way, they're trying to scare you into watching their program or buying their magazine.

There are ways to protect yourself and your family against whatever inflation does emerge in our lifetimes. Investing in stocks, especially through a tax-deferred investment account like an IRA (individual retirement account) or 401(k), historically has been a decent "hedge" against inflation because companies raise prices as inflation rises, and their profits and stock prices have tended to go along for the ride.

Potentially even more effective is a tax-sheltered investment in some bonds issued by the government that guarantee a real return above inflation: U.S. Treasury Inflation-Protected Securities, or TIPS. You can buy these bonds directly from the government, or invest in a mutual fund that owns them. Right now, the "real return" these bonds offer may not look attractive--it is generally less than 2%--but there is value in the inflation protection they offer, and they also provide diversification for stocks and other types of bonds you may own in your investment portfolio.

Also available from the U.S. Treasury are Series I savings bonds, or "I bonds," which, depending on your circumstances, may have some tax advantages and currently offer a 1% "real return" above inflation.

In sum, it doesn't look as though a return of the 1970s is likely any time soon, but still it is prudent to consider the effects that inflation may have on your long-term finances. Do some research or get some good advice, save, and invest.

Jeremy Stark of CUNA Mutual Group and MEMBERS Capital Advisors provides economic and financial market analysis and investment advice for institutional clients in the credit union system. The CUNA Mutual Group is the leading provider of financial services to credit unions and their members nationwide. MEMBERS Capital Advisors is CUNA Mutual's registered investment advisor affiliate.

June 13, 2005