A Walk Down Memory Lane

In 1965 I was studying for a degree in Engineering.In order to broaden my horizons, I took a course in economics; the textbook was Paul Samuelson’s “Economics.”Samuelson was a proponent of Keynesian theories, many of which John Maynard Keynes developed during the Great Depression of the 1930s.

Keynes believed that much of the pain of recession/depression could be alleviated by the government and/or the Federal Reserve Bank putting more money in the hands of the public, thereby increasing spending, which would encourage more production and employment, resulting in lowering the high unemployment which was endemic to recession/depression. In summary, more money leads to more demand leads to more production and more employment. He also said that introducing more money into the economy at full employment would merely result in more inflation.

In fairness, Keynes recommended a balanced approach: when the economy is slower than optimal, he prescribed increasing money available to encourage growth in demand, production, and employment. When this has been accomplished (as evidenced by low unemployment) then reduce growth in the money supply. Samuelson’s textbook was, and has been, widely used since my college days and has influenced economists, central bankers, and policymakers ever since. Unfortunately, they have adopted the first part of Keynes’ prescription (print money to stave off recession) and ignored the second part (stop printing money when the recession has been averted or you will get inflation). That oversight has had profound consequences.

I entered the investment business in 1968 when everyone believed that a 4.5% yield on a quality corporate bond and a 17 price-to-earnings (P/E) ratio on stocks was normal. People did not talk about inflation because it had been consistently less than 3% since 1951. The major concern of economists at the time was the business cycle of 3-5 years and how to avoid the recession part of it. In the 1960s we had extended the growth part of the business cycle beyond the expected 3-5 years and avoided the recession part of the cycle; so naturally economists took credit for having licked the business cycle. By the time a friend of mine got his degree in economics in 1968, his school canceled their course on the business cycle because they believed it was obsolete. The cure for recession was to print more money (to encourage more demand, production, and employment).But printing more money did not end the business cycle, it merely overlaid inflation on each part of the cycle. Despite believing we had licked the business cycle, we had recessions in 1970, 1974, and 1980; and the difference between these and prior recessions was we also had to deal with inflation at the same time.

1968 was the first year since 1951 that inflation exceeded 3%. By 1970, inflation reached 5½%, driving interest rates up and bond and stock prices down. But the general perception was that it was “temporary.” In early 1970, I took a job with an insurance company as an analyst, and I remember the VP of Finance saying, “It’s a once in a lifetime chance to get 6½% on a corporate bond, everyone knows that 4½ % is the normal interest rate.” And it appeared he was right; the U.S. had a recession in that year, inflation fell back to 3%, interest rates fell, our 6½% bonds appreciated in value only to be called away from us before we could make as much on them as we expected, and parts of the stock market (mostly the “Nifty Fifty”) hit new highs. The S&P 500 representing the broader stock market did not.