The twenties of the first century of the new millennium appear more and more like a already seen of the turbulent seventies and eighties of the last century of the old millennium. Economic shocks, inflation, bank collapses, geopolitical tensions and more social unrest, strikes and political instability. Judging by how the old West is managing all these crises, one wonders if the historical memory still exists or if someone or something has it cancelled.
In 1979 Paul Volker, appointed governor of the Federal Reserve, began his battle against the‘inflation which was already at 11 percent. He did this by raising interest rates and contracting the money supply. Interest rates rose to over 15 percent and the money in circulation was ‘rationed’ with the intention of curbing the price rush upward. In 1983, the combination of these two strategies produced the desired results. A victorious Volker declared that inflation had fallen to 4 percent. However, the price paid was very high: two recessions, soaring unemployment rates and high volatility on the financial markets.
Diverse banks were overwhelmed by the anti-inflation cure. In 1982 Penn Square Bank was forced out of business leading to other bankruptcies, including Seattle First National Bank (Seafirst) in Washington state; two years later it was the turn of the Continental Illinois National Bank and Trust Company which became the most significant bank failure until the 2007-2008 crisis. The collapse of the banks was caused by the unexpected and prolonged increase in interest rates and the energy crisis. A deadly combination. Almost all the banks that found themselves in difficulty had in fact subscribed to the debt of developing countries, eg Latin America, which the increase in interest rates had made to gravitate excessively or had equity investments in energy companies now in serious difficulty in their portfolios. In both cases, interest rate and price movements produced imbalances in their balance sheets, imbalances that were impossible to contain.
L’intervention of the Federal Reserve to avoid bank contagion was only partially successful, despite the highs interest rates offered to savers. Indeed, there was a decline in deposits which contributed to the crisis of the banking system. Then as now, public confidence in the financial system wavered. Today we are faced with a very similar though not identical scenario. In the seventies it oil shock, caused by oil prices quadrupling overnight, it triggered the inflationary spiral even though inflation had been lurking since the mid-1960s.
Today it was the war in Ukraine. Energy and food inflation accounted for more than two-thirds of theinflation record in 2022. I prices of food products, for example wheat (as an ingredient in flour, bread and pasta) or oilseeds for which imports from Ukraine and Russia had played an important role before the war, recorded in 2022 inflation rates much higher than the average for food inflation.
The banking crisis and the collapse of some banking institutions are still today linked to low confidence in the system – Svb, like Credit Suisse and now Deutsche Bank are victims of the loss of value on the markets distrust of investors and customers. But the instability of the banking sector, now tangible on the markets, is also the product of anti-inflation medicinemedicine that is called recession. There is no successful anti-inflation experiment in economic history that has not taken advantage of the recession. And therefore it would be good today to prepare for a radical change in the financial and economic climate which, at best, will last for a few years.
Unlike the 1970s and 1980s, when the world economy absorbed the blow of therising energy costs restructuring itself around the new variables, today adapting to the perennial war in Ukraine is not possible. The conflict it will continue to add to costs even if the world economy finds new sources of energy and food. War is a continuous and profound element instability, the best ground for inflation to flourish again and again. If the war is not ended, the bitter recessive medicine will not work and we will be poorer and poorer.