When investor questions are raised about inflation, the conversation often turns toward the possibility of inflation and interest rates returning to the peaks of the 1970s and 1980s

When we talk to serious, Successful Investors, few ask, “Do you think the central banks will raise rates two or three times by a quarter-point before the end of the year?” or “Do you think inflation will hit 3% in the next year?” Successful Investor questions are more like, “What are the chances that interest rates and/or inflation will get back up to the peaks of the 1970s/1980s?”

That is a much more important question.  A quarter-point change in interest rates or inflation is a fluctuation. A return to the peaks of the 1970s/1980s would be a disaster.

How Successful Investors Get RICH Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor. How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

What is inflation?

In economic terms, inflation is the steady increase of the price of goods and services that accompanies an increase in the supply of currency. The average inflation of a developed country is generally near 2%. This means that if your investments see a 10% gain in a year, you need to account for inflation which reduces it to an 8% gain in today’s dollars.

Looking deeper into investor questions on inflation

The productive way to address investor questions on the spurring of inflation is to look at the 1970s and 1980s and to try to figure out what was special about them.

It seems to us that in the years prior to the 1970s inflation era, three specific political/economic factors worked together to unlock a lot of pent-up demand for money, goods and services, and funnel it into a narrow timeframe where it could have great impact. These factors helped spur the rise in interest rates and inflation that followed. 

Three factors that spurred the rise in interest rates and its following inflation

The first factor was that, during four decades between the early 1930s and the early 1970s, the U.S. managed to fix the price of gold at around $35 U.S. per ounce.

This helped set up the U.S. dollar as something of a world currency during three crucial, historic periods: the 1930s depression, the Second World War and the post-war boom. The role of world-currency issuer let the U.S. expand its money supply without burdening itself with a heavy load of domestic inflation—not burdening itself right away, that is. But eventually the $35 gold peg gave way, like a dam that bursts when the force of a rising river becomes too much. The breaching of that $35 barrier helped set off a worldwide wave of inflation, as the value of the U.S. dollar withered in relation to the value of gold.

The second factor was the control by Western governments and countries over the price of Mideast oil.

Thanks partly to that control, oil prices remained low from the end of the Second World War until the early 1970s, despite vast increases in oil demand, in time with growth of the auto industry. This source of cheap oil brought many economic benefits to the West. Rising auto manufacturing produced jobs. Oil refining and marketing also expanded, as rising numbers of ever-larger cars hit the road. Along with profits for oil companies and growth in oil-related jobs, all this resulted in much higher oil-based tax revenues, which helped pay for construction of vast highway networks.

This arrangement also aided the less-developed oil-producing countries, of course, but the West gained much more. In 1960, five oil producers (Venezuela, Iran, Iraq, Saudi Arabia and Kuwait) formed OPEC (the Organization of the Petroleum Exporting Countries) to get a larger cut of their oil wealth for themselves. It took time for them to gain the upper hand. In the second half of the 1970s, however, world oil prices shot up more than five-fold.

Oil prices have stayed highly volatile ever since. Even at their lowest levels, however, they have been far above pre-OPEC lows. This, like the rise in gold prices, helped spur inflation around the world.

The third factor was the mass entry of the baby-boom generation into adult life, starting in the late 1960s.

The boomers’ entry into the workforce held back increases in productivity, since busi13nesses had to take time to train the newcomers. The newly employed boomers soon began the customary sequence of marrying, having kids and borrowing money to buy houses. The combination—growth in consumers plus lagging productivity—helped push up inflation and interest rates in a variety of ways.

Looked at this way, the 1970s/1980s seemed sure to suffer high inflation and high interest rates, which lingered for the next couple of decades. Today, however, we don’t face any special factors with this kind of potential for spurring big increases in inflation and interest rates.

Our recommendations on investor questions involving inflation

In particular, stay out of any investment that seems aimed at simply cashing in on an inflationary surge that may never come.

All in all, we’re reasonably optimistic about the market, provided that you follow our three-part Successful Investor approach: invest mainly in well-established companies, spread your money out across most if not all of the five main economic sectors, and avoid or downplay investments that are in the broker/media limelight.

What is your biggest fear with inflation rates?

How much do inflation rates factor into your investment decisions?