Is the Loans Industry on the Verge of Collapse?

 

If you're a borrower and have been wondering if the loans industry is on the verge of collapse, you're not alone. Interest rates and inflation were sky-high during the late 1970s and early 1980s. In fact, it's been so bad since then that experts are predicting a record-breaking summer. And things are only going to get worse.

Inflation rates and interest rates rose dramatically in the late 1970s and early 1980s

Inflation and interest rates soared in the United States during the late 1970s, a period known as the Great Inflation. The OPEC oil embargo, the Iran Revolution, and the war with Iraq all contributed to a spike in oil prices. Paul Volcker, then Chairman of the Federal Reserve, began a campaign of interest rate increases in 1979 to stem the rising cost of borrowing. The rise in interest rates coincided with the invasion of Kuwait by Iraq. The resultant heightened uncertainty pushed up the price of crude oil.

The recent period of oil shocks may be a precursor to the next great recession. This episode was largely driven by oil prices, though the relationship between oil prices and the American economy has changed. In fact, the United States is on the verge of becoming a net oil exporter by 2020, and it is consuming a greater share of renewable sources of energy. The episode of the late 1970s was also characterized by an economy growing rapidly, whereas the economy now is not growing at five percent per year.

The booming economy during the early 1970s created an inflationary episode. While consumer prices worldwide grew at an average of 7.7% per year, the Federal Reserve decided to tighten its monetary policy to lower prices. As a result, the rate of inflation soared dramatically. The Federal Reserve's attempt to curb inflation was a failure. After the Nixon administration instituted a freeze on wages and prices, inflation declined dramatically.

The rising levels of interest rates and inflation have increased investor concerns about future deficits. When the government is running a large deficit and incurring large debts, the inflationary pressures are magnified. Meanwhile, the economy is forced to print money to pay off the debt. Inflation rates and interest rates have become "unsustainable."

After the Great Inflation, the public began to question the Fed's monetary policies. It was widely believed that the public was increasingly unhappy about inflation and that it was an indication of a failure of macroeconomic policy. It had been six years since inflation was barely above one percent per year, but inflation spiked significantly as the decade went on. By the late 1970s, business investment was slowing, productivity was down, and the trade balance worsened. As a result, inflation was widely considered the primary cause of this malaise.

Paul Volcker became chairman of the Federal Reserve in 1979. At the time, year-over-year inflation was over eleven percent, and national joblessness was under six percent. Volcker's new monetary policy meant that the central bank had to have more control over the growth rates of reserves and broad money. Volcker also reversed his predecessors' misguided policies. The new chairman also helped set the stage for the long economic expansions of the 1980s and 1990s.

In the 1970s, the US dollar had become increasingly unanchored, and many foreigners held dollar deposits. Nixon's devaluation of the dollar frightened investors and worried about inflation. Nixon wished to boost the US economy with a growth-oriented monetary policy. However, he was forced to resign because of the Watergate scandal. This destabilized the international financial system and led to higher inflation rates.

The late 1970s was a decade characterized by global political economy. Many countries adopted a laissez-faire policy on key-currency exchange rates despite imbalances and instability. Pegged rates had a 25-year relationship with the U.S. dollar and were more flexible for five years. However, most economists believed that floating rates were the only way to ensure that the world economy would remain stable. However, this approach spurred inflation rather than real growth and gave policy coordination a bad reputation.

While monetary policy is the key to controlling inflation, the Fed's role is contingent on the Treasury's ability to validate its actions. Without additional revenue, the Fed's efforts to slow the pace of inflation would be futile. The 1980s monetary tightening strategy was successful only because the U.S. government was repaying its bondholders at a higher rate. Keynesian economic theory presumes that monetary and fiscal policies should be coordinated.