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Inflation Lessons from the Past, for the Present

Dec. 22, 2022
The possibility of a recession in 2023 recalls a comparable development in the not-too-distant past – and hints at what may happen if the pattern continues.

Speaking to a business group not too long ago, I was asked if I had ever seen market conditions as crazy as the current situation in manufacturing and manufacturing technology. The group pointed specifically to the impossible labor shortage, record levels of order backlogs, record-setting order rates, and Federal Reserve interest rate hikes – which most economic analysts believe will initiate a recession soon. Yes, I had seen something that crazy, just like anyone who has been involved in manufacturing for over 40 years.

There are a lot of similarities between our current economic circumstances and those of 1981-82.

The ‘81-82 recession was the worst one since the Great Depression and currently it’s considered the second worst, behind the 2007-09 recession. The dollar's strength at that time provided U.S. consumers instant wealth as imported product prices fell. The Japanese yen fell by about 35% from the beginning of 1981 until it bottomed at 273 in October 1982.

Similarly, the Japanese yen fell 35% between November 2020 and November 2022, despite large infusions of cash by both the Trump and Biden administrations to prevent a pandemic-induced financial disaster.

As 1981 began, manufacturing was riding the crest of a fantastic run of good years, and a recession was the last thing U.S. manufacturers were considering. Sure, the economy was overheating, and inflation was climbing at an unusually high pace, but manufacturers side-stepped the challenge by moving to foreign components while the dollar was strong.

Backlogs crept up to more than five years in the manufacturing technology industry. The auto, construction, job shop, and oil industries were screaming for more capacity in late 1980 and early 1981. Producers of capital equipment could practically name their price. Some capital equipment producers even dropped their distributors because customers were knocking on their doors pleading to get their equipment ordered and delivered faster.

However, it was a different story in the service sector, where inflation – particularly wage inflation – was generating panic. There, businesses relied on people who were not nearly as easy to "import" from lower-cost countries. The service sector and consumers were driving the economy at the time, which led Federal Reserve Chairman Paul Volker to take their plight very seriously.

In early 1980, as the monthly compound annual growth rate in inflation hit 19.9%, Volker told Congress that the U.S. economy could not survive increases in prices and wages at that rate. He vowed to crush inflation at all costs. Volker increased interest rates to 22% by the end of 1980 before modestly reducing them in 1981 as the impact began to slow inflation.

By the end of December 1982 the inflation trend had flipped, as the Consumer Price Index showed a decline. In February 1983, interest rates decreased to 8.5%, and the Federal Reserve declared victory.

The war against inflation, however, had been costly and manufacturing took a heavier toll than any other sector. The manufacturing industries represented only 30% of the U.S. workforce, but 75% of all jobs lost during the recession were in manufacturing. The residential construction industry and auto manufacturers ended the year with 22% and 24% unemployment, respectively.

History will not repeat itself, but at the same time, we should take some lessons from this cautionary tale.

We will experience at least a modest recession in the first two to three quarters of 2023. Like in 1981, the recession will not impact all industries or sub-sectors equally. Sectors like job shops, construction equipment, and power generation, among others, will continue to see growth, though modest in comparison with 2021 and 2022. Sectors such as automotive powertrains, household appliances, and recreational vehicles are likely to see lower volumes in 2023 relative to the past two years.

Manufacturers might consider this as a possible result of crazy market conditions that surround them now – and develop strategies to help them address that outcome.

Patrick McGibbon is an economist and Chief Knowledge Officer for AMT – the Association for Manufacturing Technology, and a member of AMT’s Strategic Alignment team.

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