Fighting Inflation in Wartime

The dogs of war have been let loose again. Where they will rampage, for how long, who will be caught up, and how it will end are the ultimate uncertainties that run alongside the death and destruction of war. Markets attempt to manage the fog of war as they do any other uncertainty. Historically markets can rise during war unless the war appears lost. Losing a war is not good for stocks—capital is washed away and a country’s economy resets to zero.

After the battle of Midway in June 1942, just six months after Pearl Harbor, the U.S. market rallied and mostly rose throughout the rest of the war. Trading in capital markets was light. In Germany, after an initial drop the market rose steadily with Hitler’s rise in 1933 until late 1941 when it leveled off, sensing a turning point well before the defeat in Stalingrad, until it closed in 1944. The Japanese stock market closed with the surrender in 1945 and, like the German market, did not reopen until 1949 under the U.S. protectorate and following U.S. SEC rules.

In the early days of this war, the Russian market has crashed from the expected impact of global economic sanctions. On the other hand, oil—Russia’s most valuable export—is rallying, crossing above $110/barrel less than a week into the invasion. As one analyst put it, Russia is casting a long, dark, unpredictable, and very complicated shadow.

The U.S. economy remains strong even if we can anticipate aggravated supply chain issues from the war. The near-term concern is navigating the oil spike and its continuing impact on high inflation. The tightrope the Fed will begin walking in its mid-month meeting between raising the overnight rate too slow or too fast over the rest of the year has gotten tauter if more focused. 

Powell’s Tuesday (Mar 1, 2022) discussion of a series of +0.25% increases would still only push the rate to 1% by late summer—well below recent inflation running above 7%. Tighten too fast and growth can be choked into a recession. Tighten too slow and inflation could run away leading to stagflation—an even worse inflationary recession.  

We need only look to the OPEC oil shock of 1973 (when inflation increased to 7.7%) and the 1979 oil crisis sparked by the Iranian revolution that led to double digit inflation in the 1980s, to understand the risks.  

Though tough on everyone, businesses can manage inflation more easily, by raising prices, than retirees on fixed income and portfolios, who must manage expenses lower. Frugality, whether by choice or necessity, can be a virtue in wartime.