The 1979-1982 Economic Crisis and Its Initial Lessons

Key Insight

From 1950 to 1980, debt, inflation, and growth cycled in increasingly larger waves, accelerating after the dollar's link to gold ended in 1971. The 1970s saw three such waves; the 1974-75 wave brought inflation to its post-World War II peak, with the Federal Reserve tightening money supply, driving interest rates to record highs, and causing the worst stock market and economic downturn since the 1930s. The largest wave, from 1979 to 1982, was a major economic reversal, marked by soaring and crashing interest rates and inflation, extreme volatility across stocks, bonds, commodities, and currencies, and unemployment reaching Great Depression levels. This period's market movements were unified by swings in money and credit growth, exacerbated by the oil shock following the fall of the Shah of Iran, which also spurred the creation of the first oil futures contract.

In 1979, with inflation out of control, Federal Reserve Chairman Paul Volcker announced a 5.5 percent money supply growth limit. This was predicted to break inflation but also risk strangling the economy, markets, and potentially causing a catastrophic debt crisis. During this turbulent time, Bunker Hunt, the world's richest man, acquired substantial amounts of silver as an inflation hedge, starting at approximately $1.29 per ounce and cornering the market as prices rose to around $10. Despite advice to sell due to an 'inverting yield curve' (short-term rates exceeding long-term rates, historically preceding economic downturns and declines in inflation-hedged assets), Hunt held on, influenced by Middle East oil producers' plans to also buy silver. By early 1980, silver reached nearly $50.

In March 1980, silver prices crashed back below $11, leading to Hunt's financial ruin and nearly destabilizing the U.S. economy, necessitating Federal Reserve intervention. This event underscored the critical importance of market timing. Concurrently, the economy in 1979-81 was more volatile than the 2007-08 financial crisis, prompting a controversial prediction of a depression 'as bad or worse than the thirties' in March 1981, due to enormous debt levels. However, this prediction proved incorrect when, after Mexico defaulted in August 1982, the Fed responded by making money more readily available. This action, combined with money flowing from borrower countries into the U.S., led to a non-inflationary rebound: inflation fell, growth accelerated, and the U.S. economy experienced its greatest non-inflationary growth period for the next eighteen years, safeguarding banks through Fed loans and international financial restructurings. The experience of being profoundly wrong, especially publicly, was personally and professionally devastating, leading to significant financial losses and the reduction of the business to a single employee.