When "Currency Devaluation" Meets "Energy Shock": Memoirs of the 1970s

· Investment Highlights ·

In the 1970s, the US dollar was decoupled from gold, leading to a global downgrade in confidence in the fiat currency system. Subsequently, the world was hit by energy crises, significantly increasing asset price volatility. Today, as the global order is being reshaped, the dollar's credibility—once bolstered by globalization—is again being challenged. With recent intensification of global energy shocks, we need to learn from the lessons of the 1970s.

Pegged to Gold: The Establishment and Crisis of Dollar Hegemony. The Bretton Woods system established the US dollar as the dominant international currency through the "dual peg" principle, but faced the "Triffin dilemma." Post-WWII, as Western Europe and Japan recovered, US gold reserves continuously flowed out. In the late 1960s, the Vietnam War and the "Great Society" programs led to rising US fiscal deficits and excessive monetary issuance, making the Bretton Woods system unsustainable. Asset performance: From 1945 to the mid-1960s, US assets saw strong stocks, stable bonds, and firm exchange rates; in the late 1960s, inflation heated up, the Fed tightened, real US bond returns turned negative, US stocks weakened, and the dollar faced increased devaluation pressure.

Tied to Oil: Reshaping Dollar Hegemony and Stagflation. After the Bretton Woods system collapsed, the US—with Saudi Arabia and others—created "petrodollar" agreements, binding the dollar to oil transactions and reestablishing dollar supremacy. Oil-producing countries sold oil for surplus dollars, which then flowed back to purchase US assets, providing low-cost financing for America. However, the two oil crises in the 1970s caused oil prices to soar; coupled with prior monetary expansion, this led to severe US stagflation. Asset performance: Gold, freed from official price controls, rose sharply; prices of oil, agricultural products, and other commodities generally increased. The bond market entered a bear phase, with frequent yield curve inversions; US stocks were weak overall, with a long period of valuation contraction, only the energy and materials sectors being relatively resilient.

Volcker Fights Inflation: Defending a Strong Dollar. Facing runaway inflation, Volcker initiated aggressive tightening policies after becoming Fed chairman in 1979, strictly controlling money supply and raising interest rates to historic highs—breaking inflation expectations at the cost of short-term recession, restoring Fed credibility and the strong dollar. Asset performance: In initial tightening, the bond market fell sharply, yield curve inverted; high rates attracted capital, and the dollar strengthened. Stocks were subdued then rose: high rates depressed valuations and earnings, but with inflation easing and rates falling, earnings recovered and valuations expanded, beginning a bull market in stocks. Commodities and gold fell significantly due to higher holding costs and a stronger dollar. Ultimately, the bond market saw decades of a bull run and the strong dollar’s dominance solidified.

Current US Stagflation Expectations: Similarities and Differences with the 1970s. The current US situation is similar to the 1970s in that it faces “fiat currency confidence downgrade” plus energy shocks: dollar's share in global reserves is falling, Middle East conflicts push up oil prices, monetary excess and fiscal expansion pose an unanchoring risk to inflation. The key differences: AI revolution enhances total factor productivity, shale oil turned the US into an exporter, labor union coverage and wage indexation clauses are weak, meaning the "wage-price spiral" rigidity is much lower than before. Volcker’s lesson: policy needs determination to rebuild credibility, but today's tech progress creates space for a soft landing, so the Fed need not copy shock therapy. If dollar confidence continues to deteriorate and inflation de-anchors, some lessons from the 1970s are worth referencing.

1 Pegged to Gold: The Establishment and Crisis of Dollar Hegemony

The evolution of the dominant international currency is closely tied to shifts in international power and iterations in national competitiveness. During WWII, US industrial capacity expanded rapidly and economic power surged. At war’s end, the US held over 70% of global gold reserves, providing a solid foundation for the dollar to become the new dominant international currency. In July 1944, 44 countries convened to build a dollar-centered international monetary system—Bretton Woods. The core was the “dual peg” principle: dollar pegged to gold (1 ounce = $35 fixed), US government obliged to redeem gold at official price; other currencies pegged to the dollar, maintaining fixed exchange rates. Subsequently, trade settlements used dollars, making the dollar the international payment and reserve currency.

Under Bretton Woods, the US as the issuer of the international reserve currency faced the Triffin dilemma. On one hand, to meet the growing global demand for dollars, the US needed to run persistent balance of payments deficits to supply dollars; on the other, to maintain the dollar-gold peg, the US needed balance of payments surpluses to accumulate gold. After WWII, Marshall Plan accelerated Europe’s rebuilding and US imports enabled Japan’s rapid recovery—US gold continued flowing out, and demand for dollar-gold exchange intensified.

To shore up dollar credibility, in October 1961, the US and seven Western European countries formed the “Gold Pool” to intervene in the market and maintain the official gold price. The central banks contributed gold reserves according to proportion, forming a pool of about 270 million ounces. If gold price exceeded $35.2, they sold gold to reduce the price; if below $35, they bought gold to replenish stock. The Gold Pool could stabilize prices short-term, but its ability was limited. In March 1968, a panic buying in the London gold market caused the Gold Pool to collapse. Thereafter, a dual pricing system emerged—private market prices decided by supply and demand, with no official intervention, diverging from the official price. This marked the beginning of the end for Bretton Woods.

After the mid-1960s, the US was mired in the Vietnam conflict, and fiscal spending soared due to the “Great Society” plan, escalating deficits. To cope, the Fed issued excess currency. Prior to the mid-1960s, US base money grew on average 1.8 percentage points below real economic growth; afterward it exceeded real growth and the gap widened. Excess money led to domestic inflation, deteriorated the balance of payments, gold outflow intensified, and the US could not meet growing dollar redemption demands. Further, other countries lost confidence in the dollar and converted dollars to gold, exacerbating US gold reserve losses.

In August 1971, the Nixon administration announced the "New Economic Policy," suspending the obligation for foreign central banks to redeem gold at $35/oz. In March 1973, the EEC, Japan, and others announced floating exchange rates for their currencies against the dollar. Subsequently, the international monetary system entered the "Jamaica system" in 1976. The end of Bretton Woods highlighted the inherent contradiction: sovereign currency as international reserve currency. When the issuing country’s interests conflict with global public goods, it prioritizes itself—disrupting global public goods provision.

The performance of dollar assets under Bretton Woods can be divided into two stages. First, from 1945 to the mid-1960s, Bretton Woods provided US assets a stable, high-credibility foundation. This era featured rapid US growth and mild inflation; dollar assets saw strong stocks, stable bonds, and firm exchange rates overall. US Treasuries, backed by global reserve currency demand, had stable yields and positive real returns. US equities, benefiting from post-war prosperity, low rates, and technological progress, saw sustained rises—earnings and valuations formed a virtuous cycle. The dollar’s gold backing and fixed exchange rates ensured long-term strength, low risk, and high liquidity.

Second, from the late 1960s to 1971, dollar assets shifted from stability to weakness, showing clear differentiation. Rising inflation expectations and Fed tightening caused US bond yields to rise and prices to come under pressure, with real returns turning negative; stocks were volatile and weak, as earnings slowed and valuations compressed, leading to a market correction. Dollar depreciation pressure increased, facing global capital selloffs and central banks redeeming gold, further weakening dollar credibility. In 1971, with Bretton Woods collapse, the dollar quickly depreciated, stocks and bonds both came under pressure, only short-term bonds resisted losses somewhat. The era of stable dollar assets ended.

2 Tied to Oil: Reshaping Dollar Hegemony and Stagflation

After Bretton Woods ended, the dollar faced a crisis of confidence and heavy depreciation pressure. To maintain its status, the US in 1974 formed an agreement with Saudi Arabia: military protection and political support in exchange for Saudi Arabia denominating and settling its oil exports in dollars. Other OPEC members followed suit—making oil importers hold substantial dollars as reserves.

Under the petrodollar system, the dollar moved from offshore to onshore in a cycle. Oil exporters amassed large dollar surpluses from crude exports, but limited domestic market capacity meant they could not absorb these funds internally, so they flowed back to the US via buying Treasuries, stocks, real estate, etc.—reallocating dollars domestically. This inflow provided low-cost financing for the US, supporting low rates and fiscal deficits; oil nations gained stable asset appreciation and political protection.

With the creation of the petrodollar system, the US economy was disturbed by oil price volatility. In the 1970s, the US endured two oil crisis shocks. First, in October 1973, the Fourth Middle East War broke out and the Arab oil producers imposed embargos and cut production for Western countries supporting Israel. Oil prices rose from $2.7/barrel in September 1973 to $13/barrel in January 1974. Second, at the end of 1978, the Iranian Islamic Revolution toppled the pro-US government and oil output plunged. In September 1980, the Iran-Iraq war began, with both countries’ oil production and transportation badly hit, expanding supply deficits. Oil prices soared from $14.5/barrel in December 1978 to nearly $42/barrel in November 1979.

These two supply shocks pushed up global energy costs and catalyzed US stagflation. After the first oil crisis, the US economy entered recession. In the second half of 1974, US GDP was negative for multiple quarters, industrial output declined sharply. In 1974, CPI growth hit 12.2%, unemployment reached 9%. The traditional inverse relationship between inflation and unemployment (Phillips curve) was broken. The second shock deepened stagflation: CPI hit 14.6% in 1980, jobless rate exceeded 7%, real GDP again contracted. Corporate costs soared, inflation expectations among consumers became unanchored. For years, high inflation, high unemployment, and low growth coexisted; monetary policy was caught between “growth stabilization” and “anti-inflation.”

It should be noted that inflation was already evident before the oil crisis; oil shocks were not the root of US stagflation. More specifically: First, prior excessive fiscal and monetary expansion set up the problem. The Vietnam War and Great Society plan expanded deficits, and the Fed’s money supply growth far exceeded real economic absorption capacity. Second, the Fed tightened to fight inflation but vacillated for fear of worsening recession, failing to stabilize inflation expectations effectively. Third, the labor market had rigid wage indexation clauses and strong unions. Price rises triggered automatic pay raises; firms passed costs through higher prices, forming an entrenched “wage-price spiral.” Fourth, after dollar-gold decoupling, sovereign credit money lacked an anchor, making inflation expectations easily rise and hard to fall.

During US stagflation in the 1970s, real assets clearly outperformed financial assets. First, gold—freed from official price controls—entered a strong upward trend. International gold prices rose from $35/oz in 1971 to a peak of $850 in 1980; with inflation resistance and safe-haven features, it was a standout asset. Second, commodities became core holdings: oil, agricultural products, and industrial metals prices generally rose. As imported inflation intensified, energy and materials sectors had resilient profits, outperforming other industries in equities. Overall, real assets resisted inflation while financial assets struggled.

Third, the bond market entered a bear phase: yield curves inverted repeatedly. The Fed wavered between fighting inflation and stabilizing growth, and monetary policy swung back and forth, failing to contain inflation but intensifying rate volatility. With inflation out of control, nominal Treasury rates surged, real rates deeply negative. Curve dynamics: in the 1970s, short-term rates were mainly dictated by Fed policy, long-term rates by inflation expectations and term premium—recession and easing steepened curves, high inflation and tightening flattened or inverted them.

During stagflation, short maturities outperformed long maturities. Short-term Treasuries could follow Fed rate hikes and through rolling reinvestment, lock in returns. Long-term Treasuries suffered heavily from inflation expectations and anticipation of further tightening; losses were worst during aggressive tightening. In the 1970s, bond yield peaks matched stagflation peaks; only when inflation was controlled and rates peaked did long-term bonds rebound. Overall, Treasuries lost their safe-haven function; short-term bonds outperformed long-term ones in nominal yield, but after inflation yielded negative real returns—failing to hedge inflation. Long-term Treasuries were some of the worst-hit assets.

Fourth, US stocks performed poorly overall, enduring a lengthy valuation compression. During the stagflation decade, real corporate profit value eroded, S&P 500 P/E ratios shrank, and the index’s annualized gain was under 1%, well below inflation. Especially during the 1973-1974 oil crisis, S&P 500’s maximum drawdown reached 48.2%. Structure-wise, US sectors diverged sharply: energy, materials, and commodity-related industries benefited from rising prices and saw relative positive returns; finance, utilities, and discretionary consumers suffered from high rates squeezing valuations and demand. Overall, stagflation meant weak profits and high discount rates—limiting equity asset allocation value.

3 Volcker Fights Inflation: Defending a Strong Dollar

In 1979, Paul Volcker became Fed Chair, facing runaway inflation and executing strong tightening policies. He focused on money supply, strictly controlled M1 growth, drastically raised rates to a 22.36% peak for Fed Funds, 13% discount rate, raised bank reserve requirements, expanded coverage—decisively shrinking money and credit. Though this induced recessions in 1980 and 1982 and caused unemployment to exceed 10%, Volcker held firm, eventually breaking inflation expectations. US inflation fell from its 1980 peak of 14.6% to a 1983 low of 2.4%. Volcker ended more than a decade of US stagflation, restoring Fed’s anti-inflation policy credibility.

Volcker's tightening caused asset class divergences. First, bonds turned upward. Initially, the Fed sharply tightened liquidity and aggressively raised rates—short-term rates soared well above long-term rates, causing deeply inverted yield curves and widespread bond price drops. With inflation expectations cooled by high rates, nominal rates trended down from highs, and as the economy stabilized, risks were released—ushering in a decades-long bull market in US bonds.

Second, the dollar index strengthened markedly. Under Volcker's hard tightening, US base rates rose sharply, creating large internal-external rate gaps; as inflation was contained and the economy stabilized, the dollar entered a strong upward cycle. High rates attracted global capital, further strengthening the dollar, cementing its international status, and exerting pressure on global commodities and capital flows.

Third, stocks recovered after initial weakness. Early on, high rates increased capital costs and squeezed corporate profitability; combined with recession fears, equities suffered and growth stock valuations compressed, with weak performance overall. Once inflation subsided and rates fell with economic recovery, corporate profits recovered, valuations expanded, and US stocks exited their trough and began a bull market.

Fourth, commodities and gold retreated. High rates raised holding costs, the dollar strengthened, and weakening demand ended the bull run; gold and oil prices fell sharply.

4 Current US Stagflation Expectations: Similarities and Differences with the 1970s

The current US macro environment resembles the 1970s in suffering from a "fiat currency downgrade" combined with "energy shocks." On one hand, the dollar’s share in global reserves keeps declining, signaling weaker sovereign credibility. On the other, 2026 Middle East geopolitical conflict has pushed up oil prices — reenacting the kind of external supply shocks seen in the 1970s. Both cycles saw prior excessive monetary and fiscal expansion, creating risks of inflation de-anchoring. In this context, real assets' anti-inflation and anti-credit-devaluation advantages are more pronounced; their value relative to financial assets has greatly increased.

However, the current economic structure has key differences from the 1970s. AI technology is driving higher total factor productivity, improving supply chain efficiency, countering labor cost rises, and creating a new capex cycle. In energy, the shale oil revolution has made the US an exporter, dramatically reducing oil price shock transmission. In labor markets, union coverage is much lower today, and wage-price automatic indexation clauses are much weaker, so the rigidity of a "wage-price spiral" is much less than in the 1970s, and inflation self-reinforcement is notably reduced.

Volcker's lesson: fighting inflation requires policy determination to reverse expectations, accepting short-term pain to rebuild central bank credibility. High oil prices may sharply increase US inflation pressure, and the Fed will likely maintain a tight bias. However, structural differences from the 1970s mean the Fed need not repeat aggressive "shock therapy." Tech progress has boosted potential productivity, creating more room for a soft landing. Should dollar confidence deteriorate and inflation become unanchored, some lessons from the 1970s are worth referencing.

Risk Warning: Escalation of geopolitical conflict, increased global stagflation risk, unexpectedly tight monetary policy, etc.

Source: Liang Zhonghua Macro Research (ID:gh_5365febaafca), Wallstreetcn columnist

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