Sky-high gas prices are surfacing memories of a bygone era — the 1970s — defined by bellbottoms, disco music and (you guessed it) gas lines.
Modern motorists might pine for the prospect of 50-cent a gallon unleaded gas that the decade averaged, but don’t compare that to the $4-plus a gallon we’re shelling out ($5 in California!) today. For a true apples-to-apples price comparison, it’s worth reviewing a concept that not only made Warren Buffett fabulously rich — but also makes us all a bit poorer.
“My life has been a product of compound interest,” Warren Buffett once famously said. What worked investment-wise for the Oracle of Omaha over three quarters of a century also works in reverse with rising prices.
Since Buffett took over the flagging textile company in 1965, Buffett’s Berkshire Hathaway has been compounding returns at an average rate of about 20% per year — legendary over this time frame. Assuming perfectly even returns, his initial $15 per share investment would have become $18 after a 20% return that first year. Now do that for 12 years, and by 1976 the shares are cracking the $100 threshold. In 1989, a cool $1,000. Add another zero in 2001, and then again in 2014. Every dozen or so years, Berkshire increases in value a whopping 900%. Live to nearly a century, and it adds up (albeit slowly).
Of course returns like this are never perfectly even and most of us don’t actually live to be 100. And weren’t we talking about gas prices anyway?
Enter inflation. Over the last century, inflation has averaged 2.87% per year. While most investors would balk at an investment return this low, persistently-low inflation flies largely under the radar. Nevertheless, a 100-dollar bill in 1922 — with inflation steadily hacking away at its value every year — would be worth only $5.44 today. You would have had 18 times as much purchasing power had you spent that cash 100 years ago.
The Federal Reserve aims for inflation of around 2%. But even at this lower and seemingly benign level, that C-note drops to $82 after a decade, and $67 after two decades. The power of compounding interest in reverse.
Purchasing power
Back to those groovy dirt-cheap gas prices of yore, heading into 1970 the national gas price average was 36 cents a gallon — or $1.72 in today’s dollars. It’s a manageable number compared to today’s prices, but $1.72 is materially higher in the modern brain than a mere 36 cents.
In fact, as early as 1929, gas had been a lot more expensive adjusting for inflation — $2.38. Gas prices trended down for four decades until the 1970s when President Nixon closed the gold window and the world suffered two oil shocks. After a brief respite during the 1980s and 1990s, gas prices have been trending higher since the new millennium, leading to average prices north of $5 in some states.
The same concept works with Big Macs too. When McDonald’s (MCD) franchisee Jim Delligatti invented the iconic burger in Pittsburg in 1974, he charged a whopping 65 cents for it (not much higher than the national average of 53 cents for gas!). But that equates to $4.75 — less than the current average Big Mac price of $5.81 in the U.S. — but also not chump change.
The point is, while Big Mac prices surged from 65 cents to $2.39 cents in nominal terms from the 1970s to the 2000s, they actually dipped when adjusted for purchasing power — from $4.75 to $3.94. Call it the miracle of burger technology.
Writing for Fortune in 1977, Buffett had a few choice words to say about inflation when he offered the example of a widow living on a fixed 5% savings rate amid inflation that was running at a similar rate. “It makes no difference to a widow with her savings in a 5% passbook account whether she pays 100% income tax on her interest income during a period of zero inflation or pays no income tax during years of 5% inflation,” he said.
Speaking as to the hidden tax of inflation, he continued, “Either way, she is ‘taxed’ in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 100% income tax but doesn’t seem to notice that 5% inflation is the economic equivalent.”
Wise words that make you think.
And for those who were wondering: bellbottoms — I wore them; disco — I danced it; gas lines — I sat in them — all as a toddler.
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Jared Blikre is a reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared.
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Source: finance.yahoo.com