The Fed Votes -- in Favor of Stagflation

The Federal Reserve seems determined to bring back the 1970s -- and that won't be any golden-oldies party for investors.

The Fed has just voted for stagflation, a dreadful mix of slow to no growth and high inflation that made a good part of the 1970s such a bad time for investors. According to Ibbotson Associates, the S&P 500 showed a compounded annual return of just 3.2% from 1973 to 1979. Long-term government bonds didn't do a whole lot better, with a 3.5% compounded annual return for the same period.

Mind you, those were the nominal rates of return for the period -- that's before inflation. Figure in inflation, and investors lost money during these years.

At the Aug. 8 meeting of its Federal Open Market Committee, the Fed decided not to raise key interest rates. That put an end to a string of 17 consecutive increases in short-term interest rates that had taken the central bank's benchmark from 1% in June 2004 to 5.25% now.

A Wing and a Prayer

Oddly enough, Fed officials chose to end their attempt to lower inflation by raising interest rates even as they publicly acknowledged that inflation had picked up speed. "Readings on core inflation [translation: overall inflation minus changes in the volatile prices of food and energy] have been elevated in recent months," the Fed said in its press release. "However, inflation pressures seem likely to moderate over time."

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