Does hole in muffler cause backfire, or is it the other way around?

[bondoking]

My '78 one-owner (me) Z is all stock, inluding the original muffler and exhaust system. For the past couple of years it has been making a 'Phhfft !' sound when I let off the gas when shifting gears. My favorite Z mech has found some smallish holes in the muffler and claims those are causing what I interpret to be a backfire. I always thought it was the pther way around...........engine running too rich.......unburned fuel in exhaust.........Bang...........equals holes in muffler. What says the peanut gallery.? I am thinking new exhaust +headers+muffler, but if the engine is running rich I obviously want to get that right before blowing holes in new steel. #1and 2 spark plugs are burning a little dirty.........others are clean. Compression is OK in all sic cyls. Where should I start?

[olzed]

Time to replace the exhaust system. A 34 year old muffler deserves to put out to pasture. It has served you very well.