The Oil Crisis of 1973

Last month I investigated commonalities between recessions of the last 50 years or so. But of course this recession will be different, because (among other things) we will simultaneously have a labor shortage and a lot of people out of work. That’s really weird, and there’s almost no historical precedent- the 1918 pandemic took place during a war, and neither 1957 nor 1968 left enough of an impression to have a single book dedicated to them.

So I expanded out from pandemics, and started looking for recessions that were caused by any kind of exogenous shock. The best one I found was the 1973 Oil Crisis. That was kicked off by Arab nations refusing to ship oil to allies who had assisted Israel during the Yom Kippur war- as close as you can get to an economic impact without an economic cause. I started to investigate the 1973 crisis as the one example I could find of a recession caused by a sudden decrease in a basic component of production, for reasons other than economic games.

Spoiler alert: that recession was not caused by a sudden decrease in a basic component of production either.

Why am I so sure of this? Here’s a short list of little things,

 

But here’s the big one: we measure the price of oil in USD. That’s understandable, since oil sales are legally required to be denominated in dollars. But the US dollar underwent a massive overhaul in 1971, when America decided it was tired of some parts of the Bretton Woods Agreement. Previously, the US, Japan, Canada, Australia and many European countries maintained peg (set exchange rate)  between all other currencies and USD, which was itself pegged to gold. In 1971 the US decided not to bother with the gold part anymore, causing other countries to break their peg. I’m sure why we did this is also an interesting story, but I haven’t dug into it yet, because what came after 1971 is interesting enough.  The currency of several countries appreciated noticeably (Germany, Switzerland, Japan, France, Belgium, Holland, and Sweden)…

 

(I apologize for the inconsistent axes, they’re the best I could do)

 

 

…but as I keep harping on, oil prices were denominated in dollars. This meant that oil producing countries, from their own perspective, were constantly taking a pay cut. Denominated in USD, 1/1/74 saw a huge increase in the price of oil. Denominated in gold, 1/1/74 saw a return to the historic average after an unprecedented low.

 

 

 

(apologies for these axes too- the spike in this graph means oil was was worth less, because you could buy more with the same amount of gold)

 

This is a little confusing, so here’s a timeline:

  • 1956: Failed attempt at oil embargo
  • 1967: Failed attempt at oil embargo
  • 1971, August: US leaves the gold standard
  • 1972: Oil prices begin to fall, relative to gold
  • 1972, December: US food prices begin to increase the rate of price increases.
  • 1973, January: US Stock market begins 2-year crash
  • 1973, August: US food prices begin to go up *really* fast
  • 1973, October, 6: Several nearby countries invade Israel
  • 1973, October, 17: Several Arab oil producing countries declare an embargo against Israeli allies, and a production decrease. Price of oil goes up a little (in USD).
  • 1974, January, 1: Effective date of declared price increase from $5.12 to $11.65/barrel. Oil returns to historically normal price measured in gold.

This is not the timeline you’d expect to see if the Yom Kippur war caused a supply shock in oil, leading to a recession.

My best guess is that something was going wrong in the US and world economy well before 1971, but the market was not being allowed to adjust. Breaking Bretton Woods took the finger out of the dyke and everything fluctuated wildly for a few years until the world reached a new equilibrium (including some new and different economic games).The Yom Kippur war was a catalyst or excuse for raising the price of oil, but not the cause.

 

Thanks to my Patreon subscribers for funding this research, and several reviewers for checking my research and writing.