This Is Not the 1970s

Every day that passes without a final conclusion to hostilities in the Persian Gulf multiplies possibilities and deepens a situation already fraught with uncertainty. Each new morning brings news of potential deals or threats to scupper them, new measures and new countermeasures. Nevertheless, matters are not so muddled that they obscure certain economic realities. The Strait of Hormuz remains closed, which is denying the world some twenty percent of its seaborne oil and gas supplies from Iran, Iraq, Kuwait, Saudi Arabia, and the other oil-rich states in the region. Energy prices remain high. Furthermore, a renewal of fighting could well bring destruction to oil- and gas-producing facilities in all these countries, imposing additional supply shocks and erasing any hope of near-term relief. If that happens, the global economy will become more constrained and oil prices will continue to rise.

Those looking for guidance about what to expect will be tempted to look back on the 1973 oil crisis that produced explosive inflation, recessions, and economic stagnation. However, while some parallels do exist, in most ways, today’s circumstances differ dramatically from those of the 1970s. When the Organisation of Petroleum Exporting Arab Countries embargoed oil sales to the United States and the Netherlands after the 1973 Yom Kippur war, the resulting energy shock created a widespread fear that fossil fuels would become increasingly scarce. The concept of “peak oil” became popular, along with dire predictions of an energy-starved future. These expectations exaggerated the immediate inflationary effect of oil-price hikes, creating an inflationary psychology that made it difficult to secure inflation relief and economic reinvigoration even when immediate pressures eased.

The present situation is very different. Remarkable efficiencies in energy use, new drilling technologies, and the development of alternative energy sources have, if anything, created a sense of oil and gas abundance. The concept of “peak oil” is no longer a credible short-term concern. Worldwide, there is an expectation that if and when the Strait of Hormuz becomes more secure, supplies will resume their regular flow. When the war eventually arrives at its definitive conclusion, major efforts will be made to repair damaged production facilities, and even though such repairs would take time, energy producers and users can expect more abundant future supplies once they are completed.

Nor does it appear that the monetary authorities will make the same mistakes they made in the 1970s. Back then, the US Federal Reserve and most other major central banks pursued lax monetary policies in an effort to mitigate the economic setbacks brought about by oil shortages and price hikes. They pumped money into their respective economies, which generalised and extended the inflationary effect of the energy-price increases. In the absence of these misguided policies, the oil-price hikes would certainly have had some inflationary effects, but they would have been more limited. Today, central banks seem to have learned the lessons of these past errors. Recent decisions to postpone interest-rate cuts and talk of interest-rate hikes testify to very different central-bank perspectives than in the 1970s.