The Oil Crisis of 1973

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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.