The True Story of the Oil Crisis of 1973-1974

On October 6, 1973, Egypt and Syria attacked Israel. The Soviet Union supplied the Arab nations and the United States backed Israel. On October 16, with the war going badly for Egypt and Syria, a group of Arab oil producing countries retaliated, raising oil prices by 17% and announcing production cuts. The ‘Oil Crisis’ had begun. On October 19, the Organization of Arab Petroleum Exporting Countries (OAPEC) proclaimed an embargo of oil exports to nations supporting Israel. By the end of the embargo in March 1974, the global oil price had quadrupled, from $3 per barrel to nearly $12 per barrel; US prices were significantly higher. 

When, in 1974, American inflation hit 11%, many blamed the ‘oil shock’. John Kenneth Galbraith later wrote that “Four factors were at odds with American economic well-being” in the 1970s, one of which was “the highly specific matter of energy prices” which “became an inflationary force in the economy as a whole.” More recently, J. Bradford DeLong argues that:

This is a common explanation for the high inflation of the 1970s. But is it correct?

Both Galbraith and DeLong concede that inflation was rising before the oil shock: from 1.6% in 1965 to 5.9% in 1970. It was one of the ills Marvin Gaye sang about on 1971’s ‘Inner City Blues.’ 

On August 15, 1971, President Nixon announced, “I am today ordering a freeze on all prices and wages throughout the United States.” Galbraith blamed “the continuing pressure of wages on prices and prices on wages – the now-tedious wage-price spiral,” without explaining how consumers could simply swallow the higher prices generated by this supposed spiral. DeLong gets closer. Originally imposed for 90 days, controls remained in place until shortly after Nixon’s reelection in November 1972, and he writes that “…the supply of money greatly outran demand, and as Nixon’ price controls were lifted, inflation accelerated ever upward.” Milton Friedman would have substantially agreed.    

This inflation meant that the dollar was, Robert Bartley wrote, “depreciating against oil, against gold, against foreign currencies, and against nearly everything else.” Under the Bretton Woods system, dollars were convertible into gold at $35 per ounce. As the dollar depreciated, people began swapping their dollars for gold. Besides imposing price controls, August 15 also saw Nixon ‘close the gold window,’ suspending the redemption of dollars for gold and freeing the currency from the last vestiges of the discipline of the gold standard. 

This inflation also meant that, with oil priced in dollars, oil producers were receiving a depreciating asset in payment for their product. Bartley explained that:

In September 1973, the Organization of the Petroleum Exporting Countries (OPEC) issued a resolution “concerning the recent international monetary developments and their adverse effect on the purchasing power of the oil revenues of Member Countries,” noting that “these developments have resulted in a de facto devaluation of the United States dollar, the currency in which posted prices are established.” They resolved to adopt:

This they did. “In the first half of 1974,” Bartley wrote, “after “the shock,” a barrel of oil was worth almost 1/12 of an ounce of gold,” just as it was in 1969. 

The oil shocks were, then, more a consequence than a cause of the inflation of the 1970s. 

The notion that they were the causes was, however, politically useful. As Galbraith noted, 

Little has changed. In April, 2022, President Biden claimed that a war which began in February 2022 was responsible for “70 percent of the increase in inflation” which began in May 2020. As a track from 1973 put it, ‘The Song Remains the Same.’