It’s one of those myths that just won’t die. Those interested in the economy are well aware of it, but most often are unaware that it's a myth. It’s the one about the 1973 Arab oil embargo's impact on U.S. energy costs.
The Wall Street Journal’s Jon Hilsenrath is the latest to promote the fiction that rising prices of crude in the 1970s were an effect of “a shock in the supply of a crucial commodity” when “OPEC embargoed sales of energy supply to the U.S.” Hilsenrath claims the latter resulted in higher prices for U.S. consumers. Except that it didn’t.
For one, Hilsenrath’s history is incorrect. The embargo was Arab members of OPEC that didn’t, for instance, include Iran. Iran is not an Arab country. Of course, to single out Iran is to miss the point. The simple truth is that there was no embargo of substance. With trade, there’s no accounting for the final destination of any good. Americans still consumed “Arab” or “OPEC” oil as though it had bubbled up in West Texas; the only difference that they consumed that same oil after it was purchased out of countries not embargoed by the “Arabs” or “OPEC.” As Saudi Oil sheikh Yahmani acknowledged about the 1973 embargo, it was wholly “symbolic.”
The shame is that is that Hilsenrath didn’t just get the history of the embargo wrong, he also misunderstood the economics of it. In an essay meant to explain for readers the causes of 1970s inflation, Hilsenrath didn't. At best, he just revealed to readers a basic misunderstanding of inflation itself. In his defense, Hilsenrath merely parroted the same myths about inflation and its causes that most politicians, pundits, reporters, and economists do.
Hilsenrath wrote that inflation “started rising in the late 1960s,” but that’s when the correct history and economics ended. According to the reporter, higher prices were in part a consequence of “rising federal spending to fund the Vietnam War and President Lyndon Johnson’s Great Society programs. That spending resulted in increased consumer and business demand for goods and services, which drove prices higher.” Except that what Hilsenrath describes is an impossible scenario rooted in Keynesian mysticism about government spending. If Hilsenrath is to be believed, government consumption essentially amounted to “excess demand” above and beyond regular “consumer and business demand” for goods and services, thus higher prices.
More realistically, government doesn’t pull its spending power from Pluto or Mars, rather governments can only spend insofar as we the people have less to spend. All demand is a consequence of production that previously took place, which means governments that produce nothing only have spending power insofar as they tax or borrow it away. In other words, government spending can in no way increase demand; instead government consumption is a consequence of producers having their consumptive power either forcibly shifted (taxes) to government, or voluntarily through borrowing. Stated simply, there’s no such thing as “excess demand.”
From there, it was more than a bit surprising that in an essay meant to explain 1970s inflation, Hilsenrath never mentioned President Nixon’s decision to sever the dollar’s link to gold. Hilsenrath didn’t mention this despite the latter having been a very explicit devaluation of the dollar. At least in the olden days, currency devaluation was inflation. To the mildly sapient, it still is.
Notable here is that while Nixon didn’t officially devalue the dollar until August 15, 1971, there was a growing market expectation that the U.S.’s commitment to a dollar measured as 1/35th of a gold was on the wane. This explains Hilsenrath’s correct assertion that inflation began to rear its ugly head in the late 1960s. Yes, by then the market price of gold as measured in dollars started to move above $35.
What’s important about all this is that while Hilsenrath mistakenly explained away soaring oil prices in the 1970s as an effect of embargo, the reality was that all commodities – from meat to wheat to soybeans – were soaring in price to reflect the dollar’s devaluation. Priced in the spot market, commodities are very sensitive to movements in the dollar, and the dollar was in rapid decline. The decline explains oil’s surge, but also rejects the notion that an embargo was the cause. Again, commodities across board were rising. The rising commodity prices were an effect of the dollar’s devaluation. Put another way, Hilsenrath not only got the history wrong, he mistook cause and effect. To blame inflation on rising prices is like blaming rain on wet sidewalks. Causation is reversed. The dollar was devalued, thus rising prices.
Fast forward to the present, prices of all manner of goods and services are undeniably higher. The difference is that this is not inflation. We know this simply because unlike the 1970s, and very much unlike the first decade of the 21st century, the dollar hasn’t been in freefall versus commodities or foreign currencies. This isn’t to say the dollar has been rising as it often did in the Reagan and Clinton years of the 1980s and 1990s, but also that it hasn’t suffered a notable decline. Translated for those who need it, we’re not in the midst of inflation.
What we’re suffering the effects of now is the aftermath of a mindless imposition of command-and-control by governments around the world in response to a spreading virus. Unsurprisingly forgotten by pundits, economists, politicians, and reporters is that before the lockdowns, production of the goods and services we enjoy was born of a beautiful global symmetry whereby billions of workers were engaged in trillions of different commercial arrangements. Then the lockdowns eviscerated these arrangements to varying degrees.
Considering what panicky politicians did, the wonder is that prices aren’t much higher today as a reflection of how much damage was needlessly done to commercial arrangements.
For the purposes of this piece, the simple truth is that higher prices aren’t always evidence of inflation. All manner of things can cause prices to rise, but a rise in any price logically implies a fall in other prices. Think about it. On the other hand, inflation itself is always and everywhere a devaluation of the currency. Hilsenrath’s incorrect conclusions about what happened during a real period of inflation (the 1970s) make it challenging for him to explain what’s happening now. Instead, myths will endure.
