Swiss Franc History: Volcker Shock, Oil Glut and the Breakdown of Gold and Emerging Markets

After the Volcker moment or sometimes called “Volcker shock”, commodity prices plunged, the gold price collapsed. Thanks to additional supply, e.g.  from Northsea oil, a so-called oil glut appeared. After the increase of debt in the 1970s, some economies in Southern America collapsed. The major reason was Volcker’s tight monetary policy with high interest rates and the dependency on US funds. Global economic growth remained lack-lustre during these years.

A glut of crude causes tighter development budgets

Mexico, Britain, Ecuador, Malaysia. The list of oil-exporting nations that have cut their prices keeps growing longer. After years of feasting on high prices brought on by petroleum scarcity and soaring demand, the oil-producing states are discovering that the price of crude can go down as well as up. Drooping demand and a steadily swelling surplus production of some 2 million bbl. per day have created a miniglut that grows bigger by the week.

… As longtime champions of steady, but moderate, rises in the price of oil, the Saudis have refused to mimic price hawks like Libya, Iran and Iraq. Instead, the Saudis for the past nine months have been pumping nearly 2 million bbl. per day above their self-imposed limit of 8.5 million bbl. daily in order to create an oil surplus and drive prices down.

For the United States, the slumping cost of crude will mean less inflation and at least moderately more growth than most experts had been forecasting for 1981 and 1982. Consumer prices will probably rise by about 10% for this year, as a whole, vs. projections of as much as 12% to 13% late in 1980. Lower oil prices may help the U.S. to avoid the recession in 1981 that many economists had also predicted.

Are the Saudis doing the West a favor by producing 10 million bbl. per day or are they doing themselves a favor?

Some critics of Saudi intentions, like Washington Lawyer Douglas J. Feith, a staff member of Ronald Reagan’s National Security Council, assert that the Saudi Arabians simply could not afford to cut back much on output even if they wanted to. As Feith has argued, the Riyadh government needs every dollar it can get from its oil exports simply to pay the high cost of financing the nation’s rapidly expanding economy.

(Time Magazine 1981)

Gold Price Inflation Adjusted

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Gold Price Inflation Adjusted

Gold Price Inflation Adjusted - Click to enlarge

With the high inflation the Dow-Gold ratio fell from 25.1 to 1.5 in the year 1980. Investors, however, prefer to hold gold, oil or other commodities when global growth demands more of the assets and the US expansion is hampered by the high costs of imported oil.

The maybe most important reason that the US dominance continued in the 1990s, was the US lead in the computer revolution.

With the decline of the US from the year 2001, this tendency completely changed again. The Dow-Gold ratio inverted from levels of 1.5 in 1980 with the strong US economy, positive real interest rates and weak emerging markets.

Dow-Gold Ratio 200 years

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DOW-Gold Ratio1800 to Now

- Click to enlarge

Emerging markets like Mexico and Brazil initiated in the 1970s a growth path via rising oil and commodity prices and the increase of debt – based on the at time very strong Keynesian influences. From 1982 on they did not receive enough income from commodities, the dutch disease of the 1970s became apparent. Growth in emerging markets, especially in Latin America collapsed, it let a lost decade.

Volcker and the Brazil Debt Crisis

Volcker and the Brazil Debt Crisis

- Click to enlarge

Oil was cheap. The Swiss safe-haven, that takes profit of short distances in times of high oil prices and that has trade surpluses to emerging markets, was not needed any more.Still in 1976 the Swiss had sent home many foreign workers. The combination of a weaker currency, a lack of labor supply and wage inflation translated into heavy price inflation. Inflation was over 6% in 1981 and 1982. This high inflation was only repeated in 1990/1991 when another oil glut depressed prices. German wage inflation in expectation of the reunification plus the effects of the 1987 monetary expansion in response to the stock market crashed caused inflation to rise over 5% again.

As opposed to 2014, however, the Swiss did not have a far lower current account surplus during earlier oil gluts.

Volcker saved the United States and made the emerging markets relatively poor, for nearly two decades. Oil was cheap.

Price Inflation Follows Monetary Expansion

Price Inflation Follows Monetary Expansion

Price Inflation follows Monetary Expansion ebrand SNB Source: snb.chf - Click to enlarge


<– Back to history overview

Read also:

History: The Lost 1980s Decade in Latin America


Bloomberg News, How Volcker Launched His Attack on Inflation, Online

Bennett T. McCallum, The Concise Encyclopeida of Economics, Monetarism, Online

Kirk Lindstrom, Dow-Gold Ratio Continues Climb As ‘Civilized’ Investors Buy Equities, in Seeking Alpha, Online

George Dorgan
George Dorgan (penname) predicted the end of the EUR/CHF peg at the CFA Society and at many occasions on and on this blog. Several Swiss and international financial advisors support the site. These firms aim to deliver independent advice from the often misleading mainstream of banks and asset managers. George is FinTech entrepreneur, financial author and alternative economist. He speak seven languages fluently.
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