The “Cost-Push Inflation” Myth and the 1970s Stagflation

The following table connects economic and political events with FX price and oil price movements. It is obvious that the OPEC initially only reacted to inflation and the devaluation of the dollar. From the outbreak of 1973 war, however, the picture changed and OPEC became more aggressive with oil price hikes.

DateMonetary and Political Events source and WikipediaCurrency Market (via Univ. of Brit. Columbia)OPEC and Oil Market Major source
1961-1965U.S. current account surplus of 2.6 bln. $, inflation less than 2%Bretton Woods system remains stable.Nominal oil price remains stable, slight decline of real prices.
1966-1968U.S. current account deficit, Capital outflows from U.S. of a total of 3 bln. $, inflation rises to 4.7%Bretton Woods remains mostly stableNominal oil price remains stable, decline of inflation-adjusted prices.
19696.2% U.S. inflation, current account deficit, capital inflows of 6.7 bln. $ into U.S. thanks to higher ratesDEM is revalued from 4$ to 3.67$Nominal oil price remains stable, rapid decline of real prices.
19705.6% inflation, Capital outflows of 10.7 bln. $ due deficit and lower rates.Nominal oil price remains stable, decline of real prices.
19713.2% inflation, but U.S. current account deficit of 6.3 bln.$
Total outflows of 30.5 bln$
DEM and CHF revalued by around 5%.Early 1971: price for Mediterranean oil was adjusted from $2.55 to $3.45
August 1971Nixon closed the "gold window", renounced to the obligation to change gold against 35$. Yen appreciates by 10%.no immediate reaction
December 1971The Group of Ten signed the Smithsonian Agreement.The US pledged to peg the dollar at $38/ounce with 2.25% trading bandsEarly 1972: price hike of 8.49% to reflect the weaker dollar in the concession prices caused by the new parities
1972U.S. current account deficit of 11 bln$, total outflows 11 bln.New FX parities remained in a "fragile stability" in 1972.Oil prices remained stable in 1972.
June 1972Sterling crisis: GBP is allowed to freely float GBP depreciated against other majors. Bundesbank buys GBP for 4.7 bln. $Oil prices remained stable.
Early 1973Rapid deterioation of U.S. balance of payments. US outflows of 10 bln.$ in first three monthsBundesbank absorbed about 8 bln$
February 7, 1973The US senate decided to investige the Watergate scandal.Another dollar crisis started: USD lost 15% against the yen and 12.5% vs. DEM and CHF in a couple of daysno immediate reaction
March 1, 1973Renewed speculative attacks against the dollar. The German FX market remains closed. BuBa increases rates to absorb liquidity and fight inflationCHF 1973 gains up to 20%, DEM to 15%, FRF to 12%.In April OPEC increased prices by 5.7%, which meant that oil prices in DEM, CHF and JPY had fallen in 1973.
March 19, 1973Start of the bloc floating of all European Union currencies "currency snake" against the dollar. The Bretton Woods system was finished. FRF, BEF, NLD and DEM improved by around 13% in 2013 vs $, ITL by 5%.Chartno immediate reaction
May 1973The European currency snake members improve further.From January till end May 73, DEM has risen 19%, FRF by 17%, CHF by 23%June 1: Eight OPEC countries rise prices by another 11.9% Totaling 1973 oil price rise to around 18%.
July 2013DEM and CHF top at 42% , 40% 1973 gain against dollar, FRF at 34% gain, Chart
Summer 1973Due to rising prices, spending in the U.S. slows. The current account deficit shrinked again. 1973 current account deficit: 1 bln.$
Total outflows 5.3 bln.$
Stock markets started stronger slide. DEM, CHF and FRF started falling again, DEM to 30%, CHF to 25%, FRF to 20% yearly gains
October 1973October 6, 1973: Egypt and Syria lauchYom Kippur War to regain Sinai and Golan heightsDEM, CHF and FRF accelerated their descent with the start of the war.October 19: The Gulf Six (Iran, Iraq, Abu Dhabi, Kuwait, Saudi Arabia and Qatar) unilaterally raise the posted price of Saudi Light marker crude 17 percent from $3.12 to $3.65
November 1973November 27: President Nixon signs the Emergency Petroleum Allocation Act (EPAA). November 5: Arab producers announce 25 percent cut in production below September levels.
December 1973December 22: OPEC Gulf Six decides to raise the posted price of marker crude from $5.12 to $11.65 per barrel effective January 1, 1974.
December 1973But only 3 days later: Arab oil ministers cancel January 5 percent production cut. Saudi Arabian oil minister promises 10 percent OPEC production rise.

 

Further reading:
Black Gold: The End of Bretton Woods and the Oil-Price Shocks of the 1970s, David Hammes (University of Hawaii) and Douglass Wills (University of Washington), The Independent Review, v. IX, n. 4, Spring 2005, ISSN 1086-1653

 

 

 

 

 

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George Dorgan
George Dorgan (penname) predicted the end of the EUR/CHF peg at the CFA Society and at many occasions on SeekingAlpha.com 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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