🚦 The 1973 oil crisis: How geopolitical shocks can disrupt global economies

5/52 Learn from History (Macro Mistakes)

Nov 30, 2024

💡 New on Macro Mornings? Start here

🚦 This is part of a 52-week series on Macro Mistakes - Designed for those who want to learn from history.

I share lessons from the biggest macroeconomic mistakes made by investors, companies, and countries, helping you avoid similar pitfalls and capitalize on future opportunities. Feel free to catch up on previous emails here if you'd like to start from the beginning!

Dear all,

Continuing our "Macro Mistakes" series, we’re diving into a pivotal moment in history that demonstrates the immense power of geopolitical events to reshape entire economies:

The 1973 Oil Crisis. This crisis wasn’t just about rising oil prices; it was a wake-up call for the global economy, showing how vulnerable we can be to macro factors beyond the financial markets.

The 1973 Arab Oil Embargo: The Old Rules No Longer Apply : Parallels : NPR

✍ The Story

The 1970s were a time of rapid change. Economies were growing, technology was advancing, and the world was becoming more interconnected.

But in October 1973, everything changed when the Organization of Arab Petroleum Exporting Countries (OAPEC) proclaimed an oil embargo.

The decision came in response to the U.S. and other nations supporting Israel during the Yom Kippur War.

The embargo specifically targeted countries that were backing Israel, causing an immediate disruption in global oil supplies.

At the time, oil was the lifeblood of industrial economies. It powered factories, transportation, and heating.

When the supply of oil was suddenly cut, prices skyrocketed. In just a few months, the price of oil quadrupled, rising from $3 per barrel to $12 per barrel.

This unprecedented spike in prices sent shockwaves through the global economy, leading to widespread inflation, economic stagnation, and the birth of the term stagflation.

❌🚫 The Macro Mistake

The 1973 oil crisis exposed a critical macroeconomic vulnerability: the over-reliance on a single commodity - oil. Many countries, particularly in the West, had built their economies around cheap and abundant oil.

This reliance left them incredibly vulnerable when supply was disrupted.

Here are a few of The Macro Mistakes that magnified the impact of the crisis:

Over-reliance on oil: By 1973, oil accounted for more than 50% of the energy consumption in many industrialized countries. This made their economies highly susceptible to disruptions in oil supply. When OAPEC imposed the embargo, there were few alternatives available, and the rapid rise in prices caught everyone off guard.
Underestimating geopolitical risks: The oil-producing countries in the Middle East held a tremendous amount of power over global energy markets. Western nations, especially the U.S., underestimated how these nations could leverage that power in response to geopolitical events. In 1973, the decision to support Israel led directly to the embargo, highlighting how geopolitical decisions can have enormous economic consequences.
Inflationary pressures: Even before the oil crisis, inflation was creeping higher due to loose monetary policies and increasing government spending. The sudden increase in oil prices added fuel to the fire, pushing inflation rates into double digits in many countries. Central banks were slow to react, and by the time they raised interest rates, inflation had already spiraled out of control.

👨‍🎓 The Macro Lesson

The 1973 Oil Crisis offers us several crucial macroeconomic lessons that are still relevant today:

Diversification is key: Relying too heavily on a single resource or industry is a recipe for disaster. In the 1970s, Western economies were far too dependent on oil. Today, the same lesson applies to industries or assets that dominate an economy. Diversification - both in energy sources and economic sectors - helps to mitigate the risk of shocks.
Geopolitical risks matter: Macroeconomics isn’t just about numbers on a page; it’s about understanding the broader context in which economies operate. Geopolitical events, such as wars, sanctions, or embargos, can have massive macroeconomic consequences. As investors, we need to keep a close eye on global political developments, as they can impact everything from energy prices to supply chains.
Stagflation risk: One of the key outcomes of the oil crisis was the emergence of stagflation - a situation where high inflation is combined with economic stagnation. This is one of the hardest macroeconomic conditions to manage, as traditional tools like raising interest rates can choke off growth even further. The lesson here is that inflationary pressures need to be managed proactively, before they spiral out of control.

The economic fallout from the oil crisis was severe.

In the U.S., inflation soared to over 12% by 1974, and unemployment climbed as businesses struggled with rising energy costs.

The combination of inflation and economic stagnation created a decade of sluggish growth, known as the "Great Inflation" period.

Other countries faced similar challenges. In the U.K., inflation reached 24% in 1975, while in Japan, the oil crisis contributed to the end of its post-war economic boom.

The crisis forced many countries to rethink their energy policies and spurred investment in alternative energy sources.

It also led to the development of strategic oil reserves, as nations sought to protect themselves from future supply disruptions.

🔒 Macro Bonus

Those who understood the macro implications of the oil crisis were able to navigate the turbulent economic waters more effectively.

Some investors shifted their focus to commodities, like gold, which soared during the crisis as inflation eroded the value of paper currencies.

Others moved into energy stocks and companies that were positioned to benefit from the higher oil prices.

The lesson here is that understanding the broader macro context - particularly how geopolitical events can influence key resources - allows us to adjust our investment strategies and avoid being blindsided by shocks.

What Could Have Been Done Differently?

Had governments and central banks been more proactive, some of the worst economic impacts of the oil crisis might have been mitigated.

For example, early investments in alternative energy sources could have reduced the reliance on oil.

Central banks could have acted sooner to contain inflation by tightening monetary policy earlier, rather than allowing inflation to run rampant.

For individual investors, the key takeaway is to remain macro-aware. When you see economies overly reliant on a single resource or sector, it’s a red flag.

Diversification - not just in portfolios, but across entire economies - is essential for long-term resilience.

The 1973 Oil Crisis was a stark reminder of how interconnected the world is, and how geopolitical shocks can have lasting economic consequences.

Next time, we’ll explore another historical macro mistake: Japan's Lost Decade and the long-lasting impact of a deflationary spiral.

This case offers valuable insights into how monetary policy, asset bubbles, and demographic shifts can shape an economy for decades.

Alessandro
Founder of Macro Mornings

Discover the Trends That Matter - VIP One-on-One Session for My Insiders

📈 As a valued member of my community, gain exclusive insights and a direct discussion with me to stay ahead of market moves. This is your chance to fully utilize your knowledge!

🏆 Don’t miss this unique opportunity: let’s discuss the latest macro developments and how to leverage them. What does this mean for you? Being part of a select group turning insights into action.

🚀 Don’t miss the chance for tailored guidance. In a dedicated session, we’ll analyze the macroeconomic landscape together, highlighting what really matters for your investment decisions.

📅 Reserve your session here → https://calendar.app.google/DFNQvEkH9C6k8Wfu6