How Today's Crises Are Rehashing the 1970s: Inflation, War, and Oil

Consistently weak monetary policies inevitably have poor growth and distributional consequences, putting political stability at risk. Civil wars and violent confrontations between countries occur in severe instances.

In April 2022, consumer price inflation in the United States was 8.3%, while it was 7.5 percent in the eurozone. This raises the issue of who is to blame. President Joe Biden of the United States has claimed that Russian President Vladimir Putin is to blame for 70% of inflation in March. According to the European Central Bank, excessive inflation should be viewed in the context of the pandemic and the Ukraine conflict. President of the European Central Bank Christine Lagarde believes that sharply rising energy prices have nothing to do with the ECB's monetary policy. Is inflation, however, solely attributable to the war and pandemic?

Inflation is "always and everywhere a monetary phenomenon," according to Milton Friedman, and thus the responsibility of central banks. Given that the money supply has historically increased significantly faster than output in all developed countries, the ensuing massive monetary overhang should be at the root of growing inflation. While stock and real estate prices have risen rapidly throughout the century, consumer price inflation began to take up in mid-2021, fueled by rising energy prices. Rising energy prices are linked to the global monetary overhang for five reasons, one of which was exacerbated by the epidemic.

First, a flight to real assets has begun as confidence in the dollar and euro has eroded. Not only can tangible assets include real estate and equities, but also stakes in commodity mining and raw minerals such as oil and gas. Second, the main central banks' ultraloose monetary policies, along with expansionary fiscal policies, have stimulated aggregate demand, and consequently demand for energy and raw materials. Third, when businesses believe that price increases will be permanent, they stockpile raw materials, driving up demand and prices.

Fourth, countries that export energy and commodities have huge dollar and euro reserves, which are devalued by inflation in the United States and the eurozone. Energy and commodity exporting countries can hedge against depreciation by boosting prices because they are generally oligopolists. Some Arab countries have recently declined to increase oil and natural gas output in order to undercut global market prices. Fifth, commodities and energy are primarily exchanged in dollars. Prices of raw materials and energy will rise in the euro area if the euro depreciates as a result of the ECB's prolonged loose monetary policy.

This raises the question of whether there are any parallels with the 1970s, when high and prolonged inflation coexisted with conflict in the oil-rich Middle East. Inflationary pressures were present even before the first oil crisis in 1971, and they are still present now. Since the second half of the 1960s, the United States has used the printing press to partially fund the Vietnam War and increased social spending. Inflation was exported to the many countries with dollar-pegged currencies. Energy and commodity exporting countries had an incentive then, as now, to raise prices to compensate for real losses in the value of their dollar reserves. This was the catalyst for the Organization of Petroleum Exporting Countries' cartel policy and the first oil crisis in 1971.

Consistently weak monetary policies inevitably have poor growth and distributional consequences, putting political stability at risk. Civil wars, as proven by the Arab Spring, or violent conflicts between countries occur in extreme situations. The Egyptian president Anwar el-Sadat wanted to deflect from domestic political difficulties, which prompted the Yom Kippur War in 1971. Russia's economy has been slowed by lower oil prices since 2014. One of Putin's main objectives for going to war could have been to secure his control in Russia. Finally, like in the 1970s, rising oil and commodity prices have contributed to heightened worldwide inflationary pressure.

Inflation in the 1970s was only stopped when Paul Volcker, the new head of the US Federal Reserve, hiked interest rates to 20% starting in 1979. (Volcker shock). As a result, oil prices began to decline. The Federal Reserve and the European Central Bank are still a long way from taking similar actions. The Fed has made it clear that it will raise interest rates, but a rise in interest rates above inflation is still a long way off. Despite increasing inflation, President Lagarde has kept all options open in the euro zone.

A firm defense of price stability takes a different form. This means that inflationary pressure will last longer, especially in the eurozone, because huge levels of government debt can be melted down by inflation, assisting in the financial stabilization of heavily indebted euro area countries. However, because this process is likely to be accompanied by ongoing economic instability, the Ukraine crisis may not be Europe's final political disaster.

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