OPEC & The International Oil Crisis Of The 1970s

The emergence of OPEC - the Organization of Petroleum Exporting Countries - in 1960 essentially shifted the oil market away from Western producers and into the hands of oil producers located primarily in the Middle East, which in turn led to a drastic shift in the pricing strategy and market demand for oil. In particular, prices for oil accelerated on a sharp upward slope from 1973 to 1979, when numerous wars in the Middle East — as well as a dwindling global supply coupled with increasing global demand — resulted in both geopolitical and economic factors dictating a substantially higher market price for oil.

While the entire world was affected by what essentially can be equated as a rise in the price of energy, the US economy found the dramatic rise in oil prices - an astounding 184% in just the first six months of 1974 - to be particularly detrimental: it created a unique situation known as stagflation, whereby the rise in oil prices resulted in an overall rise of all prices, or inflation. This in turn increased business expenses and thus decreased profit margins — thereby setting the stage for a contractionary economy that ushered in an era of higher unemployment. The equation was simple yet devastating: inflation plus unemployment equaled stagflation, which resulted in a weak economy.

As a result of stagflation and the overall lack of stimulus the US economy was facing, the US dollar began to fall sharply in value. The result of this, however, was more drastic than usual: since all oil transactions are denominated in US dollars, OPEC's realized profits were diminished, as the devaluation of the US dollar essentially devalued the revenues OPEC received. In order to compensate for the devalued US dollar, OPEC decided to further raise the price of oil. The result was what appeared to be an endless cycle: a rise in oil prices weakened the US economy, which in turn weakened the US dollar; due to the fact that oil transactions were and still are denominated in US dollars, though, the devaluation of the US dollar resulted in reduced realized revenues for OPEC - and hence they countered this by increasing oil prices.

Political conflicts continued in the Middle East, as the Yom Kippur War was followed by the Iranian Revolution. After a decade-long oil crisis, prices finally returned to more "normal" valuations in the 1980s, when US president Ronald Reagan introduced fiscal policies to alleviate the stagflation brought about by high oil prices. Reagan reduced taxes, thereby providing entrepreneurial stimulus that resulted in a revitalization of the US economy. Meanwhile, Federal Reserve chairman Paul Volcker tightened monetary supply by raising interest rates - and thus countering the dilemmas stemming from inflation.

Is it possible for an OPEC-inspired oil crisis to re-emerge? Statistically, the answer is no. The correlation between oil price and US GDP since 1980 is non-existent. This may result from the fact that oil prices are simply headed downwards; the advent of new oil drilling technologies has drastically reduced the cost of producing oil, which ensures that competition in the marketplace will drive the consumption price of oil downward as well.

Alternatively, it may also stem from varying monetary policies the US Federal Reserve has begun to employ with reaction to oil price changes. While Volcker employed a reactionary policy to oil prices under which interest rates were raised, Greenspan has chosen to do the opposite: he has cut interest rates, hoping to stimulate the economy and ward off and oil-induced maladies in the process. Essentially, Greenspan has operated under the belief that the inflation threat is minimal, and that loosening the money supply by slashing interest rates is the best way to ensure the economy remains in optimal condition even when oil prices are raised.

Ultimately, if the correlation between oil and GDP is a matter of the past, than Greenspan's policies should prove to be ideal, as they will allow for continued growth without the possibility of inflation. If Greenspan is incorrect, however, and a rise in oil prices does serve as a catalyst to inflation and a contractionary GDP, then the ensuing situation may be more problematic: lower interest rates and higher oil prices could lead to accelerated inflation, which in turn will bring about higher business costs and perhaps the same fatal quagmire that plagued the United States throughout the 1970s: stagflation.