Hamas’s surprise attack against Israel has fanned the flames of an age-old conflict in the Middle East and sparked fears that the global economy faces a repeat of the turbulent 1970s. Almost exactly 50 years ago, an oil price shock caused by the Yom Kippur War and subsequent crude embargoes against nations that supported Israel in the conflict helped usher in a decade of stagflation—a toxic mix of weak economic growth and spiraling inflation. Now, as the current war in Israel continues to escalate, Deutsche Bank’s macro strategist Henry Allen can’t help but feel a sense of déjà vu.
“As we look back at the 1970s today, there are a striking number of parallels with our own time,” the Wall Street veteran wrote in a Monday note. “Over the weekend, the attacks on Israel showed how geopolitical risk can return unexpectedly.”
Anemic economic growth and crushing, stubborn inflation were the status quo in much of the 1970s—not just in the U.S., but worldwide. Between 1973 and 1983, as GDP growth rates plummeted in many nations, inflation averaged 11.3% globally, more than three times the average of the previous decade. Allen’s main fear is that we could see a repeat of this type of persistent inflation during the 2020s. He pointed to a number of reasons why he’s so concerned on Monday, from the threat of another oil price shock to growing “industrial unrest” from workers that can be seen in union strikes.
Parallels to the 1970s
"The most obvious parallel between the 2020s and the 1970s has been the surge in energy prices, particularly that of oil," according to Allen.
The 1970s saw two major oil price shocks caused by wars in the Middle East that exacerbated inflation globally.
The first came in October 1973, when OPEC, which then was called the Organization of Arab Petroleum Exporting Countries, or OAPEC, cut its oil production and imposed an embargo on a number of nations for supporting Israel in its fight against a coalition of Arab states led by Egypt and Syria during the Yom Kippur War. The move led the price of a barrel of oil to jump 300% from $2.90 to $11.65 in just four months.
Similarly, the Russia-Ukraine war and subsequent sanctions against the West for its support of Ukraine lifted oil prices from around $80 per barrel at the start of 2022 to over $139 in just three months. Prices then slowly retreated to a low of around $74 this June, but supply-demand imbalances have led to a steady rise ever since. And the Israel-Hamas war threatens to bring back another bad memory from the 1970s—a second oil shock.
In 1979, the Iranian Revolution crippled Iran’s oil production, reducing global crude output by roughly 7%. Then the Iran-Iraq War began in 1980, leading to further cuts in oil production. Crude prices rose from under $10 per barrel in early 1979 to $34 per barrel by February 1981 as a result.
“These supply shocks caused serious difficulties for the economy, both in the 1970s and today, since they push up inflation and dampen growth at the same time,” Allen explained, noting that rising oil prices have put central banks in a tough spot as they continue their inflation fight amid fading global economic growth.
However, Capital Economics’ deputy chief markets strategist Jonas Goltermann said he doesn’t believe the latest conflict in the Middle East will have as dramatic of an impact on oil prices as past wars have.
"It would take a major escalation for this conflict to generate a shock comparable to the one in 1973 following the first Yom Kippur War. Back then the oil price quadrupled over the space of a few months; such an outcome remains a tail risk scenario," he wrote in a Monday note.
Putting the potential for another oil price shock aside, Deutsche Bank’s Allen noted that inflation still remains well above central banks’ targets in many nations worldwide, just as it did in the 1970s. And in another repeat of history, economists may be a bit too optimistic about the path ahead for consumer prices.
“Forecasts were repeatedly too optimistic in the 1970s, as the persistence of inflation was underestimated,” he wrote, explaining that there has been a “similar phenomenon” in the 2020s, which could lead central banks to be too dovish. “Now is not a time to get complacent…the 1970s showed how unexpected shocks could rapidly send inflation higher once again.”
The number of striking workers is also on the rise in a repeat of the 1970s. Actors, screenwriters, autoworkers, journalists, and more have all taken drastic steps to push for higher wages to compensate for inflation in recent years.
In the 1970s and early 1980s, U.S. workers regularly saw their wages rise by 7%, 8% or as much as 9% annually to compensate for rising prices. But some economists believe the persistent wage increases helped exacerbate inflation and fear current worker strikes could do the same.
The good news, according to Allen, is “even as the number of strikes reaches its highest in decades, the scale of the industrial action is at just a fraction of its levels in the 1970s.”
Still, striking workers and oil price shocks are definitely reminiscent of the disco era, and even the weather is feeling a lot like the ’70s. “We are also seeing an El Niño event this year, which echoes a similar event in the early 1970s that put upward pressure on food prices,” Allen warned, adding that “there is a clear risk that it could create another inflationary shock.”
El Niño events can cause warmer and drier winters in North America, reducing crop yields.
This year, the U.S. Climate Prediction Center estimates that there is a 73% chance that there will be a “strong” El Niño event.
Reasons for optimism
While there are certainly a lot of similarities between the 1970s and today, there are also a number of differences and reasons to believe the global economy can avoid stagflation.
First, central banks around the world have raised interest rates aggressively to counter the rise of inflation, which was ultimately how consumer price increases were slowed in the early ’80s. Second, after years of supply-chain inflation, Allen said that supply chains have “broadly healed.” The New York Fed's Global Supply Chain Pressure Index—which measures constraints caused by supply chains worldwide—has dropped back below its long-term average after hitting a record high in late 2021.
Commodity prices, overall, are also still from their post-Russia invasion peak; consumers’ inflation expectations remain anchored; and the U.S. economy is far less energy intensive than it once was due to a number of factors, including a reduced emphasis on industrial production and new vehicle efficiency standards. U.S. energy intensity—a measure of primary energy consumption per real GDP dollar—has fallen nearly 80% since 1950, according to the U.S. Energy Information Administration.
“An energy shock in the 1970s was capable of causing far more economic damage than today, because our economies were much more reliant on energy,” Allen explained.
Summing it all up, the veteran strategist said that there have been “a lot of promising signs that a return to the 1970s can be avoided,” but the latest conflict in the Middle East means “it is too early to sound the all-clear.”
“After all, inflation is still above target in every G7 country, even if it has come down from its peak. We saw in the 1970s how fresh shocks can lead to expectations becoming unanchored, particularly if they already follow a period where inflation has been above target. At the same time, growth remains sluggish in several countries, and relative to recent years, policymakers face more constraints when stimulating the economy,” he wrote.
