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Listen to the price of oil and you can hear the echoes of the 1970s

When oil prices double or higher in a year, bad things often happen. Sometimes it’s a recession, like in 1974, 1980 or 2001. Other times, a recession has just begun, like 1990 or 2008. On Monday, the short-lived global crude benchmark rose. spiked to $139 a barrel, double from a year ago, as an embargo on Russian oil exports was discussed. Can these dismal historical correlations be justified, or can this be like 2017, when oil prices doubled and everything went awry?

The two best comparisons for what’s going on are 1974 and 1979-81, but they offer different explanations for what might happen next.

The Arab oil embargo of 1973-74 has a strong resonance to this day. Oil prices soared after the destructive land grabs by allied dictators, led by Egypt and Syria. A superpower posture prevented direct U.S. involvement in the war that led to the embargo, but the lucky defender, Israel, surprisingly fought back, aided by weapons. America.

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A Shell gas station in Washington DC in 1974.


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Warren K Leffler / US News & World Report Photo Collection / Getty Images

The Federal Reserve was unable to cushion the blow to the economy by the unexpected spike in oil, as it was still trying to catch up with runaway inflation — inflation was partly caused by false political pressures. to keep interest rates low. Stagnant inflation has taken hold, as inflation soars and the economy suffers a twinge of record-high energy prices and higher interest rates. Stocks tumble: The S&P 500 index lost 43% in 12 months, its highest level since the Great Depression of the 1930s, and the decline was not exceeded until Lehman Brothers collapsed in 2008.

The Iranian revolution of 1979 showed that rapidly rising oil prices and interest rates did not necessarily have a strong impact on stocks. U.S. prices at pump exceeded $1/gallon for the first time — adjusted for inflation, to levels a week ago — when oil more than doubled, and rose further as the United States imposed sanctions. Once again, the Fed is racing to catch up with inflation, under a hawkish new chairman chosen by President Jimmy Carter. But stocks have performed well, with the S&P index back to 12% in 1979, in line with inflation, despite a jump in oil prices and a sharp rise in interest rates.

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The Iranian revolution of 1979 showed that rising oil prices and interest rates did not necessarily weigh heavily on stocks.


Photo:

GABRIEL DUVAL / AFP via Getty Images

A brief recession in the early 1980s, in which the Fed initially raised interest rates further, briefly corrected stock prices, but then oil prices began to fall, too. It was only when Fed President Paul Volcker proved his ability to fight inflation by raising interest rates to 19 percent in 1981 and triggering a deep recession that stocks entered a bear market. By 1982, the S&P 500 had reached its lowest valuation, using Professor Robert Shiller’s cyclically adjusted price-to-earnings measure, since 1932.

There are two key differences between the market crash of 1974 and the recovery of 1979-1980. First, the economy was hit harder in 1974, shrinking by half compared with the fall of 1980, while the recession more than doubled.

Second, stocks weren’t cheap in 1974, trading at their average level since 1881, according to Professor Shiller’s gauge, while in 1979 and 1980 they were much lower than they were. long-term average. Valuations are a hopeless predictor of short-term returns, but tell us that after living through the miserable 1970s, investors are used to bad news. It wasn’t until the second and much deeper recession in 1981, that evidence that Mr. Volcker was willing to rattle the economy and push unemployment to post-World War II highs did shareholders. noisy.

There is good news and bad news compared to today. The good news is that the economy is much more resilient to oil shocks, both because US production has been boosted by shale and because the economy is more energy efficient. Energy intensity, measured as the amount of energy needed per dollar of gross domestic product, fell by about 40% from before the Arab embargo until after the Iran embargo, and has halved since then. from that.

The bad news is that stocks are a lot more expensive than they were then, as are bonds, houses, and most other investments. That leaves them vulnerable if the US economy becomes more sensitive to what could easily lead to a slump in Europe and emerging countries that are more dependent than the US on energy and food exports. Russian products. It also leaves equities vulnerable if the Fed removes what has become the biggest supporter of high valuations: sub-inflationary interest rates. For now, even if the Fed is certain to tighten policy, it is not expected to tighten as much.

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Fed President Paul Volcker raised interest rates sharply in 1981, triggering a deep recession.


Photo:

Diana Walker / Getty Images

Write to James Mackintosh at james.mackintosh@wsj.com

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