The world goes from shock to shock. After the epidemic in 2020-2021, energy in 2022. The entry into the war of Russia, the world’s largest exporter of oil and gas, last year caused prices to rise. And takes us back half a century.
According to Bruno Le Maire, Minister of Economy and Finance, the movement is “comparable in intensity and brutality to the 1973 oil crisis.” Are we really back to this dark period, which marks the country’s entry into a crisis from which many French people have the impression that they never came out?
Barrel over $250
This time, the rise in prices is less violent. By the end of 1973, the price of oil had quadrupled in three months. At the end of March 2022, its price “even” did not double from its lowest point at the end of December. The quadrupling suggests that the barrel will continually approach $250, a scenario supported by very few observers at the moment.
The price of gas in Europe has quadrupled in seven months and could well exceed that figure. But in the energy supply, it weighs less than oil (a third less in Europe), even if some industrialists and individuals need it.
Jewels, weapons and villas
Rising prices undermine revenues. In 1973 France’s energy expenditure (balance of imports and exports) was 1.5% of its GDP. In 1974 it jumped to 4%. In other words, 2.5% of GDP suddenly moved from France to the oil-producing countries (which then bought more jewelry, weapons and villas on the Cote d’Azur).
Last year this energy bill was of the same order as in 1973 (1.7% of GDP). So a shock as big as it was at the time would cause it to exceed 4% of GDP, depriving the French of 60-70 billion euros. Again, this scenario is not the most likely today, even if it cannot be ruled out in very tough markets.
Thus, the energy shock in 2022 may be weaker than in 1973. This is not the only difference. Because two mechanics have changed a lot since then: the mechanics of wages and the mechanics of economic policy.
First, wages. Prior to the 1973 oil shock, inflation was robust. In France, prices rose by an average of 4% per year during the two decades leading up to the oil shock, compared to just 1.4% over the past two decades. In most companies, wages de facto followed prices, and forms of indexation have since disappeared (with the exception of the minimum wage).
Unionized workers had higher bargaining power backed up by labor organization. It is easier to block a mine or a factory than a service facility where workers are scattered…
After the oil shock, the purchasing power of households increased by almost 3% per year to the detriment of the profitability of companies and their investments. Which now seems unlikely.
Next is economic policy. The oil shock led to new president Valéry Giscard d’Estaing’s grandiose budgetary blunder: the 1974 refrigeration plan proved ineffective in the face of the problem not of excessive demand but of increased supply.
This was followed in 1975 by an untimely revival led by Prime Minister Jacques Chirac, and the following year by morbid austerity led by his successor, Raymond Barré. Even darkening the picture, today it is difficult to imagine such an accordion stroke.
Independent central banks
Monetary policy was then controlled by the government. It has long since fallen behind, with interest rates below the rate of inflation. The real change came later, from the United States. Federal Reserve Chairman Paul Volcker declared his (already written) independence by raising interest rates to 20% in 1981. In doing so, he caused a recession, broke inflation…and destroyed his chances of being reappointed as head of the Fed two years later.
Since then, all the central banks of developed countries have become independent. The statutes of the Bank of France and others were rewritten. Price stability is their main mission.
Drop your prices
However, there is a doubt. Because during the financial crisis of 2008 and then the crisis of 2020, the States accumulated huge debts. Thus, central banks are likely to face a difficult choice between keeping interest rates very low to maintain the ability of governments to refinance debt, and raising interest rates to fight inflation.
Central banks are likely to prefer to see prices rise above interest rates, as they did in the 1970s, but unlike back then, households bear the bulk of the costs of the shock. Even if the States try to limit the damage by giving them public money.