In his recent post, “The True Story of the Oil Crisis of 1973-1974,” October 19, 2023, John Phelan gets the facts right but the economic interpretation wrong.
John argues, as the late Wall Street Journal editor Robert Bartley had argued, that OPEC quadrupled the price of oil in order to keep the price constant in terms of gold. John writes:
“In the first half of 1974,” Bartley wrote, “after “the shock,” a barrel of oil was worth almost 1/12 of an ounce of gold,” just as it was in 1969.
But he also quotes the September 1973 OPEC resolution’s statement that OPEC’s members would adopt “ways and means to offset any adverse effects on the per barrel real income of Member Countries resulting from the international monetary developments as of 15th August 1971.”
Why do I say “But?” Because real income is measured in terms of what it will buy. OPEC members didn’t sell their oil so they could buy only gold. They sold their oil so that they could buy goods and services. By how much did the overall prices for goods and services rise? Between 1969 and 1974, by which time almost all the price controls and been ended, the CPI rose by 35%. So OPEC’s attempt to keep their per barrel income constant in real terms would explain at most a 35% increase in the price of oil between 1969 and 1974, not a 300% increase.
Why would OPEC refer to “the international monetary developments as of 15th August 1971?” The most likely reason is that doing so was good PR for a move that OPEC knew would be unpopular, namely a quadrupling of the price of oil over a few months.
There could be another reason that somewhat fits OPEC’s idea of bringing gold into the discussion. When any cartel sets prices, it needs to set them with reference to something. But what? Possibly the OPEC members thought they could hold the cartel’s price together for a few years by setting it in terms of gold. But that’s different from OPEC’s claim that it was simply trying to maintain the Member Countries’ per barrel real income.
What about the effect of the oil price increase on inflation? It was not large. In 1973, we imported approximately 6.3 million barrels per day (mbd) of oil. So when the price of oil quadrupled, from $2.75 per barrel in early 1973 to $11 per barrel in early 1974, the annual income transfer to foreign producers due to that price increase was $8.25 per barrel times 6.3 mbd times 365 days, which is $19 billion. U.S. GDP in 1973 was $1.326 trillion. $19 billion is 1.4% of $1.326 trillion. Using the equation of exchange, MV = Py, where M is the money supply, V is the velocity of money, P is the price level, and y is real GDP, we can calculate the part of inflation due to the oil price increase. The effect of y falling by 1.4% is a 1.4% one-time increase in the price level. So the increased price of oil was a substantial contributor, but not the most important contributor, to the inflation from early 1973 to early 1974, and only a small contributor to the inflation from 1969 to 1974.
You might wonder why I consider only the price increase on imports. Didn’t the price of domestic oil increase also? Yes. But two things. First, Nixon’s price controls didn’t allow the domestic price of oil to rise to equal the world price. That didn’t happen until January 1981, when Ronald Reagan, in his first month in office used the discretion the president had been given in 1980 legislation to end the price controls on oil and gasoline. But second, and more important, even if the price of domestic oil had been allowed to rise to the world price, that would have represented a transfer of income from domestic consumers to domestic producers but not a loss of real income to the U.S. as a whole.
