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Comment & analysis / LettersPrint article | Email article

Crude oil price rises of today are unlikely to lead to the stagflationary scenario of the 1970s
By Bernard Munk
Published: October 15 2004 03:00 | Last updated: October 15 2004 03:00

From Dr Bernard E. Munk.

Sir, Joachim Fels ("Beware a toxic cocktail from 30 years ago", October 12) suggests a strong parallel between the oil shock of the 1970s and the current environment. While it may turn out that in the immediate future world economic growth will be slower and inflation higher, in our view connecting that outcome with the current rapid rise in oil prices is a stretch. Using the past to predict the future runs into trouble precisely because economic agents, even policy authorities, learn from the past. As the folk wisdom has it: "The market never does it to you twice in the same way." While the current oil shock is reminiscent of the 1970s upset, it is far more likely that it is the differences between the periods not the similarities that will determine the outcome of growth and inflation.

Organised financial markets (futures, options, swaps and so on) did not exist in the 1970s. These markets make the economy inherently more flexible and less subject to the effects of "shock". The knowledge that these risks have already been parcelled out among the players creates confidence that the deleterious consequences of a potential shortage have been largely mitigated already. Consider the curiously small pick-up of crude by American refiners through swaps with the Strategic Petroleum Reserve once the SPR was opened by the administration. If refiners thought that markets would not function well, and crude oil would become "unavailable" even at high prices, would one not have expected a much larger response to the "shortage of crude"?

Government, often thought to be the slowest-learning of agents, has also absorbed many of the lessons of the previous stagflation episode. The Fed recognises that stagflation in the 1970s had its root in monetary excess and is now quite explicit in stating that it is not about to monetise the current oil shock. Given the rather mild inflation that the US economy has (apparently) just surmounted, the Fed's continued posture of interest-rate normalisation as well as recent Fedspeak suggest appropriate anti-inflationary rectitude.

Uncertainty, not high prices for a particular commodity, is the enemy of real growth. As long as government policy does not create more uncertainty, such as by imposing physical allocations of oil and products, private financial transactions will mitigate and distribute the costs of uncertainty. This will limit the reduction to growth and the acceleration of inflation. Preventing the adjustment to high prices will slow growth and probably not curb inflation, an outcome policymakers seem intent to avoid.

The emergence of China and India as substantial buyers of crude, as a result of their rapid growth, combined with insufficient prior upstream investment, will no doubt mean a higher average price of crude oil in the short and intermediate run. That is a real disturbance but it does not of itself mean slower world growth. One ought not to downplay the rapidity or magnitude of the crude oil price rise, but it is quite an open question as to how much we should shave our growth estimates and raise our inflation projections for 2005. History is less likely to repeat than it is to rhyme.

Bernard E. Munk, Munk Advisory Services, New York, NY 10023, US

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