Central banks and treasurers might be worried that US strikes on Iran nuclear facilities will lead to skyrocketing oil prices, higher inflation and a global economic slump akin to the 1970s, but looking at the numbers shows it’s nothing like that era and doesn’t even come close.
The speed at which oil prices have risen and the reach of oil as part of the global economy is so dramatically different compared to the spikes in 1973 and 1979 which led to a period of economic stagnation in the Western world.
Look at the level of oil use in the economy as a percentage of millions of tonnes of oil per billion dollars in real GDP.
That percentage has fallen from about 13 per cent in the early 1970s to about 4.5 per cent today on a global basis.
In Australia it’s gone from about 8 per cent to about 3 per cent, according to AMP and the Energy Institute. This is due to alternative energy sources and electrification, such as electric vehicles.
Then take a look at the speed for which the price of oil moved in the two big spikes of the 1970s compared with recent movements. The 1973 global oil shock saw a fourfold rise in oil prices after the Arab/Israeli war led to OPEC boycotting oil supplies to the US. The second oil shock, in 1979, saw a threefold increase in oil prices.
The latest conflict has led Brent crude price to rise just 13 per cent higher since Israel first launched an attack.
“With the global usage of oil collapsing since the 1970s, you have to see an even bigger increase in the price to have anywhere near the same impact,” says AMP chief economist Shane Oliver. “It would be very hard to beat that scenario.”
While the oil price level rises in nominal terms, it’s nothing when comparing the impact in real terms. The effect of higher prices and broader use in the economy was that global macroeconomics was upended. Prices rose even though demand was falling.
Something similar could happen again on a much smaller scale.
But past modelling by JP Morgan shows that some counter-intuitive stuff happens to the Australian economy when oil prices rise.
A supply shock that lifts oil prices leads to a decline in consumer prices in Australia of about 0.2 of a per cent in the first year, according to JP Morgan economist Ben Jarman.
The fall in the price level reflects both some appreciation in the exchange rate in the short term as well as a fall in real GDP of about 0.2 of a percentage point in the first year.
Australia is also relatively well placed because, as a net energy exporter, we may benefit from higher prices for gas exports.
Oliver says unless the price of oil rises 100 per cent within 12 months the impact on Australia will probably be “a wash” and that means the Reserve Bank will stick to its interest rate cutting path.
Central banks have to make calls about whether they see high oil prices as sustained or temporary and volatile.
In the 1970s when the supply side OPEC shock sent inflation skyrocketing, then Federal Reserve chair Arthur Burns lifted interest rates despite monetary policy primarily affecting demand.
The Federal Reserve has been cool-headed enough so far to look through this volatile pricing and next month the Reserve Bank probably will too.
Financial markets have reduced the odds of a 0.25-percentage-point rate cut next month from 92 per cent to 88 per cent.
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