Recession History Pt. 2 – 1973 -1975

People continue to worry about whether a recession is coming, or if it is already here. If you have been reading our blog for a while and taking the information to heart, you should have nothing to worry about. For those of you who are new, or didn’t heed the information check out these articles:

A couple of weeks ago we wrote Recession History Pt. 1 – 1929, if you have not read that yet, we would encourage you to do so. In that article, we look at what caused the initial stock market crash, subsequent depression, how society came out of it, and what we learned which we can apply to today. This week we continue with part two, looking at arguably the next most influential recession since then, 1973-1975.

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What is a Recession?

Before looking at the 1973 recession, it is important to understand what a recession is.

A recession is a macro-economic term that refers to a significant decline in general economic activity. This is often measured by two consecutive quarters of negative growth.

The following are some general characteristics of a recession:

  • Real GDP decreases.
  • Firms faced with unwanted inventories and declining profits reduce production, postpone investment, curtail hiring, and may lay off employees.
  • Business failure outnumber start-ups.
  • Falling employment erodes household incomes and confidence.
  • Consumers react by spending less and saving more, which further cuts into sales, fueling the recession.

Historic Recessions

In the last 100 years, there have been 18 recessions. This means that one occurred roughly every 5.5 years. Based on the table below, the average amount of time from the end of one recession to the beginning of the next was just over 4.5 years. Each recession lasted for an average of just over one year.

Below is a table outlining those recessions:

DatesDurationTime since Previous RecessionBusiness ActivityTrade and Industrial Activity
Jan 1920 – July 211y 6m10m-38.1%-32.7%
May 1923 – June 19241y 2m2y-25.4%-22.7
Oct 1926 – Nov 19271y 1m 2y 3m-12.2%-10%
Peak UnemploymentGDP Decline
Aug 1929 – Mar 19333y 7m1y 9m24.9%-26.7%
May 1937 – June 19381y 1m4y 2m19%-18.2%
Feb 1945 – Oct 19458 m6y 8m5.2%-12.7%
Nov 1948 – Oct 194911 m 3y 1m7.9%-1.7%
July 1953 – May 195410m3y 9m6.1%-2.6%
Aug 1957 – April 19588m3y3m7.5%-3.7%
Apr 1960 – Feb 196110m2y7.1%-1.6%
Dec 1969 – Nov 197011m8y 10m6.1%-0.6%
Nov 1973 – Mar 19751y 4m3y9%-3.2%
Jan 1980 – July 19806m4y 10m7.8%-2.2%
July 1981- Nov 19821y 4m1y10.8%-2.7%
July 1990 – Mar 19918m7y 8m7.8%-1.4%
Mar 2001 – Nov 20018m10y6.3%-0.3%
Dec 2007 – June 20091y 6m6y 1m10%-5.1%
Mar 2020 – Present10y 9m

Note: The list of recession above is for the U.S. However, this has a high correlation with the Canadian economy and is for illustration purposes.

Recession of 1973-1975

This recession lasted 16 months, from November 1973 to March 1975, and is often referred to as the Oil Crisis Recession. When looking at stats like unemployment and GDP, this recession doesn’t look particularly bad. However, it was unique. It differed from past recessions due to it being one of stagflation.

Stagflation is not very common but occurs when there is low economic growth and relatively high unemployment coupled with rising prices (inflation).

This economic time saw a period of five consecutive quarters of GDP decline. Officially ending the overall post world war 2 economic expansion.

What Caused this Recession?

The 1973 oil crisis was quite different from past recessions. So what happened on the economic landscape that led to such an uncharacteristic recession?

Below we look at 4 things that had significant impacts on how the recession played out: OPEC raising oil prices, wage and price controls, fall of Bretton Woods System, and the abandonment of the Gold Standard.

OPEC raising Oil Prices

The Organization of Petroleum Exporting Countries (OPEC) is an intergovernmental organization of 13 of the world’s largest oil-producing countries. The goal of OPEC is to keep oil prices stable and at reasonable levels.

In 1973, the OPEC countries, many of which are in the middle east, stopped all exports to the US and other western nations. This was done as punishment for their support of Israel.

This halt of all exports caused gas prices in the US to quadruple. 1973 saw prices jump from 25 cents to over a dollar in only a few months. The American Automobile Association recorded that at one point 20% of gas stations in the US had no fuel for over a week. You better hope that if you were on a road trip that the gas station you stopped at wasn’t 1 in 5 that had no fuel.

Oil consumption in the US during this time dropped roughly 20%. There was even a point where some gas stations wouldn’t sell a customer more than 10 gallons of fuel at a time.

Once oil imports into America started again, the exporting nations of OPEC, were able to keep prices high by controlling the supply. Since much of the world, specifically the western world and the US, was so dependant on oil this saw inflation increase dramatically.

The oil embargo only lasted a year. However, the effects are still seen today which we will touch on below. These events brought to light how dependent the western world was on oil and how much of a vulnerability that was.

Nixon Shock

The Nixon shock was a series of economic measures taken by President Richard Nixon in 1971. These measures were created to combat rising inflation. Measures that were implemented were: wage and price controls, surcharges on imports, and the cancellation of convertibility of U.S. dollars to Gold.

Wage and Price Controls

In the early 1970’s inflation in America was much higher than in previous decades. To combat this president Richard Nixon imposed wage and price controls.

The goal of these policies was to keep prices and wages “flat” which would then control inflation. Although in theory this sounds great, and in the short term it seemed to work, the house of cards was quick to fall.

What was originally supposed to be a 90-day price and wage freeze, it turned into 1000 days broken into 4 phases. Although prices were to remain flat, nearly 93% of requested price increases were approved because they were seen as necessary to cover costs.

During the first phase, which seemed to be successful, the government administration used expansionary fiscal and monetary policies. However, over the long term, these overly expansionary policies led to dramatically higher inflation.

Fall of Bretton Woods System and Abandonment of The Gold Standard

The Bretton Woods System, established in 1944, was a new international monetary system. Based on the agreement, gold was the basis of the U.S. dollar, and other currencies were based on the U.S. dollar’s value.

The goal was to create an efficient foreign exchange system and discourage the competitive devolution of currencies. Out of this agreement, the International Monetary Fund (IMF) and the World Bank were created (both of which still exist today).

At the time, America controlled around two-thirds of the global gold reserves. But this started to change when other countries were cashing in their U.S. dollars for gold. Effectively, there was a run on US gold reserves, prompting the halt of conversion of USD to gold.

This run on gold was happening because of the high inflation in America. This double-digit inflation was decreasing the value of US dollars held by foreign countries. So, more and more countries and banks started redeeming their dollars for gold to maintain their purchasing power.

In 1971, President Nixon canceled the ability for people holding U.S. dollars to convert them to gold. Although this didn’t destroy the Bretton Woods system, it did make it nonoperational since one of the main features of it was no longer available.

Although this cancellation was supposed to be temporary, assuming changes would be made to the system, it was never restored. By august of 1971, the Bretton Woods system was effectively terminated. What took its stead was a free-floating fiat currency system.

How Did This Recession End?

There were two main factors that we want to touch on that helped the economy to recover: leaving the Gold Standard and Increased Exploration.

Leaving the Gold Standard

Leaving the Gold Standard allowed the Americans the flexibility to increase the money supply in order to curb price inflation. Price inflation was putting downward pressure on the American consumer’s ability to continue to lead a comfortable lifestyle. Decoupling the U.S. dollar from the backing of gold allowed the U.S. Federal Reserve to increase the money supply without increasing its physical holdings of gold. This allowed American consumers easier access to money, mitigating the impact of price inflation.

Increased Exploration

When the US government saw how reliant they were on foreign countries for oil, they realized something had to change. This realization sparked an increase in oil production and exploration on U.S. soil. By doing this, America was able to cut oil imports, produce local jobs, and support economic growth. What was seen as a vulnerability, soon turned into a strength of the U.S.A.

Applying the 1973 Recession to Today

The 1973 recession was the worst recession since the 1930s. Although a lot of things have changed in the almost 50 years since the Oil Crisis of the 1970s, there are still some similarities, or at the very least, things to make note of.

Oil Prices

The first thing to take note of is the change in oil prices. In April of 2020, we saw oil futures trade at a very unusual negative price. At the bottom of the trough, oil future contracts were trading at -$40 a barrel.

This is not really a similarity, in fact, it seems to be a polar opposite; oil prices crashed in 2020 compared to a quadrupling in the 1970s. However, oil and petroleum consumption during both periods decreased substantially.

Gas consumption in America dropped by nearly 30% at the end of March 2020. Furthermore, if you do a simple search for “oil and gas consumption 2020” it seems a lot of people think oil and gas consumption will continue to decline. However, rather than it being due to a shortage of supply, it is due to forced quarantine and extensive travel restrictions.

The future oil landscape could play out as follows. Since oil prices are historically low, a lot of oil producers will turn off the taps or be forced into receivership (unless someone *cough* The Fed *cough* bails them out). If production continues, at the same pace and demand does not rise, oil prices could remain low for a prolonged period of time or even turn negative again.

However, if production is halted we could see oil prices slowly increase or remain flat until all current supply is used up. At this point, taps will be reopened. When this happens it is very possible that we could see oil prices skyrocket temporarily.

Gold Standard

The dollar was totally decoupled from gold in 1976. Since then we have run on an entire fiat money system. This has allowed the government and Federal Reserve to print money and accumulate debt with seemingly little regard. During the gold standard the price of gold was fixed ($__ per ounce). The more dollars that were issued, the easier it was for people to purchase U.S. gold reserves.

Without a gold standard today, the US Fed can print additional dollars without any serious offsetting liability. There is no functional way for the holders of US dollars to demand the Fed take back the US dollars they printed and give the holder the equivalent in physical gold.

The consequence or liability born of printing additional US dollars is shouldered by the holders of existing US cash. As more US dollars are printed, the existing US dollars are worth less and less. Effectively, savers are incurring losses by holding savings in cash.

Stagflation

This one was of the defining characteristics of the 1973 recession. It is also a very real possibility that we will see it in this recession as well.

What is Stagflation

Stagflation is a time of low economic growth with relatively high unemployment and higher inflation.

Shadow Stagflation in 2020

Let’s start with unemployment. In 2020 thus far, more than 30 million Americans have filed for unemployment since mid-March. That is nearly the whole population of Canada.

Secondly, there has been immense amounts of fiscal government stimulus. The Federal reserved has pumped Trillions into the US economy, and Canada has injected Billions into theirs. With tons of money being injected into the economy, we will see higher than normal inflation in the wrong parts of the economy. Check out our recent article Helicopter Money to Increase Short Term Inflation 2020?

When money is injected into the economy it inflates GDP. If we look around us today, we know that there is no way that the economy is currently expanding. Millions of people are losing their jobs, businesses are being shut, mortgages and rent are going unpaid, travel and tourism is non-existent, shall we go on?

Yet, because of the huge government stimulus packages, GDP will probably be reported such that it looks as though the economy has expanded.

So high inflation will happen, but it will go unreported. Why? Because it will be seen in things that have low or no weighting in the CPI calculation.

Economic growth will be reported as good, but it will be bad. Why? Because the reported GDP will be due solely to the huge stimulus packages.

Unemployment on the hand, that number is a little harder to skew. Unemployment is rising and that is no secret.

So, we will have high inflation, rising unemployment, and slow economic growth. Sounds a lot like stagflation, doesn’t it? However, it probably won’t be reported as such. Hence why we call it Shadow Stagflation.

Conclusion

The long-term effects of the 1973 recession remain today; speed limits and fuel economy stickers, local exploration and development of natural resources.

There is also a lot we can observe from the 1970’s recession that can be applied to today, but the 2020’s are likely to look much different. Decoupling from the gold standard was a drastic and bold move that was justified at the time.

Who knows exactly how this will all unfold, but we do know that drastic and bold measures will need to be taken again. The smartest economists and savviest politicians will have to craft solutions and policies that allow shops to reopen, people to get back to work, wages to increase, and the economy to recover.

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Sources

https://en.wikipedia.org/wiki/Incomes_policy

https://en.wikipedia.org/wiki/Bretton_Woods_system

https://en.wikipedia.org/wiki/Nixon_shock

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