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Home > Social Issues
The Oil Shocks of the 70s
by Bob Powell, 5/4/05
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Joe, "Mr. Fixit", gets more elbow room, but later there's a problem.

Such fixes are very attractive in corporations and government. Later, when the crunch comes, there's usually another person in the chair who gets the blame.

What's especially annoying is that often people look back and say, "Boy, too bad Joe isn't around anymore; he really knew how to take care of things."

So the guy who created the problem escapes responsibility. In fact, Joe probably got promoted as a reward for the quick results he got thanks to short-term thinking ... and the new guy got fired.

This illustrates the difficulty in understanding and managing the behaviors in dynamically complex systems, systems with multiple feedbacks and long delays.

While the benefits can be immediately apparent, the negative "side effects" can appear much later ... even months or years later. But there are no "side effects", there are only effects that we did not foresee or chose to ignore for short-term benefit.

The "common wisdom" is that Jimmy Carter was to blame for the gas crises in the 70s. Many use them as examples that those called liberals can't be trusted on economic issues. But it's not that simple. Here's why Jimmy Carter got a bad rap!

This article explains the root causes of the two "oil shocks" in the 70s.

The 1973 Oil Shock ... Nixon devalued the dollar and the impact rippled through the economy.

The first was the increase in the price in the fall of 1973. This was a result of Nixon devaluing the dollar and abandoning the gold guarantee. It took years for the impact to ripple through the economy. Such delays are a major reason why the bahaviors of complex systems are so difficult to understand and manage. The short-term benefits of decisions can appear quickly, with the unintended negative benefits coming much later.

Interesting note on the crisis:

James Akins, 83, dies; energy expert presaged danger of relying on Mideast oil By T. Rees Shapiro, Washington Post, 7/27/10

James E. Akins, 83, who as the State Department's chief energy expert in the early 1970s controversially predicted that growing U.S. dependence on Middle East oil gravely threatened the national economy and was vindicated when nearly all of his predictions came true, starting with the 1973 Arab oil embargo, died July 15 at his home in Mitchellville after a heart attack. ...

Above all, Mr. Akins implored in his reports, the United States should quickly take whatever measures necessary to curb oil usage and begin staunch conservation efforts, even though such efforts would "be as unpopular as they will be costly."

According to Daniel Yergin's definitive 1991 book about the energy industry, "The Prize: The Epic Quest for Oil, Money and Power," Nixon's top domestic adviser, John Ehrlichman, told Mr. Akins, "Conservation is not the Republican ethic." ...

See the Chronology below.

The 1979 Oil Shock ... a panic run on gas that created the crisis.

The second was in the summer of 1979. It was the result of individually-logical actions that were collectively irrational.

John Sterman, in Business Dynamics, Systems Thinking for a Complex World, includes an assignment Challenge (p. 212) on the oil shock in the summer of 1979. He explains what caused the long gas lines in the Instructors Manual, p. 82:

So, where did the gas go in 1979? The total inventory of gas in the system remained nearly constant. But the actions of nervous drivers moved the gas from below ground tanks at the corner gas stations to above ground rolling storage [in vehicle gas tanks].

The fear of shortages was a self-fulfilling prophesy that created artificial, speculative demand that caused lines and price increases. OPEC and President Carter were blamed, but we did it to ourselves.

So when many panicked and felt they had to top off their gas tanks, others saw the long lines and panicked, too. The extra volume of gas required to completely fill all the gas tanks of all the cars exceeds 2.5 days of supply in the supply line to gas stations.


The crisis should ease once the average car is nearly full ... [and] once deliveries ... are accelerated, every customer should be able to buy what they need.

Rationing schemes such as odd/even license plate rules or maximum purchase rules (e.g., 5 gal max.) ... [only reinforce perceptions] that the shortage is real and cause drivers to top off more often ... strengthening the positive loops and intensifying the shortage.

A much more effective policy is a minimum purchase of 10 gallons. You would have to pay for 10 gals whether your tank took it or not. ... Implementing such a counterintuitive policy would require great political courage on the part of government officials, but education about the dynamics of these self-fulfilling hoarding crises would help build public support. At the very least, policymakers should avoid imposing rationing schemes that only worsen the problem.

For additional details and a system dynamics model from Business Dynamics, see Oil Shock.


Chronology leading to the oil shock in 1973

The U.S. started the chain of events when Nixon devalued the dollar relative to the gold and finally abandoned the gold guarantee. Carter was blamed because the resulting inflation rippled through during his term.

This Oil Shock came when OPEC raised the price of oil to compensate for the dollar devaluation. The increased price of oil rippled through the economy, causing inflation.

The Fed raised interest rates to "fight inflation" causing the recession of the 80s and increasing the value of the dollar relative to foreign currencies (the Dollar Shock). This made imports less expensive and caused the Trade Shock; it was cheaper to manufacture products abroad and import them. Deregulation was another response to reduce costs (The Deregulation Shock); subtly and systematically, this resulted in a corporate culture where national interest was of decreasing consideration in business decisions.

Hence our increasing economic and defense vulnerability.

Here's the chronology of the 70s taken from Secrets of the Temple by William Greider. It's an excellent book that reads like a can't-put-it-down thriller that should be required reading for anyone who wants to understand the Federal Reserve.

August 15, 1971 – President Nixon dismantled the Bretton Woods agreement. It had made the U.S. dollar the stable benchmark for all currencies (gold was $35/ounce).

December 1971 – Nixon devalued the dollar by 7.9% (gold at $38/ounce).

Early 1973 – The U.S. devalued the dollar by 11% (gold at $42/ounce).

March 1973 – The gold guarantee was permanently abandoned.

Fall 1973 – OPEC quadrupled the price of crude oil. William Greider wrote in Secrets of the Temple:

In the fall of 1973, six months after the dollar was permanently “floated,” OPEC quadrupled the price of crude oil. The OPEC price escalation was a direct and logical response to Nixon’s fateful decision. Oil trades worldwide in dollars and if the U.S. was going to permit a free fall in the dollar’s value, that meant the oil-producing nations would received less and less real value for their commodity. The dollar had already lost one-third of its value in only half a dozen years and seemed headed toward even steeper decline. In substantial measure, Saudi Arabia and the other OPEC nations were grabbing back what they had already lost – and tacking extra dollars on the price to protect themselves against future U.S. inflation. The Wall Street Journal observed: “OPEC got all the credit for what the U.S. had mainly done to itself.” [WSJ, 1/30/86]  The abrupt run-up of oil prices fed instant inflation into the price of everything else. Poorer nations that could not pay the bills borrowed heavily – the “recycling” of petrodollars by major banks.  Banks collected the deposits of revenue-rich OPEC governments and lent the money to developing nations so they could avoid bankruptcy and keep their economies growing.

1974 –- 75 –Recession. Unemployment peaked at 9.1%. Industrial production down ~15%. But when growth of the economy resumed, so did inflation. There was high inflation and high unemployment … both were not supposed to happen at once.

December 1978 – “buy now, pay cheaper” inflation spiral in progress

79Q1 – Inflation at 11%

Summer 1979 – Gas lines, panic buying and “topping off” of gas tanks

Sep. 1979, late – Fed tightened money, but vote split was 4-3, made markets nervous … skeptical that Volcker would halt inflation

Fall 1979 – Speculation frenzy in gold and silver was rampant. Farmers encouraged to be leveraged in purchasing machinery and land. Speculators buying homes creating artificial demand. Builders see other builders constructing homes …--  the “"me, too"” syndrome. -- resulting in excess supply, contributing to the later crash. Paul Volcker (Chairman of the Federal Reserve under Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987) called this the “froth of inflationary expectations.”

URL: http://www.exponentialimprovement.com/cms/oilshock.shtml

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