The pandemic and Russia’s invasion of Ukraine have created the largest energy shock since 1979 and 1980. Since the start of the war in Ukraine, the price of gasoline has increased roughly 20%, and in Los Angeles, the average price for regular unleaded gasoline is $5.98 per gallon, according to the American Automobile Association.
In 1973, a gallon of gasoline along U.S. Highway 61 cost 25 cents. You could fill your Volkswagen bug for $2.50.
This type of price dislocation will hurt midsize firms at the heart of the American real economy, altering the costs of doing business and pushing up inflation.
That adjustment will fall hardest on middle- and lower-income consumers, many of whom cannot work from home and still need to drive to work. Still, the American economy is resilient enough that it will be able to absorb this energy shock, the latest in a series of supply shocks.
That ’70s Show?
There are some lessons to draw from the events of nearly a half century ago. The doubling of gasoline prices in 1979 and 1980 came during the turmoil that followed Iran’s revolution and the beginning of Iran’s decade-long war with Iraq. That shock came only six years after the oil embargoes following the 1973 Arab-Israeli war cut off U.S. oil supplies.
At the time, the shock was profound. Consider what it cost to fill up a car with gasoline. In 1973, a gallon of gasoline along U.S. Highway 61 cost 25 cents. You could fill your Volkswagen bug for $2.50. Less than a year later, that same tank of gas cost $3.60.
By 1979, a gallon of gas had climbed to 72 cents a gallon. And then two years later, the second round of shortages raised the price to $1.42 per gallon and fill-ups were forever double digits.
Those costs may now seem inconsequential, but real damage was being done to household finances, and the economy. People would waste hours waiting in line to fill their gas tanks. And they would waste gas running their cars to inch up closer to the pumps.
That is illustrative of a true oil shortage and indicative of how quickly consumer behavior, which was quite rational given the price dislocation, can result in demand destruction.
Throughout history, we have seen that an economic or financial shock can push a teetering economy into an outright downturn. The 1973 oil embargo resulted in the stagflation from 1973 to 1975 characterized by inflation, high unemployment and low growth.
Some years later, the oil shortages following the Iranian revolution resulted in runaway inflation and the devastating 1980s double-dip recession that brought the G-7 economies to their knees.
Today, the national average price of a gallon of gasoline is $4.25, about 75% higher than it was in February 2020, before the pandemic. And that should be a concern.
In addition, because higher costs are a function of geopolitical events and are not aligned with basic domestic supply and demand, there is the risk of another turn upward in oil prices—and another increase in gas prices.
But there are reasons to think the U.S. economy will not suffer as much this time. North America is virtually energy independent, and the U.S. economy is not only more energy efficient but is also less dependent on oil, especially imported crude.
But because oil prices are arbitraged in a global market, they will increase as Russian supplies are drained from markets in the West. And because the cost of goods will now include higher transportation costs along the global and domestic supply chains, prices of all goods will increase.
The takeaway
Higher prices for energy and goods will act as a tax on household finances, leading to less consumption and to changes in spending preferences—all of which becomes a drag on output.
