Oil shocks: Continued impact of the Yom Kippur War

By Jatin Bavishi

The sixth of October 1973 marks an important date in history. On that day, which followed Yom Kippur—the holiest days for Jews—Israeli occupied lands in Sinai Penninsula (Egypt) and Golan Heights (Syria) were invaded by a coalition of Arab countries. Though the war ended 20 days later with peace brokered by the UN, it had deep impacts on the political economy of the whole world, especially concerning oil relations.

The background

The Gulf region had already established itself as a prime global oil supplier, but hitherto it was a junior partner in the deal, with the business dominated by seven Western oil companies fondly called the ‘Seven Sisters’. In preparing for the war, the Arab countries had made up their mind to use oil as an economic and diplomatic weapon. An uninterrupted flow of oil was required in the veins of every developed country to keep their fiendish ‘growth’ alive.

The war found the West—led by the USA—siding with Israel, while the Soviet Union backed the Arabs. Two weeks into the war, the Arab members of Organization of Petroleum Exporting Countries (OPEC) decided to impose an embargo against the non-complying countries while mandating export cuts. This embargo continued well after the formal ceasefire of the war and saw oil prices shooting up by as much as 400% within a year.

Impact in the USA

The immediate brunt was felt by consumers who not only had to pay excruciatingly high prices but also had to face the trauma of waiting in long serpentine queues for hours to avail their quota of oil. This also marked the beginning of the end of extremely macho oil guzzling muscle cars like Corvette and Cud, as well as the entire automobile clusters around Flint (Michigan).

The oil shocks witnessed the simultaneous rise of what were previously perceived to be inversely moving entities—namely high inflation and high unemployment (called stagflation). This was a major blow to the entire edifice of policy making because Governments of the day used to focus their energies on finding the right inflation-unemployment combine: now, new tools had to be developed.

The rise and rise of sultans

Never before had the sultans and dictators realized the power of ‘black gold’. The price rise gave them huge windfalls and simultaneously held the world as a virtual hostage. Not used to such bounties, the rulers used the money in budgetary blowouts. Lavish construction projects were sanctioned and state of the art defence equipment was purchased. These luxurious palaces were adorned with expensive chandeliers, air conditioners, and fountains which required skilled manpower: none of which was available within the domestic economy.

According to The Economist, 60% of export revenue was spent on imports of goods, services, and labour. It also indirectly aided poorer nations (like India) through remittances of workers in construction and other informal activities (though under bad working conditions). Importantly, some of these countries also started making financial contributions to spread their own version of political Islam, both directly by setting up educational institutes and indirectly via proxies in the form of armed mercenaries.

The birth of petrodollars

Squandering windfalls is not advisable, and financial planning is required to avoid doing so. As already mentioned, the avenues of spending were limited within the Arab countries; consequently, they increasingly resorted to importing. Hence, although the global economy had entered a recession, absence of such conspicuous spending would have caused a greater slowdown.

However, the more important feature was the growth of petrodollars—currency earned from export of petroleum. The Arab-American bonhomie was strengthened and the US successfully managed to put a large chunk of petrodollars into buying Treasuries and other financial assets, which boosted asset prices and pushed down bond yields. This effectively enabled the US to cheaply fund and perpetually run large budget deficits; a policy it continues to date (though China has taken over Arabs in this role). This also implied that dollars, which were being exchanged for oil, would become the dominant currency of the world. The political ramifications of this friendship came under scrutiny in the future, but being showcased at the time of the Cold War, the US emerged as the economic hegemon after the shock.

Fast forward

The present world is largely shaped by these tactical positions. The 1973 shock was followed by another shock in 1980’s. The twin shocks have been ascribed as chief reasons behind events such as the Latin American debt crisis, the fall of the Shah of Persia, and the Iran-Iraq war. Forty-five years after events unfolded, the global economy and power structure remain incredibly altered. New sources of oil have been discovered and oil itself has lost its sheen for its contribution to global warming. Yet, the clout of oil is far from over. It reminds me of one of Star Treks classic statements: “On earth, petroleum once turned petty thugs into world leaders”.

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