Expert Discusses the Threat of Stagflation and Recession Amid Rising Oil Prices
This weekend, I settled comfortably on my expert couch and read an important article by my favorite economist, John Cochrane, titled 'A War with Iran Doesn’t Necessarily Have to Be a Rehash of the 70s Show.' The article reminds us that in the 1970s, a conspiracy among oil producers led to a significant price increase, which sharply raised inflation in Western countries.
Today, social media is abuzz with discussions among couch experts about whether we are heading toward the abyss of stagflation and recession. Many point to the situation in the Middle East, where war is brewing, oil prices are soaring, and inflation remains stubbornly high. The parallels with the 1970s seem ominous, leading some to believe it is time to stock up on fuel reserves and prepare for the worst.
However, based on research conducted by Cochrane, the situation appears to be different this time. He argues that energy prices alone do not lead to recession unless the government intervenes with inadequate actions. In the 1970s, the United States was marked by price controls, credit restrictions, windfall taxes, export bans, speed limits, and a slow response from the Federal Reserve, all of which contributed to an economic crisis.
Today, the landscape in the U.S. has changed dramatically. The country is no longer a hostage importer but has become a net exporter of oil, thanks to fracking technology and the removal of several energy restrictions. While gasoline prices at the pump are higher, the nation is overall earning money that flows into the economy. Moreover, the U.S. has transitioned into a service-oriented economy that consumes significantly less oil for each dollar generated. Therefore, rising oil prices can be viewed as a tariff from Trump, which, although it impacts growth, does not guarantee a recession.
In this context, politicians are stepping onto the stage, eager to regulate things in what they believe is an effort to 'protect the people.' The European Union is already seriously discussing subsidies, price caps, and taxes on oil profits. Initially, to improve the climate, energy is taxed, domestic drilling is banned, nuclear generation is dismantled, and real industry is sent to China. When prices inevitably rise, they simply flood the market with more subsidies and controls.
Couch critics who can do the math understand that price controls lead to gas lines and even greater economic losses. The most productive businesses, which need energy the most, cannot access it, while suppliers see no reason to exert themselves. The first principle of economics is simple: do not redistribute income by distorting prices. But the first principle of politics is to do exactly the opposite!
A separate story involves the U.S. central banks. The Federal Reserve will be very tempted to respond to this supply shock by injecting money and stimulating demand. They may again want to simply 'ignore' oil inflation, as they did during the COVID era, until it reached 8%. If they slow down again amid harmful government decisions, stagflation could return very quickly.
So, what should the government do in this situation? Nothing. Just step aside, remove restrictions, and let the market work. The market will direct energy to where it is economically most important and force others to conserve or seek alternatives. It is essential to control inflation and not create financial problems with one’s own hands.
But for a bureaucrat, doing nothing is worse than death! So, what do you think? Can the state refrain from intervening and not 'save' everyone with its brilliant ideas for once?