WHAT ARE YOU GOING TO DO WHEN THE GAS IS LIMITED AND GOES UP TO $10.00 A GALLON WITH THE TARIFFS?
As tariffs bite, get ready
for a 1970s-style supply shock
Market turmoil over mounting U.S.
tariffs on China and the threat of the same on Mexico in large part
stems from a fear of the unknown:
No one knows what a major trade war would do, as the U.S. hasn’t been in one since the 1930s.
There is, however, a more recent analog: the 1973 Arab oil embargo. Both that embargo and the new tariff barriers represent a supply shock in which a reliable supply of cheap imports—oil then, manufactured goods now—is suddenly curtailed.Prices paid by American consumers and businesses go up, hitting confidence and purchasing power.
The 1973 embargo tripled the price of oil and plunged the U.S. into what was then its worst recession since the 1930s. The circumstances, of course, were different and a similarly severe slump today looks unlikely. Nonetheless, the oil shock provides a useful road map for the present. Perhaps most important: Even after the short-term pain passes, permanently more expensive inputs require costly adjustments to supply chains and business models, weighing on growth for years to come.
In 1973, after Egypt and Syria attacked Israel, the U.S. rushed arms and aid to the Jewish state. In retaliation, Arab oil exporters cut production and suspended exports to the U.S. American business and consumers, long used to plentiful oil for less than $4 per barrel, were utterly unprepared when it rose above $11. The country’s bill for imported oil and related products shot to $132 billion in today’s dollars in 1974 from $28 billion in 1972—a de facto tax increase equal to about 1.5% of gross domestic product. The Federal Reserve initially cut rates, then raised them sharply as oil sent inflation into double digits. Governments compounded the chaos with rationing and price controls, which led to long lines at gas stations.
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The recession ended in 1975, but the reverberations lasted for years. Countless companies and workers found their factories, products and skills—developed for a world of cheap oil—no longer useful. American auto manufacturers never mastered the switch from big to small cars. Productivity growth slowed sharply after 1973 and economists believe the oil shock was a major reason why.
The U.S. until recently was as reliant on cheap manufactured products from China as it was in the 1970s on cheap oil from the Middle East. But just as the U.S. came to regret its dependence on Arab oil, many now want the U.S. to disentangle its economy from China’s as tensions have risen over its trade and technology policies and geostrategic rivalry
Economists at Goldman Sachs estimate U.S. tariffs imposed or proposed on steel, aluminum, solar panels, washing machines and imports from China now equal an annualized $200 billion. Adding all threatened tariffs on Mexico brings that to $288 billion by the end of October. At 1.4% of GDP, that is roughly equivalent to the Arab embargo “oil tax.” That doesn’t include the hit from China’s—and potentially Mexico’s—retaliatory tariffs, as well as severed supplier relationships because of U.S. sanctions on Huawei Technologies Co.
The tariff war’s economic consequences should be milder than those of the 1973 embargo, for several reasons. Most important, the Fed’s preferred measure of underlying inflation is just 1.6%, below its 2% target. So while Goldman estimates the tariffs could add up to 1.25 percentage points to inflation, the Fed is likely to worry more about their impact on growth and cut rates rather than raise them.
The benefit of higher prices on imported oil went to foreign oil producers. By contrast, tariffs are paid to the U.S. Treasury, which could spend the money to offset some harm from the levies.
No one knows what a major trade war would do, as the U.S. hasn’t been in one since the 1930s.
There is, however, a more recent analog: the 1973 Arab oil embargo. Both that embargo and the new tariff barriers represent a supply shock in which a reliable supply of cheap imports—oil then, manufactured goods now—is suddenly curtailed.Prices paid by American consumers and businesses go up, hitting confidence and purchasing power.
The 1973 embargo tripled the price of oil and plunged the U.S. into what was then its worst recession since the 1930s. The circumstances, of course, were different and a similarly severe slump today looks unlikely. Nonetheless, the oil shock provides a useful road map for the present. Perhaps most important: Even after the short-term pain passes, permanently more expensive inputs require costly adjustments to supply chains and business models, weighing on growth for years to come.
In 1973, after Egypt and Syria attacked Israel, the U.S. rushed arms and aid to the Jewish state. In retaliation, Arab oil exporters cut production and suspended exports to the U.S. American business and consumers, long used to plentiful oil for less than $4 per barrel, were utterly unprepared when it rose above $11. The country’s bill for imported oil and related products shot to $132 billion in today’s dollars in 1974 from $28 billion in 1972—a de facto tax increase equal to about 1.5% of gross domestic product. The Federal Reserve initially cut rates, then raised them sharply as oil sent inflation into double digits. Governments compounded the chaos with rationing and price controls, which led to long lines at gas stations.
Get news and analysis on politics, policy, national security and more, delivered right to your inbox
The recession ended in 1975, but the reverberations lasted for years. Countless companies and workers found their factories, products and skills—developed for a world of cheap oil—no longer useful. American auto manufacturers never mastered the switch from big to small cars. Productivity growth slowed sharply after 1973 and economists believe the oil shock was a major reason why.
The U.S. until recently was as reliant on cheap manufactured products from China as it was in the 1970s on cheap oil from the Middle East. But just as the U.S. came to regret its dependence on Arab oil, many now want the U.S. to disentangle its economy from China’s as tensions have risen over its trade and technology policies and geostrategic rivalry
Economists at Goldman Sachs estimate U.S. tariffs imposed or proposed on steel, aluminum, solar panels, washing machines and imports from China now equal an annualized $200 billion. Adding all threatened tariffs on Mexico brings that to $288 billion by the end of October. At 1.4% of GDP, that is roughly equivalent to the Arab embargo “oil tax.” That doesn’t include the hit from China’s—and potentially Mexico’s—retaliatory tariffs, as well as severed supplier relationships because of U.S. sanctions on Huawei Technologies Co.
The tariff war’s economic consequences should be milder than those of the 1973 embargo, for several reasons. Most important, the Fed’s preferred measure of underlying inflation is just 1.6%, below its 2% target. So while Goldman estimates the tariffs could add up to 1.25 percentage points to inflation, the Fed is likely to worry more about their impact on growth and cut rates rather than raise them.
The benefit of higher prices on imported oil went to foreign oil producers. By contrast, tariffs are paid to the U.S. Treasury, which could spend the money to offset some harm from the levies.
There’s no panic about shortages and
no lineups. There are, of course, de facto lineups at the Commerce
Department as American importers file thousands of requests for
waivers, in addition to pervasive uncertainty about whether
threatened and retaliatory tariffs will be imposed, or existing
tariffs lifted, which is chilling investment.
Historically, tariffs were meant to boost domestic manufacturing production by protecting it from cheap foreign competition. But globalized production means that imports nowadays often consist of intermediate goods moving from one stage of a supply chain to another, and there are no U.S. substitutes at the ready.
Rather than manufacture in the U.S., many importers are contemplating shifting Chinese production to Vietnam, raising prices or dropping products most affected by tariffs. Some had planned to shift production to Mexico but they may have to reconsider. As with the oil shock, these adjustments could take years and add countless inefficiencies, chipping away at productivity.
One final lesson from the oil shock: The Arab embargo didn’t change American support for Israel. It did, however, cause the U.S. to build strategic reserves, seek more secure supply in the North Sea, Mexico and Alaska and conserve energy through fuel-economy standards. High prices eventually made the fracking revolution possible and that is on the verge of ending net U.S. oil imports. The U.S. has thus largely insulated itself from the foreign “oil weapon.”
The lesson for today is that tariffs may not change China’s behavior. But by breaking the trade, investment and knowledge chains that tie the two economies together, it may in the long run make the U.S. less vulnerable to Chinese influence, which is what the Trump administration wants.
And, as in the 1970s, disrupting those bonds has a price.
Greg Ip
6 hrs ago
Historically, tariffs were meant to boost domestic manufacturing production by protecting it from cheap foreign competition. But globalized production means that imports nowadays often consist of intermediate goods moving from one stage of a supply chain to another, and there are no U.S. substitutes at the ready.
Rather than manufacture in the U.S., many importers are contemplating shifting Chinese production to Vietnam, raising prices or dropping products most affected by tariffs. Some had planned to shift production to Mexico but they may have to reconsider. As with the oil shock, these adjustments could take years and add countless inefficiencies, chipping away at productivity.
One final lesson from the oil shock: The Arab embargo didn’t change American support for Israel. It did, however, cause the U.S. to build strategic reserves, seek more secure supply in the North Sea, Mexico and Alaska and conserve energy through fuel-economy standards. High prices eventually made the fracking revolution possible and that is on the verge of ending net U.S. oil imports. The U.S. has thus largely insulated itself from the foreign “oil weapon.”
The lesson for today is that tariffs may not change China’s behavior. But by breaking the trade, investment and knowledge chains that tie the two economies together, it may in the long run make the U.S. less vulnerable to Chinese influence, which is what the Trump administration wants.
And, as in the 1970s, disrupting those bonds has a price.
Greg Ip
6 hrs ago
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