Major International Economic Events

Part of a series of random articles and essays written while in school, this paper provides a relatively brief (or detailed depending on your disposition) overview of oil impacts in an international economics context.

The major international economic events since the Bretton Woods conferences at the conclusion of World War II have largely been about the control and long-term stability of the world economy. Oil as an internationally critical commodity used in almost all facets of modern industry has an outsized effect on the international trade and development. This paper explores the long term and lasting effects of Bretton Woods, the 1971 monetary policy change, the 1973 oil embargo, and the 2008 oil crisis in international economic contexts, with a special focus on the pricing development of oil.

As the world neared the end of World War II, and international trade was needing to return to a semblance of pre-war normalcy, the focus of Bretton Woods was on moving forward in the new global economy by “reconstructing a system that had not been adequately reconstructed in 1919.” (James, 2012). Due to the logistic considerations and long term international debt developed over the course of WWII, a new economic world order had developed. A return to the Gold Standard, considered a root cause of the Great Depression, was not likely. In the Bretton Woods conference, the United Nations led by considerable input from John Maynard Keynes developed the International Monetary Fund (IMF) with a focus on repairing international trade payments. (James, 2012; and Sawyer & Sprinkle, 2009) As Harold James (2012) explains, coming to an implicit agreement that “destructive disputes over trade could be overcome by agreement on monetary matters” was the foundational reasoning of Bretton Woods. The resultant pegging of world currencies to the United States dollar created a circumstance where oil, priced in U.S. Dollars, would appreciate or depreciate consistent with the dollar. Meaning, that as local currency nominally fluctuated against the dollar, the cost of Brent became ever more expensive to foreign markets outside of the United States. These costs are exacerbated by the compounding effect of annualized inflation, creating a steadily strengthening dollar in world markets. “Bretton Woods enabled and reinforced expansion in world trade over a sustained period” and is considered a great success in terms of its purpose. (Cononi & Hellerstein, 1994)

The year 1971 saw the collapse of the Bretton Woods monetary system when the United States ride itself of the dollar’s direct convertibility to gold and allowed the currency to free float. As Tamás Szentes (2013) explains, while the collapse was a truly global phenomenon, with the U.S. contribution further spurning the implosion; the end of the system was more about the “international development gap that existed at the time and the global disequilibria of the world economy.” This development gap had been steadily increasing, in real terms, the pegging of the dollar to gold was a significant limiting factor in the rise of inflation in both real and nominal terms. One the peg was lifted, the world economy moved into a period of significant stagflation, characterized by high inflation, high unemployment, and stagnant demand. The end of Bretton Woods, created a significant European impact as it had “alleviated European economies from the dollar shortage syndrome, and enabled them to trade without being conditioned by external deficits.” The Bretton Woods system was the institutionalized method for trade payments adjustments. (Szentes, 2013) This wading into the unknown was effectively the shock experienced by the global economy. This shock led to an increase in oil prices due to the free float of the dollar, which was effectively allowed to appreciate to the interest inflated, real market price.

The stagflation of the early 1970’s beginning with the delinking of the dollar, spread into the 1973 Arab Oil Embargo. During this period of significant economic and political turbulence, “the Organization of Petroleum Exporting Countries (OPEC) members declared an oil embargo in response to the West’s support for Israel versus other developing countries” who were growing increasingly concerned about the “international division of labor and built-in structural disequilibria of primary goods producing countries.” (Szentes, 2013) At the time there was wide spread “belief that Saddam Hussein was cutting off people’s lifelines,” and that Japan and Europe were turning a blind eye without regard to past American support and defense. (Bina, 1994) The oil embargo led to an effective transition of the American hegemony of oil production to the comparatively advantaged Middle Eastern oil producers, and their shift from an Americanized interpretation and flow of goods to one based on the tightly controlled supply by OPEC nations. The price of oil experienced a significant adjustment as the “world energy consumption rate increased coupled with economic growth in North America, Western Europe, and Japan.” (Isaawi, 1979) Domestic oil production in the United States peaked in 1970, and oil reserves fell, leaving the West vulnerable to Middle Eastern tightening. Charles Isaawi (1979) further argues that the neglect of other potentially viable energy sources added to the overall economic impact and encouraged a particular increase in the price of oil due in large part to the United States long term thought that oil could be had at effectively no cost, and had for many years grown its economy based on this logic.

The Great Recession which began in the summer of 2008 was caused primarily by the bursting of the American housing bubble and financial and economic instability that followed. At the same time a looming oil price shock was rising due to the continued increase in the price of oil and analyst calls, at the time, for futures contracts at or exceeding $100 per barrel (Lewis & Leff, 2010) The price of oil in the modern global economy is influenced by several factors, including futures commodities contracts, OPEC output quotas, and anticipated world demand, which tends to rise and fall on a seasonal basis. For this reason, adjusting for seasonal price changes, which are based on market demand, OPEC’s disposition regarding the loosening or tightening of supply, and commodities traders who react to the disposition of the organization, are what effectively creates the world’s price for oil. Anytime the price of a good is influenced by traders, the price will fluctuate rapidly. The 2008 oil crisis was a point of extreme contraction in the normalized price of crude as evidenced by Barunik, Kocenda, & Vacha (2015) who examined the rate of pricing spillovers in the petroleum markets. Meaning that their research looked at how pricing in one sector of the petroleum market might impact the global pricing of the other sectors and the direction of this spillover. In understanding the price of oil, and its steady increase, this helps to understand the longer-term relationship of crude to heating oil, to gasoline, as separate sectors of the greater market. They could show, conclusively that from 1987 to 2008 the price of the petroleum market commodities steadily increased, and that from 2008 to 2009 those same commodities experienced an almost 80% decline. Ron Alquist & Oliver Gervais (2013) argue that the 2008 oil crisis is a by-product of increased rates of market speculation leading up to the price shock. While Lutz & Bruce (2013) propose simply increased aggregate demand across all industrial commodities, supplanted by emerging markets in Asia, that the shock was a natural response to unexpected, and thus non-forecasted, worldwide economic growth. Based on the available research, the 2008 oil crisis would appear to be a potentially caused by a measure of all of these impacts. The increased financialization of oil as a purely financial trade, and the impact of global exchange traders buying up the price of futures contracts, coupled with an unexpected, and considerable growth in Asian demand, increased dependence and consumption of oil in the North American and European markets all converged on a steadily rising oil price.

The long term economic effects of a rising oil price has altered how Americans and the world at large functionally use and value petroleum. Increased demand growth since the creation of Bretton Woods, to conquer trade dispute concerns, and the growth and international independence of countries in the pricing of their commodities has led to increased oil costs. The modern lasting effects of these shifts has encouraged a worldwide valuation, by the market, that is highly vulnerable to a limited number of market actors, and spurned research and development into other sources of energy, that might lead to a more stable and sustainable world economy.

References

Alquist, R., & Gervais, O. (2013). The Role of Financial Speculation in Driving the Price of Crude Oil. Energy Journal, 34(3), 35-54. doi:10.5547/01956574.34.3.3

Barunik, J., Kocenda, E., & Vacha, L. (2015). Volatility Spillovers across Petroleum Markets. Energy Journal, 36(3), 309-329.

Bina, C. (1994). Oil, Japan, and Globalization. Challenge (05775132), 37(3), 41-48.

Cononi, R. E., & Hellerstein, R. (1994). 50 years after Bretton Woods: What is the future for the International Monetary System? An overview. New England Economic Review, 65.

Halevi, J., & Kriesler, P. (2004). Stagnation and Economic Conflict in Europe. International Journal Of Political Economy, 34(2), 19.

Issawi, C. (1979). The 1973 Oil Crisis and After. Journal Of Post Keynesian Economics, 1(2), 3-26.

James, H. (2012). The multiple contexts of Bretton Woods. Oxford Review Of Economic Policy, 28(3), 411-430.

Lewis, B. and Leff, J. (2010, December 23). Oil jumps to highest since 2008 crisis, $100 eyed. Reuters.

Lutz, K., & Bruce, H. (2013). Did Unexpectedly Strong Economic Growth Cause the Oil Price Shock of 2003–2008?. Journal Of Forecasting, (5), 385.

Sawyer, W., & Sprinkle, R. (2009). International Economics (3rd ed.). Upper Saddle River: Pearson Prentice Hall.

Szentes, T. (2013). Global Crises: Is The Keynesian Recipe Relevant If Applied Under A Global Governance?. Society & Economy, 35(3), 273. Doi:10.1556/Socec.35.2013.3.1