Energy disruptions manifest in diverse forms. A striking feature of the current situation is the protracted period required for financial sectors to acknowledge the magnitude of unfolding events in a conflict where Iran possesses the capability to disrupt worldwide energy output, owing to its command over the Strait of Hormuz.
As stated by Fatih Birol, director of the International Energy Agency, we are currently facing the most significant energy supply peril ever recorded. He recently informed the Financial Times that a larger quantity of petroleum has been curtailed than during the dual crises of the 1970s, and the quantity of natural gas supply halted is double the amount Europe experienced following Russia’s invasion of Ukraine in 2022. Nevertheless, developments in the Middle East are evolving rapidly. Amidst the uncertainties of conflict, historical patterns offer valuable insight into potential impacts on the world economy and the outlook for capital allocators.
The fundamental premise is that sudden supply interruptions consistently present an ultimate challenge for monetary authorities, owing to the heightened probability of rising prices and a sluggish economy, or the deleterious blend termed stagflation. The prime historical example in this context was the upheaval subsequent to the 1973 Yom Kippur War, when nations within the Opec consortium reduced output and instigated a quadrupling of petroleum costs, leading to catastrophic repercussions for the global economic system. Subsequently, after a four-year interval, crude oil costs re-doubled.
Arthur Burns, who was then chairman of the Federal Reserve, asserted that the escalating petroleum cost originated from non-monetary factors and did not warrant a monetary policy intervention. His conviction, shared by other monetary policymakers, was that such disruptions to supply could be disregarded, as the temporary price surge issue would resolve itself through the flexibility of supply and the availability of alternatives, where higher costs stimulate conservation of energy, greater capital deployment in novel oil exploration sites, and the pursuit of petroleum alternatives.
The challenge inherent in this perspective lies in the subsequent or indirect impacts of a supply disruption. Such effects encompass employees seeking elevated remuneration to offset the rising expense of power and products and services requiring significant energy input. Concurrently, firms endeavor to transfer these elevated power and workforce expenses to end-users.
Consequently, the danger arises that perceptions regarding price steadiness become “unmoored”, in the parlance of monetary authorities, and a cycle of rising wages and prices is initiated. This negates the rationale of disregarding a singular energy disruption. Thus, during the 1970s, in most global regions, inflation spiraled uncontrollably. Merely the monetary institutions of Germany and Switzerland adequately assessed the peril.
Considering the frequent challenges posed by President Donald Trump to the autonomy of the contemporary Federal Reserve, it is pertinent to observe that Chairman Arthur Burns experienced similar duress in that era from Richard Nixon. He was profoundly cowed by deceptive media disclosures engineered by Nixon and his Secretary of the Treasury, John Connally.
During the early 1970s, Burns had implored the chief executive to oppose salary increments contributing to inflation. However, disseminated narratives implied that the Federal Reserve head had concurrently sought a salary elevation. Nixon eventually acknowledged that these charges of insincerity against the Fed chairman were unfounded. Nonetheless, their influence was so significant that Burns turned into a compliant adherent of the government, maintained excessively low interest rates, and permitted the economy to become overstimulated.
By the year 1974, the rate of price increase had reached double figures, and the economic system was languishing. It was not until 1979, with Jimmy Carter’s designation of Paul Volcker to the Federal Reserve, that the Fed adequately tackled the facet of price steadiness within its two-pronged mission, which additionally encompassed maximum employment. The expense incurred in reining in escalating prices was a severe worldwide economic downturn. Nevertheless, Volcker’s stringent increases in lending rates and resultant reduction in inflation catalyzed the most significant bond market surge in several decades. Furthermore, under Volcker’s stewardship, the subsequent major petroleum crisis of 1979 yielded merely minor price-increasing effects.
That is a crucial point to recall: the uncontrolled price escalation of the 1970s was not solely an energy-driven occurrence. Currency and lending consistently hold a pivotal position during periods of unstable prices. A key determinant in this instance was President Nixon’s choice to detach the dollar from its gold standard. His dissolution of the Bretton Woods quasi-fixed exchange rate framework in 1971 constituted, essentially, a colossal move towards currency market liberalization. This transformed the dollar into an unbacked legal tender, without the support of gold. Concurrently, numerous developed nations commenced the liberalization of their financial sectors, thereby unleashing a massive surge in monetary and lending expansion.
The result proved especially detrimental in the United Kingdom, where the Heath administration’s policy of market liberalization and credit expansion fueled an uncontrolled boom in residential and commercial real estate sectors, and assisted in propelling consumer price index inflation to nearly 27 percent by 1975. Facilitating that rapid expansion was an emerging parallel banking structure — comprising what were termed
Smaller financial institutions — whose venturesome credit provision in real estate was supported by the major commercial banks, which operated under official restrictions regarding their direct property financing. This offers a stark caution from history about the current rapid expansion of private credit, where US and UK politicians are endeavoring to involve unwary individual investors.
When the UK real estate boom collapsed in the 1970s, a grave banking emergency ensued. The fiscal repercussions for the newly elected Labour administration were such that it was shamefully compelled to delegate Britain’s financial management to the IMF. Returns on government bonds surged into two-digit percentages, triggering a drastic fall in gilt prices. Senior citizens relying in their golden years on ostensibly secure fixed-income state debt instruments were impoverished. The share market endured the deepest slump of the era following the war.
On Friday December 13 1974, when the FT All-Share index plunged to its lowest point ever, the maximum drawdown from peak to trough was 72.9 per cent. The dividend payout on the index stood at 12.7 per cent, while the price-to-earnings ratio for the 500 shares in the industrial index was an exceptionally depressed 3.6. As John Littlewood, the chronicler of Britain’s equity market, has observed, such figures now appear unfathomable.
That also emphasizes the idea that cost-push inflation events trigger conflicts over resource allocation. At one level, these relate to a redistribution of earnings and assets from nations buying energy to those selling it. In the 1970s, the Opec countries were substantial accumulators of capital with limited populaces. They possessed insufficient ability to boost spending to counteract the global economic slowdown effect of the actual fiscal burden they had imposed upon industrialized nations.
In the developed economies, the primary conflict was between investors and employees. Workers sought remuneration for grappling with what is currently termed a cost-of-living crunch. More comprehensively, rising prices served as an adjustment mechanism to manage the shortcoming of the governance framework in furnishing an equitable resolution to apportioning the diminishing returns of income and wealth from escalating costs.
Circumstances are markedly altered in the current era. The global industrialized economy is considerably less reliant on energy than in the 1970s and thus not as susceptible to punitive measures by petroleum-exporting nations. Worker negotiation strength was drastically diminished in the 1980s by Ronald Reagan and Margaret Thatcher. More of the advanced countries’ central banks are, to varying extents, autonomous.
One might inquire then, why did price increases spiral uncontrollably after the Ukraine conflict and the global health crisis? The most insightful authority on this matter is the economist Hyman Minsky, who showed how extended stretches of financial steadiness and market tranquility could induce a false sense of security in decision-makers, corporations, and families about the intrinsic volatility of business fluctuations and rising levels of indebtedness.
Such was the situation for many years after the major economic downturn of 2007-09. Price growth remained subdued to such an extent that stated interest rates stood at naught and cost-of-living corrected actual interest rates were frequently below zero. Monetary authorities struggled in elevating price levels to their desired benchmarks of 2 per cent. Scholarly experts penned erudite papers about mechanisms to remedy “low inflation”.
When pressure for price increases resumed in 2021-22, the central banking officials employed Arthur Burns’s strategy and asserted that inflation stemming from supply chain disruptions would be “temporary”. Believing they had performed admirably in restraining rising costs, they also presumed that the employment sector would not exert undue pressure. But as Dario Perkins, an economist at TS Lombard, posits, the global health crisis had forged a climate where employees gained fleeting leverage. Job markets tightened, and firms were compelled to vigorously vie for personnel.
This situation does not hold true currently in the US, the UK, and a significant portion of mainland Europe. As the discourse of the Bank of England and the European Central Bank has adopted a more aggressive stance over the preceding two weeks, the concern surfaces that they may now commit an erroneous decision by reversing course and unintentionally trigger an economic downturn.
A further distinguishing factor compared with the 1970s era is that sovereign liabilities have escalated to unprecedented peacetime heights. In a persistently sluggish economic environment, administrations are likewise susceptible to the phenomenon termed fiscal imbalance, stemming from the expanding retirement and medical expenses of demographically older societies and the impetus to boost military expenditure. Also, a pronounced aversion to increasing taxation. In some countries, particularly the United States, the expense of servicing national debt surpasses military appropriations. There is thus a growing danger of monetary financing of debt, in which central banking authorities fuel inflation by underwriting the surge in government borrowing — a hazard that financial markets seemingly have not priced in thus far.
The prospects for those holding investments and savings are rather bleak unless one has faith in artificial intelligence marvels. (And incidentally, note that the high power consumption of major technology companies’ data facilities means that achievements driven by AI become increasingly challenging to realize.) If, as current trends persist, we are moving towards a period of stagnant growth and high inflation, this is consistently detrimental to both fixed-income securities and shares. Gold is the ultimate safeguard against global political instability, but it recently attained unprecedented valuations after its 65 per cent appreciation in 2025. Its sharp drop over the last three weeks nevertheless demonstrates its occasional inability to maintain value amidst broader market depreciation. Regarding cryptocurrencies like Bitcoin, it lacks inherent worth and has declined by over 40 percent during the preceding half-year.
Next, our attention shifts to the most recent UBS Worldwide Investment Returns Annual, in which Elroy Dimson, Paul Marsh and Mike Staunton utilize a worldwide financial market dataset dating back to the year 1900 to identify investment categories that act as a safeguard against rising prices. Their findings lead them to raw materials. They underscore the advantages of a diversified collection of secured commodity derivatives. These have delivered substantial long-term profits but, however, note, their attributes for safeguarding against inflation mean they yield poorer results during prolonged phases of decelerating price increases.
Should that seem overly intricate, a strong case exists for the less exciting, income-producing stocks. They might not directly protect against inflation through correlation but, as Dimson, Marsh and Staunton observe, they outpace rising costs over extended periods because of the share market risk compensation — the extra compensation demanded by investors for relinquishing ostensibly more secure government debt.
When addressing the present remarkable confluence of international political instability, rising prices, and economic downturn threats, the paramount necessity is asset allocation spread. That should include holding of less popular liquid assets, which even at today’s inflation rates exceeding official objectives is back to providing a welcome net positive yield after accounting for inflation.