The Last "Oil Shock": Lessons for Investors from the 1970s

AI Question · Will political pressure cause the central bank to repeat its historic inflation mistakes?

The current energy crisis has already been classified by the International Energy Agency as the most severe energy security threat in history—its scale even surpassing the combined total of the two oil shocks of the 1970s.

This month, IEA Executive Director Fatih Birol said the amount of oil supply lost this time exceeds the total from the two shocks in the 1970s, and that the amount of natural gas supply that was cut off is double the amount Europe lost following the 2022 Russia-Ukraine conflict.

At the same time, Trump’s continued pressure on the independence of the Federal Reserve, mirroring the history of how Nixon attacked then-Fed Chair Arthur Burns, has further heightened the market’s concerns about the capacity of monetary policy to respond.

Against this backdrop, the policy statements from the Bank of England and the European Central Bank have clearly turned more hawkish over the past two weeks. Markets have begun to worry whether policymakers will overcorrect—while fighting inflation, inadvertently triggering a recession. Analysts argue that if stagflation comes true, stocks and bonds will face pressure in tandem.

A lesson from history: Why supply shocks put central banks in a bind

Supply shocks have long been the central bank’s most severe stress test.

After the 1973 Middle East War, OPEC’s Arab member states cut production, causing oil prices to quadruple and deal a heavy blow to the global economy. At the time, Fed Chair Arthur Burns believed the surge in oil prices was a non-monetary phenomenon that did not require a monetary policy response.

The Fed’s logic at the time was that price increases would correct themselves through supply elasticity and substitution effects, without the need for intervention.

However, this logic overlooks the “second-round effects” of supply shocks: workers demand higher wages to offset rising energy and related commodity costs, and then firms pass energy costs and labor costs through to consumers, causing inflation expectations to “de-anchor,” followed by a wage-price spiral.

In addition, the political pressure Burns faced could not be ignored either.

Former U.S. President Nixon and his Treasury Secretary John Connally pressured Burns by leaking to the media, ultimately turning him into a compliant supporter of the government—keeping interest rates too low and leading to an overheating economy. It is the same as what Trump is doing now to pressure Fed Chair Powell.

As a result, inflation throughout most of the 1970s in most countries spiraled out of control, and by 1974 U.S. inflation had entered the double-digit range, with the economy falling into stagnation.

The Volcker moment: Historical lessons on the costs of tightening and asset markets

Out-of-control inflation was not fundamentally reversed until Jimmy Carter appointed Paul Volcker as Fed chair in 1979.

Volcker controlled inflation with an aggressive rate-hike “hard landing,” the cost of which was a harsh global recession—but it also gave rise to the largest bond bull market in decades. And under Volcker’s leadership, the inflation impact of the second oil crisis in 1979 was relatively limited.

The United Kingdom’s experience, however, was even more severe. At the time, the Heath government’s credit liberalization sparked a frenzy in residential and commercial real estate, and retail price index inflation peaked in 1975 at nearly 27%.

When the bubble burst, the British government was forced to cede control of fiscal policy to the International Monetary Fund. Gilt yields surged into double digits; bond prices collapsed. Older investors who relied on fixed-interest government bonds for retirement income were dealt a severe blow.

The UK stock market went through the worst bear market of the post-war period: on December 13, 1974, the FTSE All-Share Index hit its all-time low, falling 72.9% from its peak, and the price-to-earnings ratio fell to an absurd 3.6x.

This history offers ample warning for today’s private credit market. Analysts believe there are some parallels between the current high-speed expansion of the U.S. and U.K. private credit markets—aimed at bringing retail investors into private credit—and the aggressive expansion of the shadow banking system in the U.K. in the 1970s.

What’s different today: less energy dependence, but new risks have arrived

Compared with the 1970s, there are several structural differences in the current situation.

Energy intensity in developed economies has fallen sharply, and dependence on oil-producing countries has weakened significantly. In the 1980s, policy reforms under Reagan and Thatcher fundamentally weakened workers’ bargaining power, raising the threshold for triggering a wage-price spiral.

In addition, many central banks in developed countries have gained independence to varying degrees.

However, the lessons from runaway inflation in 2021 to 2022 show that these structural advantages are not enough to justify complacency.

Economist Hyman Minsky had long pointed out that long periods of economic stability often breed excessive self-satisfaction among policymakers, firms, and households.

It was precisely in the low-inflation environment lasting more than a decade after the global financial crisis that when inflation pressures resurfaced in 2021 to 2022, central banks in various countries dusted off Burns’s script again—categorizing supply-side inflation as a “temporary” phenomenon, only to misjudge once more.

Another potential danger right now comes from public debt. In peacetime, public debt levels are at unprecedented highs. In some countries, including the United States, interest spending on public debt has already exceeded defense spending.

In low-growth economies, pension and healthcare spending expansion coincides with resistance to tax increases—debt monetization risks are building up, and the market currently does not seem to be pricing this risk sufficiently.

Asset allocation: Diversification is the top principle for addressing multiple risks

In a stagflation environment, bonds and stocks have historically faced pressure at the same time, causing traditional asset-allocation logic to fail.

Gold, as a tool for geopolitical hedging, has already reached elevated levels after rising 65% cumulatively in 2025. The sharp sell-off over the past three weeks also shows it is not a stable safe haven when other assets fall. Bitcoin lacks intrinsic value, and it has dropped more than 40% over the past six months.

According to the latest edition of UBS Global Investment Returns Yearbook, Elroy Dimson, Paul Marsh, and Mike Staunton—based on a global market database tracing back to 1900—report that commodity futures portfolios have good inflation-hedging characteristics and stand out in long-term return performance, but they perform worse during long deflationary cycles.

For ordinary investors, stocks that generate stable cash flow may be more practical. Dimson and others note that while such stocks have limited correlation with inflation, they can outperform inflation over the long term by way of an equity risk premium.

With the rare combination of current geopolitical, inflation, and recession risks, analysts emphasize that diversification is the most important guiding principle for response, including allocating to cash—even in an inflation environment currently above the target level, cash has again begun to provide a positive real rate of return.