The Inflation Crisis from 1972 to 1978: Israel, the US, and Repercussions in Latin America

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The period between 1972 and 1978 was marked by significant inflationary pressures in both developed and developing nations. As seen in the graph comparing the inflation rates of Israel and the United States, the sharp rise in prices was influenced by a complex interaction of geopolitical events and economic policies. Economists such as Milton Friedman, in his book A Monetary History of the United States, 1867-1960, argue that inflation is always a monetary phenomenon, often exacerbated by external shocks and internal mismanagement. The early 1970s serve as a prime example of how global crises can rapidly fuel inflationary spirals, in small economies like Israel and in developing countries like Brazil.

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The 1973 Yom Kippur War was a turning point in Middle Eastern geopolitics, with significant economic consequences for the world. Initiated by Egypt and Syria against Israel, the war led to a destabilization of global oil markets. According to Avi Shlaim, in The Iron Wall: Israel and the Arab World, the conflict not only strained Israel’s economy due to military spending but also triggered broader economic shifts as Israel’s allies, particularly the US, provided material and financial support. The war’s aftermath strained Israel’s public finances, contributing to the sharp inflation spike seen in the mid-1970s, particularly after the war ended in a fragile ceasefire.

The Organization of the Petroleum Exporting Countries (OPEC) took advantage of the geopolitical instability to assert control over oil prices. The 1973 oil embargo, led by Arab states in response to Western support for Israel, caused a dramatic surge in oil prices globally. Daniel Yergin, in The Prize: The Epic Quest for Oil, Money, and Power, explains how OPEC’s decision to cut oil supplies sent shockwaves through the global economy. This drove up import costs for energy-dependent nations, including Israel and the US, further fueling inflation. This pivotal moment in the global energy markets highlighted the vulnerability of advanced economies to external supply shocks.

Israel’s inflation rate skyrocketed after 1973, climbing from 20% to over 50% in 1978. The sharp increase was driven by a combination of wartime expenses, a heavily regulated economy, and reliance on foreign aid and imports. In his analysis, Haim Barkai, in The Economy of Israel: Maturing Through Crises, notes that the government’s inability to curb military spending and implement necessary economic reforms contributed to the inflationary spiral. The lack of confidence in the Israeli lira led to further depreciation and capital flight, with the middle class bearing the brunt of rising prices for basic goods and services.

With inflation climbing globally, the US Federal Reserve (FED) responded by raising interest rates to curb domestic inflation. This decision led to significant capital flight from countries like Israel and other developing economies to the US, where higher interest rates promised better returns. This exacerbated inflation in nations already struggling with weakened currencies, as foreign investment dried up and the cost of borrowing soared. The FED’s aggressive interest rate hikes would later have profound implications for global capital flows and inflation control in the 1980s.

The global inflation crisis of the 1970s significantly impacted developing countries in Latin America, with Brazil as a notable example. Brazil, which had enjoyed rapid GDP growth during its “economic miracle” period in the late 1960s and early 1970s, found itself facing severe economic headwinds as oil prices surged and global financial conditions tightened. The country’s development strategy relied heavily on foreign loans to finance infrastructure projects and industrial expansion. As oil prices soared after the 1973 oil crisis, Brazil’s import bills skyrocketed, and the government had to borrow more to cover deficits in the balance of payments. According to Werner Baer in The Brazilian Economy: Growth and Development, this borrowing was often done at variable interest rates, which initially seemed favorable but would later become a massive burden. By the late 1970s, Brazil’s debt had ballooned, and the country became increasingly vulnerable to shifts in international financial markets.

The situation worsened when Paul Volcker, the chairman of the US Federal Reserve, implemented a series of aggressive interest rate hikes starting in 1979 to curb rampant inflation in the United States. The “Volcker shock,” as it came to be known, sent US interest rates soaring, which dramatically increased the cost of borrowing for countries like Brazil. Brazilian debt, much of which was denominated in US dollars and tied to fluctuating interest rates, became unsustainable as repayments skyrocketed. As Baer highlights, this led to a cascade of negative effects: the Brazilian government had to implement austerity measures to cope with rising debt costs, leading to reduced public investment and slower economic growth. The capital flight from Brazil to the US, where higher returns were now available, further worsened the country’s balance of payments. Additionally, Brazil’s exchange rate depreciated as the government struggled to meet debt obligations, resulting in inflationary pressures and a loss of confidence in the economy. By the early 1980s, Brazil was caught in a debt crisis that would shape its economic trajectory for the next decade, with long-lasting social and economic consequences.

The inflationary crisis of the 1970s, driven by geopolitical conflicts, energy market shifts, and monetary policies, had far-reaching consequences for both developed and developing nations. Authors such as John Kenneth Galbraith, in The Age of Uncertainty, argue that the events of this period exposed the vulnerabilities of global economic interdependence. The inflationary shocks reshaped economic policies worldwide, forcing central banks to adopt more aggressive measures to control inflation, while countries like Israel and Brazil struggled to cope with the long-term consequences of capital flight and stagnating growth. The lessons of the 1970s continue to inform contemporary debates on inflation management and global economic stability.