$119 Oil Won't Stop Economic Growth

The bears said the housing collapse would throw the country into recession. They said the credit crisis would throw the whole world into recession. And now, seeing that oil is the global economy's single most important strategic commodity, the bears are arguing that today's prices just have to mean a global depression.

But a funny thing happened on the way to the end of the world.

While oil has surged to all-time highs over the last month, world stock markets have surged as well. Even sectors that are sensitive to energy prices have done great. In fact, the most sensitive of all, the transportation sector, made all-time highs last week. If a depression is coming, someone forgot to tell these markets.

Or maybe oil prices don't quite work the way the bears think they do.

Most people think of the price of oil as an external force acting on the economy as though it had a will of its own. If the oil price goes up (for whatever reason), that's bad because it raises the cost of doing business and the cost of living. If the oil price goes down (for whatever reason), that's good because it lowers those same costs.

Sometimes oil does have that kind of effect. On those rare occasions when there is an unpredictable supply interruption — as during the Arab embargo of the 1970s or the Gulf War of the 1990s — the price shoots up and it's very bad news for energy consumers. But that's the exception, not the rule.

Mostly oil behaves like any other good in the economy. It is subject to all the same laws of supply and demand. When economic growth supports more demand for oil, that demand drives up the price. At some point, the price gets high enough so that further demand is discouraged.

That means that when the price of oil rises to $119, it's because we want it, and can afford it, at that price. If we didn't, then it wouldn't trade at that price in the first place.

So high oil prices don't kill growth. In fact, they are the result of growth.

Let's look at what's happened over the last five years, from 2002 to 2007. During that period, the price of gasoline almost tripled. But at the same time, gross domestic product grew by almost 33%.

In fact, even gasoline consumption itself grew, too, despite the tripling of price. Over those five years, per capita gasoline usage grew almost 4%.

Why? Because oil prices are the result of growth. During those five years, per capita disposable personal income grew by more than 25%. Gasoline prices went up, and we bought more of the stuff, not less — because we wanted it, and we could afford it.

Now perhaps you're saying, well, it's not just oil and gasoline. Prices of energy in all forms have been soaring.

So let's look at things a little more broadly. In 2002, the average American spent $1,200 a year on energy goods and services of all kinds, according to the Bureau of Economic Analysis. By the end of 2007, that had risen to $2,100 — an increase of a whopping 73%. But still, that's just $900. And over the same period, average disposable income rose from $27,200 a year to $34,100. That's a smaller percentage gain, of about 25%. But it's $6,900 — which means $6,000 left over after you've paid the higher cost of energy.

Perhaps you're thinking that the real issue here is not economic growth driving the oil price higher, but the fact that the world is running out.