When the first OPEC oil shock hit in the 1970s, President Nixon responded by lowering the national speed limit to 55 miles per hour in a bid to conserve energy. But speed limits aren’t the only thing that can change when oil prices go up. Right now, we’re seeing that rising crude prices can influence much more than just how fast you can drive your car. High oil prices change the speed at which your economy can grow.
Just as people require food, economies require energy. The relationship is straightforward: economic growth is a function of energy consumption. With national economies around the world once again forced to pay more than $100 for every barrel of oil consumed, a critical question must be asked—what happens when the world’s most important source of energy becomes unaffordable?
A glance at the latest GDP numbers is already telling us the answer. Economic growth has downshifted into a much lower gear nearly everywhere you look. Europe is struggling to keep its head above water, North America is stagnating and even the hard-charging economies of the BRIC nations are starting to groan under the weight of high energy prices.
When the price of oil goes up, something has to give. Right now, the European Monetary Union looks to be the most imminent casualty. How much longer will Greece slavishly heed the demands of its creditors and impose punishing austerity measures with the only result being the continuing implosion of its economy? Will Spain be able to tighten its belt any further when a quarter of its labor force is already unemployed? The answers seem obvious. Without economic growth, neither country can service its debt. And growth just isn’t in the cards. The ground beneath the European Monetary Union has never been shakier. And as the Euro trembles, the stage is being set for a return of the drachma, escudo, peseta, Irish pound, and lira.
When we look across the Pacific we see that even China and India, the global economy’s principal engines of growth, can’t escape the toll exacted by high energy prices. When policy makers in Beijing tried to sustain double-digit economic growth, food and energy inflation quickly slammed on the brakes. The economies of China and India will soon struggle to grow at half the torrid pace of recent years. When that happens, the rest of the world will need to pay attention.
In a world where distance costs money, China will increasingly look to its own 1.3 billion consumers to drive economic growth. If China decides to focus on tapping the potential of its huge domestic market, rather than supplying cheap goods to faraway Wal-Marts, the economic balance of power will tilt decidedly eastward. What happens if the People’s Bank of China then decides that buying US treasuries is no longer a necessity? US taxpayers, for one, don’t want to find out. They’ll be left footing the bill for Washington’s budget deficit—currently at one and a quarter trillion.
In a world of triple-digit oil prices, the global economy will be very different from the one we’ve known. But that may not be such a bad thing. You can check out what a static economy looks like in my new book “The End of Growth”. You may be surprised what you find.