Someone reading the last post, who had lived through the shock of 1979, asked me in person whether the fact that oil prices were nearing the all-time high real price of that era was as damaging a phenomenon as it was then.  Essentially, this person believes that somehow the same real price then, in the effects it had on the overall economy, was worst then than it is now.

Well, they have a point and it's worth explaining why things were worse then.  First of all, the change in prevailing economic conditions took almost everyone by complete surprise and the substantial economic adjustments that had to take place in a very short time were extremely painful.  The price went from $15 to $40 (1979 dollars) in little more than a year at almost 8% a month - practically overnight in the oil world, and no one was sure where it would stop.  Our adjustment was undoubtedly more expected and gradual.

But another good way to analyze the question is to ask how much of our economy depends on oil.  Assuming the US will continue to consume an amount of petroleum product similar to present levels at prices around $90/barrel, we would spend about $675 Billion on oil.  If our GDP is about $13.75 Trillion, that comes to about 4.9% of our economy - double what it was only 8 years ago!

In January of 1979, prices were $15/barrel, consumption was 20.5Mbpd and the GDP was $2.46 Trillion and so oil constituted 12.5% of the economy.  By January 1983, when prices had stabilized at around $31/barrel and consumption hovered about 35% lower at around 15Mbpd, petroleum product expenditures were over $450 Billion out of a GDP of "only" $3.38 Trillion or about 14% of the economy - in the same ballpark.

So, that's the difference - the ratio of oil expenditure to the overall economy.  Thirty years ago, the oil sector constituted nearly a sixth of the entire economy and continued to do so even after the shock.  The elasticity of oil demand was about -0.13.  Pretty inelastic but movable.  By January of 1999 the share of the pie had fallen to one fortieth - only 2.5%, and the elasticity was indistinguishable from zero! That's a profoundly less oil sensitive economy which is more able to absorb a six-fold increase in oil price, and a doubling in oil-intensity, without any apparent effect on consumption.

So the obvious question is how high would oil have to go up to return us to "an elastic domain" where consumers start responding to (instead of merely complaining about) changes in prices?  If the early 80's are any indication, I would wager a guess that oil would have to constitute at least a tenth of the economy to have that kind of effect, which would allow for $200/barrel oil ($6/gallon gas) and an additional increase of 125% over today's high prices.

I'll step out on a limb here and suggest that the oil pundits will start to claim $150 or $200 barrel oil as "the new alarmism".  But if the globe has sustained a six-fold rise in price in eight years without the slightest indication that it is demanding a drop less oil, why in the world would one not suspect that there if plenty more inflation yet to come?