Markets love to worry about new developments, and the recent plunge in crude oil prices is a case in point. With the exception of oil producers and related industries, a big drop in oil prices is great news for everyone.
Think of oil prices as a tax on GDP, since it takes energy to run an economy. If you tax something less, you should expect to see more of it. Cheaper energy prices should be a boon to the majority of economies around the world since we should see stronger growth. Who cares if a plunge in oil prices leads to deflation? Central banks should not be concerned (controlling oil prices is NOT part of their mandate), and consumers should be rejoicing. Spending less money on energy leaves more money to spend on something else.
The chart above shows inflation-adjusted oil prices. One thing should stand out: every recession since the early 1970s has been accompanied by a significant rise in the real cost of oil. Recoveries have generally been accompanied by a lower real cost of oil. This business cycle is no different than the rest in that sense. Cheaper oil doesn't threaten a recession, it bolsters the case for continued growth.
If gold prices of $1200/oz. are reasonable, then the chart above says that oil prices around $65/barrel are also reasonable. The ratio of gold to oil prices today is right around its long-term average; oil is neither expensive nor cheap. There's nothing scary going on here. Oil prices are coming back into line with other prices.
For most of the past several years, oil prices have been very expensive, both in nominal and in real terms. Now they are more reasonable. This is good, it's not something to worry about. Expensive oil fueled the development of new fracking technologies, and that in turn led to a significant expansion of oil supply. Oil supply now exceeds oil demand, so prices have declined, and we are likely to see less intensive efforts to expand oil production going forward. This is as it should be. Prices work to equilibrate supply and demand.
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