Combine beef, onion, egg, breadcrumbs, milk, salt, and pepper, mixing well. Shape mixture into 1-inch meatballs. Brown in oil in a large skillet over medium heat. Remove meatballs from skillet, and drain on paper towels. Reserve pan drippings in skillet.
Add flour to pan drippings, stirring until smooth. Cook 1 minute, stirring constantly. Gradually add water; cook over medium heat, stirring constantly, until thickened and bubbly. Stir in salt and pepper to taste. Add meatballs to gravy. Cover and simmer 30 minutes.