Tag Archives: Jeremy Grantham
Part 2 of the excellent interview that Leo Hickman completed with Jeremy Grantham: the co-founder of investment group GMO on what books he’s reading and why he wants to fund ‘avant garde’ farming.
It started [in the mid-1990s] with a visit to the Amazon and to Borneo with the kids. And without thinking about it you start talking about the logs along the side of the river and the lack of mature forests in Borneo. We were on family trips and happened to do a couple of tropical forests back to back. I’m sure that played a role, but we didn’t treat it as an epiphany. I would argue that one of our children got there first. While we were environmentalists, but low key, one of my sons happened to get a job which saw him end up in a dry tropical forest in Paraguay for five years and then off into the forestry business. Shortly behind that, we [his investment company GMO] began to follow that interest in forestry. We started our own forestry operation 15 years ago [at GMO] because our interest in forestry and of our realisation that land is so important. Forests were mispriced and were an attractive investment. My interest in forestry at that point was entirely commercial and then it began to morph into a decent investment, plus, “look how important these forests are to maintain fresh water, carbon sequestration, etc”…
I picked up none of that [James Hansen’s 1988 testimony before Congress on climate change and the 1992 Rio Earth Summit]. No. Absolutely not. I was following along afterwards [once the foundation launched in 1997] asking the big NGOs where was the leverage for the birds flying through Costa Rica and Panama. Let’s put our money there. Where were the hotspots? The climate question wasn’t there for me at that time. Now it is at least half of the focus for the foundation. And in the other half it brushes up against climate all the time. We are late arrivals to all this and I have nothing but admirations to those who beat me to the punch by a few decades.
I was a moderate environmentalist 10-15 years ago. But then I started to get embroiled in resources and that [the rise in price of] oil was the first paradigm shift that we’d ever come across in an important asset class, and nothing is more important than oil. I realised that the price of oil had changed forever and is not going back to the old $15 a barrel. There had been a majorly important shift. That led us to asking the question, why only oil? Why not every finite resource? And so we ended up about four years ago saying, “watch out, we seem to be running out of things”. Two years ago, we did a very detailed paper which took on a life of its own and helped to put these issues onto institutional agenda items, I think. That led me to the realisation, by looking at the data, that between population growth and China gobbling up the world that the world had changed – and dangerously so – and hidden under that that oil and food were the two most dangerous components and within that [the availability of] phosphorous was perhaps the most dangerous long-term issue of all. Digging into the phosphate problem, you realised that it can be handled, but only if the great majority of the world is fed via sustainable farming which means nurturing the soil and having it once again full of micro-organisms. If you kill them every year with herbicides and pesticides then you’re dealing basically with sand. You’ve got to restore and renew the ability to grow by re-applying all the nutrients in very big, expensive doses every year. This is in contrast to well-nurtured soil. There’s a 30-year patch in Pennsylvania at the Rodale Institutewhere they’ve never put on any phosphorous at all and they are getting productivity equal to regular farming up the road.
We arrived at all this just by looking at the numbers and the more I did the more I became concerned that we were already deep into a food crisis. Arab Spring countries were already getting throttled a bit by rising price of energy and food. They don’t spend 8-10% of their budget on these, they spend 40%. So when that starts to double on you, you can see how quickly why people take to the streets. And that’s where we are. The rich countries are really not that concerned and their casual behaviour is only serving to push up the price which is not that big a deal to them, certainly not the movers and shakers who make all the money. But it’s a terrible deal for the poor half of the world and a disaster for the poorest 10% or so. That’s the world we’re in and it could lead to country after country being destabilised.
It has forced me to go back and read all the classics. On my iPad I think I have 40 or so books now. I recommend a book by a scholar who summarises all these works back to Gibbon’s Decline and Fall of the Roman Empire. It’s called Immoderate Greatness: Why Civilisations Fail by William Ophuls. And then there’s perhaps my favourite book of a more detailed type which is called Dirt: The Erosion of Civilisation [by David R Montgomery]. That’s a really good read. Then there’s Collapse by Jared Diamond, which seems to have done quite well and is reasonable. A lot of details are queried by the experts in the field, but I thought it was fine. Then there are books on peak oil and shortages of raw materials. Books on the whole package of long-term growth on a finite planet, going back to the Limits to Growth and a book by one of the co-authors that looks at the next 40 years. That’s called 2052 [by Jorgen Randers]. And so on and so forth.
Capitalism does millions of things better than the alternatives. It balances supply and demand in an elegant way that central planning has never come close to. However, it is totally ill-equipped to deal with a small handful of issues. Unfortunately, today, they are the issues that are absolutely central to our long-term wellbeing and even survival. It doesn’t think long-term very well because of high discount rate structure. If you’re a typical corporation anything lying out 30 years literally doesn’t matter. Or, as I like to say: QED, your grandchildren have no value. And they usually act as if that was true, even though I’m sure they are actually very kind to their grandchildren.
My favourite story is about the contract between the farmer and the devil. The devil says, “sign this contract and I’ll triple your farm’s profits”. But there are 25 footnotes, as there always is with the devil. Footnote 22 says that 1% of your soil will be eroded each year, which is actually horrifyingly close to the real average over the past 50 years. The farmer signs and makes a fortune on a 40-year contract. And his son then signs up for the next 40-year contract and makes a fortune. And his son then signs up for the third and final contract. He still does very well, and in the final 20 years the family has accumulated enormous wealth, but the soil has gone. It’s the same story for all his neighbouring farms and everyone is out of business. My sick joke is that at least he will die a rich farmer when all the starving hordes arrive from the city.
Every graduate who took Econ 101 would probably sign that contract. There is no single theory that is used in economics that considers the finite nature of resources. It’s shocking. But not as shocking as the pathetic waste of space over the last 50 years given to “rational expectations“, which allows a whole generation of bankers and central bankers to believe that the market is efficient. None of it applies to the real world, or to messy human beings, many of whom are a little crooked when they have to be. It’s been a disaster and a complete waste of time. It has been remarked before that modern economics is belief in a perpetual motion machine. Capital and labour, but no mention of energy. Without energy the whole thing grinds to a halt and the whole theory is demonstrated to be totally false. I’m late in the game at recognising this. One of my new heroes is an economist called Kenneth Boulding who, at 22, got a paper into Keynes‘s journal. At the age of about 50 he realised that economics was not taking its job seriously, that it was not interested in utility, in real serious improvement in the world, but that it was increasingly interested in new, elegant mathematical theories designed to get career advancement, over usefulness. He said the only people who believe you can have compound growth in a finite world are either mad men or economists. He also said: “Mathematics has brought rigor to economics. Unfortunately, it also brought mortis.”
The first point is that each fund we have at GMO – maybe 80 or so – is run by its own team. I don’t think that money management can easily have too many rules coming down from the top. Our first responsibility is to make money for our clients. I’m happy to write them letters trying to persuade them to do this, that and the other, but if they choose not to, that is their choice, not ours. We should just be a conduit for the client’s decision on ethics. They will usually sign up for a strategy for which quite a lot of institutions have the same portfolio. My job as the quarterly-letter writer is to try and influence the game a bit, but it has to be done in a firm like ours at the top level. The solitary factor that might appear to be an exception is that we are getting close to the decision [at GMO] not to carry coal stocks and anything that has a material amount of tarsands. We have a resource fund which, of course, has stuff in the ground. It owns oil and gas companies, but it does not own coal companies or tarsands enterprises. I have written in Fortune magazine that those extreme, dangerous, carbon-intensive and polluting resources run the very substantial risk of being stranded assets because, on one hand, I think the progress of solar and wind is moving faster than most investors realise and, on the other, I expect the continuous rise in the price of hydrocarbons as we continue to move through the cheap stuff and move on to the more expensive stuff in terms of getting it out of the ground. And I don’t think that if you put billions of dollars into a new tarsands project that you will see a decent return on it. It will be underpriced by solar, wind and other alternatives which are moving at considerable speed. And point two is they will slap a carbon tax on coal and tarsands which increasingly countries here and there will do – and, eventually, the US in the hopefully not-too-distant future – and that will be a death blow. If all this doesn’t make these investments unprofitable, they will be very lucky. The probability of them running into trouble is too high for me to take that risk as an investor. If you look at the damage and you adopt a practical triage attitude, what you realise quickly is that every barrel of good, old-fashioned, relatively cheap oil will be pumped, as will every cubic foot of old-fashioned, low-cost natural gas. The real damage to the environment is the massive reserves of coal and tarsands, and elaborate, high-cost secondary/tertiary recovery of oil and gas. That’s where the battle will be fought out and, frankly, that’s going to turn out to be 60%-70% of the potential damage to the planet and we, with a bit of luck, can adjust to a world that uses up its conventional oil and gas if we behave well and drag that period out into the distant future. A lot of it will be used as chemical feedstock which is a higher and better use than using those precious resources as a fuel. Fracking enters the grey area. It’s not old-fashioned natural gas that desires to burst to the top under its own free will. You have to torture it out of solid rock and that takes extra energy and extra pollution, and so on. That’s why it is a grey-area fuel and that runs some risk of eventually becoming too high cost…
The [Grantham] foundation can invest in anything it wants. It would be nice to make lots of money [for the foundation]. I believe there are certain forms of sustainable farming that will indeed perform well in the stock market and as an investment. This is not the money that we give out as grants each year. This is the principle behind it. So it’s good to have some influence on both ends. [At GMO] we don’t aim to have more than 10-15% in farms and forestry. The funds we run for clients are, to a certain degree, neutral on ethical issues. If there is a demand from the client – which I hope there will be – to have more green and sustainable funds, I hope GMO will do it one day. But in the meantime, with my foundation, I am the client, so it is entirely my right to set our own ethical standards. For the record, for the foundation I also approve the purchase of oil companies. I just won’t buy coal and tarsands, for the reasons I’ve given. I reserve the right at a later date to say that one or two oil companies are simply too badly behaved. I haven’t done that yet, partly because I don’t have the required information.
It also involves different interpretations of effectiveness and propaganda. I have an honest disagreement with Bill McKibben. Our foundation helps fund his efforts and I have great admiration for him. But I have argued with him that there’s probably more juice to be had by going to the campuses and getting the students to stamp their feet that the college endowment should get rid of all their coal and tarsands investments because they can do that.
For the record, we need oil. If we took oil away tomorrow, civilisation ends. We all starve. It’s a little impractical and idealistic [to abandon oil immediately], perhaps. Now I understand there are other big issues, such as what does it take to concentrate the mind of a student and get them enthusiastic. In the long run, the carbon equation that Bill McKibben has gloriously helped to popularise in Rolling Stone is in front of everyone’s nose. We’ve got five times the amount of carbon reserves to cook our goose. The question is what can we get away with and what sends the biggest signal. My thinking is that, if we could get dozens and dozens of colleges and foundations to sign up to getting rid of coal and tarsands, we’re attacking something that is doable at the portfolio level – the college is not going to feel that is a tremendous encumbrance for them to optimise their return – but it represents 60-70% of the whole climate problem. By my reckoning, it’s a very focused and efficient strategy. And when everything has been disposed of and there’s a groupthink on the issue it’s a very powerful statement to send rattling round the world. Coal and tarsands are not even 1% of a typical portfolio. Oil and gas, as one of the biggest industries out there, is huge, but coal and tarsands is negligible. Far better to nail that and send a very powerful signal. And why wouldn’t the colleges sign up because it’s very good business. I love the idea when you have an environmental argument backed by a good economic argument. I would like to concentrate my efforts in those areas. I understand the principle entirely of not interfering [with a fund manager’s decision-making], but I wouldn’t dream of doing that unless I believed the pay-off was very large and the penalty for doing nothing was very high. I think there is a wonderful case for a prestigious, leading university to have their endowment officially to take into account the long-term effect on the environment – not blanket forbidding this, that and the other, but just taken into account in a sensible way.
There are other advantages, too. Rather like the corporations who have become quite green and project that image, the people who have signed up for a job have broadened a bit and as they build that image it has become a commercial advantage. It might be that only 10-20% of the graduating population of the top students are interested in the long-term wellbeing of the planet, but it’s a measurable number and it’s getting bigger and it’s enough to be commercially interesting. If you are losing 20% of the brightest students because you have an undesirable image then you had better start to change it. This is one of the soft underbellies of the capitalist system and it’s one way that they are impacted by, let’s call it, good behaviour and sustainability in the broadest sense. It would also apply to students applying for college.
My view of food leads me to believe that a spectacular investment is in farm land and in forestry. Or, if you prefer it, land. They don’t make any more of it, as they say. Fifteen years ago we started a forestry division [at GMO] because I had fallen in love with land and trees and because I realised it was a mispriced asset class. We have done extremely well in that sector outperforming the benchmark for 15 years. I think farm land is a terrific investment area. But that doesn’t mean that some mid-western land isn’t ahead of itself because of recent grain prices. It’s a very inefficient asset class and every farm is different, but you can hunt around the edge, and outside America, and you can find a decent return in an equity market that is becoming, in the US at least, rather overpriced. If you were to buy a farm, and I would be urging any buyer to think in terms of the sustainability of the farming technique, but here again our farming portfolio is relatively green but it’s not by any means limiting itself to sustainable or organic farming. My foundation, on the other hand, is at the early stages of what I hope to be a long and interesting experiment of investing in this kind of more avant garde sustainable farming. As we discover useful information and potentially profitably information we will pass it on to our GMO unit for the clients’ benefit.
We’ve recently become very aware of the fact that as our knowledge base accumulates so rapidly, our learning curve is so steep, that the point of maximum sensitivity is shifting so we are quite grateful that we can’t commit all our resources on one project. Now we’re beginning to think, perhaps, we should cool it for a year or two, because our learning curve is so steep, and wait to see. But if I had a magic wand it would be energy storage. Secondly, alternative energy, in general. And, perhaps, co-equally, farming and looking ahead to the next problem of how do we move the world to sustainable farming.
We could go to a couple of leading farm research universities and ask what does it take to beef up the programme and to train organic farmers and to publicise it so that every young man or woman with an urge to think about this can go and get a good training. They don’t really exist, by the way. The three people on the planet who do exist might write in and protest, but it’s insignificant, a rounding error compared to the training in “Big Ag”. One could have quite an effect, such is the small base. Research into organic farming – there’s been fairly minimal research into the intermediate crops that you can put on between the cash crops. They flower two weeks too late, or early, to be convenient.
One of things we tried to do last year, but failed because we couldn’t buy a farm, was to scale up the efforts of the very best organic system which had only taken place on very small plots. We were going to buy enough land to offer a project where they would have 350 acres each, maybe three of them, and would have three years to work out which system was best. We wanted to see how close to Big Ag you could get in productivity. In half-acre lots they can get to parity. Could you do that with 350 acres? And they used far less of the expensive in-puts and increasingly less as the years go by. And as the price of fertiliser and fuel rises that becomes more and more commercial, so it will be pushing in favour of sustainable farming and it will continue to push until its fully commercial. But in the meantime, it would be nice to save 5-10 years along that road by doing trials. We would like to be able to start doing a few things like that that will save a few years when it matters…
We’re moving quite fast on various types of highly improved organic farming, upgrades to land, sequestered carbon, doubling of cattle capabilities, re-considering marginal land that had been degraded. It might not fall with organic certification standards, but it takes those principles and concentrates on developing sustainable methods of food production…
We [at the foundation] also want to project the argument for sensible behaviour in a world where the news media is full of anti-science nonsense. Heartbreakingly, the Guardian is an island amid remarkably bad British coverage of the environment, much worse, on average, than in the US. The newspaper industry [in the UK] has covered itself in shit when it comes to environmental reporting, except the Guardian. The TV is much worse in America than the UK, though. An accident of history.
I can tell you where I stand today [on GM crops] and I will have to tell you again next year. That’s part of the reason why we want to do these trials to find out exactly what you can do in terms of sustainability and simultaneously ask the question of what are the compromises. How much would it hurt your productivity and cost structure to move to a more hybrid version of organic? Is it a bargain given that pure organic gets a big premium? It may well be that hybrid form of farming may give you the best output per unit of sustainability, but the most money per unit may well come from total organic following the rule book and picking up a 50% premium for your product…
We have a 50% surplus of food, as we speak. We have tons of waste and a decent amount of land and huge areas which can be increased in efficiency by going organic in, say, Africa. If hypothetically someone said to you we all must change to organic across the board, you wave your wand and everyone does it, your productivity drops by 18%. We can absorb that today. By if we wait 30-40 years and have an 18% hit they all starve.
Fiscal and monetary policies are extraordinarily difficult at the moment. The history is not clear as to what works. The theory is even less clear. My guess is that you want to be careful about how quickly you tighten the austerity screws and that the more austerity-orientated approaches look to me more dangerous and seem to be delivering greater pain on the economy. Eventually, you have to address the question of debt, but I’m on the record as saying that I think the world in general exaggerates the significance of debt. That isn’t to say it’s insignificant, but what it is to say is that it’s a paper world and it takes our attention away from the real world of the quality of education and training and the quality and quantity of capital investment and legal structure. We don’t build things on paper and yet we’ve begun to talk as if we do. People say that the Chinese have built all their railroads on debt, to which I say, “no, they haven’t”. They’ve built them with real Chinese people and real cement and real steel that are part of the real world. When you run out of people and capital capacity then you can’t increase any more. America conducted the world’s greatest experiment in debt. It tripled the debt-to-GDP level from 1982, where it was 1.25x GDP, up to 3.5x over the next 30 years. And during this time what effect did this have on the long-term growth of the system? And that’s the only reason they do it, just to get more growth? Everyone says that, of course, the financial burst caused devastation and brought us to our knees. Yes, it was a terrible idea and eminently avoidable, but if you look at the breaking of the housing bubble in America and you realise how many trillions of dollars would evaporate if it went back to the trend line of the ratio of house price to family income, you must realise that people are going to feel devastatingly poorer than they were. They still have the same house, but, in perception terms, they thought they had a pension fund stored up in their house and it went away. They feel poor and they are going to spend less and it will be a drag on the economy. It was a well-behaved bubble. It went extraordinarily high then all the way back in three years to trend line, and slightly below, and is now moving back up to trend. It was a huge hit to the economy and guaranteed the recovery would be slow. And if that was not enough there was a second factor – the price of oil quadrupled and the price of other assets, such as metals and food, tripled from 2002-2008. Every time that had happened before, like 1974 and 1979 in the two oil crisis, it was followed by global recession. That alone should have been enough to cause a recession. Add that to the housing bust and you don’t need to create any space to explain why we had a recession and a slow recovery. I remain open to persuasion that debt is that big a deal. We have had it foisted upon us that the general idea that finance is so incredibly important that, if a corner bank goes bust, the whole of civilisation grinds to a halt. It’s enormously helpful to the banking system to have believed such nonsense, but I think that’s what it is.
Whether we have the nous to pull it off is an interesting question, but I think the odds are we will scrape through. Not that we deserve to. [Laughs]. It’s a 50/50 shot that declining fertility rates and alternative energy will save our bacon. But nature and development don’t run on a puritan basis of just punishment. It’s often sheer luck. It’s sheer luck we found hydrocarbons. It’s sheer bad luck that carbon dioxide has a greenhouse effect. It’s sheer bad luck that the oil industry has incredible vested power and is prepared to use it to delay the speed of our reaction…
It isn’t that we can’t do it, it’s that the Anglo-Saxon countries – where, by the way, there is a vast concentration of oil companies – are rather intractable on this issue and they’ve managed to find a little army of non-scientific, persuasive “loony lords”, as I call them, to argue the case, either because they like being wined and dined by the enemy, or because they’re naturally contrarian and like the publicity, or that they are genuine idiots. Who knows? I’m always puzzled by the modus of these people.
What we forget at the end of all this is Pascal’s Wager. What is the penalty for acting as if this was really serious? You spend some money and end up with wonderfully cheap alternative energy? Big deal. Or you continue acting as if it’s trivial and keep listening to the loony lords and doing nothing and having it cripple the planet as we know it? If the potential threat is big enough – like insuring your house, it’s a necessary payment even though you don’t expect the house the burn down – any sensible person who understands Pascal’s Wager will agree to that. It’s simply asymmetrical. The downside risk of this getting out of control is massive. The penalty for spending more money than you should have done because as it turns out, for scientific reasons, we have completed messed up and it’s not as bad as we thought, are very modest in cost by comparison. That’s the killer argument for any rational person, but, as we know, this is not about rationality. It’s about our unwillingness to process unpleasant information. And the unwillingness of vested interests to stop funding this damn stuff.
The Manhattan Project was brilliant and is the highpoint of our achievements as a species. Anyone who says government can’t do this, or can’t do that, I say a pox on you, have a look at the Manhattan Project. They did remarkable things. They were outside the box. They stuck the brightest minds out in the desert. They were herding cats with great egos, but it worked. Amazing effort. If we did that on alternative energy we are home free. Even half that. It was our best-ever response to a problem. Civilisations have fallen for the lack of something like that. For once, we came up with the right response, but you can’t count on that being our natural reflex as a species. If it was, we would have analysed the problem of climate change and energy, and decided it was a bigger threat than Hitler. But we didn’t get a Pearl Harbour or invasion of Poland. We’re not programmed to respond to vague, problematical – you can’t put a precise number on it – and the long term. That is not our strength. We’re much better when the tiger attacks and the bombs drop. [Superstorm] Sandy was probably the closest thing we’ve had [in the US] to a Pearl Harbour moment in terms of moving public opinion of whether climate change is real.
‘The world’s most powerful environmentalist’ on battling the ‘misinformation machine’ and why China is his ‘secret weapon’
Leo Hickman: ”As I have done for my interviews with the likes of Al Gore, Bill McKibben and James Lovelock (in 2010 and 2012), I have taken the time to transcribe the full interview so readers can see what Grantham said in the kind of detail that the print edition of the Guardian can’t provide. The interview lasted three hours, so I have split the transcript in two. I will publish part two tomorrow, but here’s part one…”
It’s data driven. We [the Grantham Foundation for the Protection of the Environment] were gracefully moving into the environment, save these animals and habitats, and all these good things, then the data on resources – starting about four years ago – made me realise that some of these were really urgent. That we were already entering a foodcrisis, for example. This time last year I thought it was clear from the data that we were already five years into a food crisis and it is highly unlikely to go away. And unless we get our act together it is likely to become a cascading problem.
We’re already in a bad place. We’re on a sliding scale. The language “it’s too late” is very unsuitable for most environmental issues. It’s too late for the dodo and for people who’ve starved to death already, but it’s not too late to prevent an even bigger crisis. The sooner we act on the environment, the better. The sooner we cut off the carbon dioxide going into the air, etc. The worse accidents we will prevent from happening are 20, 30, 40 years from now. The same applies to food. The faster we act to improve the situation, the fewer Africans – North Africans, in particular – will come to grief. What is happening through the market mechanism is that the rich countries, by being unnecessarily sloppy – and by the Chinese getting richer in a real hurry and eating more meat – we are pricing up grain so that the poor are getting hungry. It’s hard to see this stopping in the immediate future. It’s also very hard to see the poor and hungry getting richer at the same speed as the way we are driving up the price of grain.
There is a stretching disparity between the haves and have nots. It’s not the win-win of globalisation that we all grew up with studying in Econ 101. The irony is that as China gets richer, it burns more coal. They put pressure on the global environment and on global grain prices. So in order to give them a nice middle class, variegated diet, they could cause poorer Asians and Africans to starve. There is no mechanism to prevent that. Egypt runs a trade deficit. Their population is programmed to grow dramatically. Three million at the time of Napoleon. Eighty-three million, said their standard when they marched into the Olympic Games last year. And they’re on their way to 140m. They’ve always been very efficient, but they can’t feed much more than half their people. The price of grain from about 2002-2008 – a tiny window – tripled. Why did it grow so sharply? We knew population was growing, but it was growing steadily, if dramatically. When I was born there were two billion, now there are seven billion. It’s the kind of curve than anyone in finance would look at and jump nervously, when you see an exponential curve like that. That’s one factor, but nothing particular to the period of 2002-2008…
…2002 was a nothing year. The only numbers I was paying attention to in 2002 was for oil. A little wheel was turning at the back of my brain that noted that oil was beginning to act differently. Our firm specialises in the study of investment bubbles. We have the best data. Over the years, we have put together a database that has 330 bubbles of which about 40 are really important ones. What we found about the important bubbles is that every single one had burst completely back to the original trend. Three years up to something triple, and then three years down. They actually tend to go down a little more quickly than they went up, which is surprising. But they always broke. I used to specialise in asking financial audiences to give me an example of the paradigm shift, a major shift in a major financial asset class. And never was one offered. Six years ago I wrote about the paradigm shift in the New York Times. It had 100 years of oil prices – very volatile, but a very central, steady trend line of about 16 dollars a barrel in today’s currency. But then around OPEC in 1972/3, the price trend leaps up to $36.
I find the parallels between how some investors refuse to recognise the trends and our reaction to some of our environmental challenges very powerful. There is an unwillingness to process unpleasant data. In a bull market you want to believe good news. You don’t want to hear that the market is going to go off a cliff. You don’t want to listen to the climate people who are telling you it is getting worse and even worse unless you do this and that. You want to listen to the good news. There were always people willing to tell you that smoking was OK and that stuff about cancer was exaggerated. There’s a professor at MIT who defended tobacco who now defends carbon dioxide saying it seems to have lost its greenhouse effect, or whatever. And then there are the vested interests. They are the single most powerful force because you are dealing with an audience who wants to hear good news and into the stock market come all the bullish stock market giant firms telling you everything’s fine because they love bull markets because they make a fortune. They don’t even mind crashes because they don’t do so badly there either. What they would die at is if the market went up at its long-term trend line at 1.8%, plus inflation, a year. But we’re not going back to 2% growth. Maybe we’ll do 1% and it will be reported as 1.5% and once again people don’t want to hear that. They want to hear Ben Bernanke‘s news that it should return to 3%…
Me calling bubbles correctly is all data driven and based on the optimism that is built into humans. Every time we see a bubble, we see an army of people screaming, “No, no, it’s not a bubble, everything is fine.” We see the climate and scores of people screaming the same that everything is fine, or that it’s a plot. It’s par for the course. The general public don’t want to hear it and will choose to listen to the optimistic interpretation. It’s a real uphill struggle. You don’t stop the bubble really until the damage is done. It goes so high that it can’t sustain itself and just pops. And maybe that will happen here and our job is to try to do a better job than we did in the tech bubble.
The misinformation machine is brilliant. As a propagandist myself [he has previously described himself as GMO’s “chief of propaganda” in reference to his official title of “chief investment strategist”], I have nothing but admiration for their propaganda. [Laughs.] But the difference is that we have the facts behind our propaganda. They’re in the “screaming loudly” rather than the “fact based” part of the exercise, because they don’t have the facts. They are masters at manufacturing doubt. What I have noticed on the blogs and in the comments section under articles is that over several years, as the scientific evidence for climate change gets stronger, the tone of the sceptics is getting shriller and more vicious and nastier all the time. The equivalent on the other side is a weary resignation, sorrow and frustration and amazement that people on the other side can’t look at the facts. The sceptics are getting angrier and more vicious every year despite the more storms we have, and the more mad crazy weather we have…
One of the problems is that typically you are not dealing with the facts. Putting in more facts makes the sceptics more angry. They have profound beliefs – as opposed to knowledge – that they are willing to protect by all manner of psychological tricks. So you have people who are very smart – even great analysts and hedge fund managers – who on paper know that their argument is wrong, but who promote it fiercely because they are libertarians. Libertarians believe that any government interference is bad. Anyone with a brain knows that climate change needs governmental leadership and they can smell this is bad news for their philosophy. Their ideology is so strongly held that remarkably it’s overcoming the facts. They are using incredible ingenuity to steer their way around facts that they do not choose to accept philosophically. Laying down more facts just makes them more angry. You may win over a few neutrals. They are the people you can win over. But it’s very hard to win over the hardcore sceptics, of which there are plenty.
We can try to bypass them on one level and we try to contest the political power of the sceptics. They are using money as well as propaganda to influence the politicians, particularly in America. It almost doesn’t even exist in countries outside the US, UK and Australia. A cynic would say that the petrol-chemical industry also happens to be Anglo-Saxon. Where are the great oil companies based? They still have great power. The oil companies seem to have pulled back from directly supporting climate sceptics over the past few years because – in England, in particular – they were embarrassed and it became untenable to be so obvious. But they’re still influential. You don’t have go via back-channels any more, courtesy of the US Supreme Court, because it is completely legal for a corporation to invest tons of money in advertising programmes to say who is good and who is bad in a race for the Senate without even asking permission from the people who actually own the company. Corporations are treated as human beings and money is treated as having the right to speak. There’s dark money and light money. The anonymity they adopt is legal. They don’t have to say who their donors are. It is quite remarkable. And then you get the Something Something for the Environment, which are actually just sceptics funded by the bad guys. And then there are the thinktanks who have become propaganda-tanks. I used to respect the Cato Institute when it came out with reports on this, that and the other, and they have received a lot of hydrocarbon funding. But when the University of East Anglia break-in was engineered they had something like 20 press conferences the following month. The response to the break-in was almost immediate and co-ordinated. I don’t think it was suspiciously rapid, but I do think it was unusually and unexpectedly rapid. It’s very likely that it was simply a terrific response of their behalf. They moved very fast. The good guys are learning slowly, but surely, to step up their response time…
If you’re saying something that people don’t want to hear or accept, a significant proportion of them will reply with hostility. Not because they know the facts, or because they have researched it themselves, but because they’re so psychologically involved in believing good news that they will oppose it with a reflex. In addition, if the solutions proposed sound like they involve the government, you will have all the political rightwing try to block it as a reflex, even if it means them overriding hard science, which is what’s going on today. Changing people’s minds is almost impossible, even among scientists. Max Planck said, to paraphrase, that science advances one funeral at a time. You could add that economics advances the same way. You have to wait to get rid of the people who have career investment in a topic before a new generation can see the light.
The scientists are getting very concerned privately – they are conservative in public and have yet to write it up – that blocking processes are sticking in the system. The jet stream is behaving very strangely. One very senior atmospheric scientist said to me recently off the record that we are liable to wake up one day and find ourselves on the latitude – which we are in the UK – of Montreal. It’s a liveable place, but not like London. They have underground tunnels because of their winters. The Gulf Stream is having a few wobbles, too, and the theory there is the melting in Greenland and the Arctic is creating a lot of cold, fresh water, which is a possible source for loss of power in the conductor, so it moves less warm water up from the Caribbean.
We don’t fund the hard science of solar technology. That would take hundreds of millions. But what we are funding is bringing together the data and put it together and representing it conveniently to the outside world. And we want to train people with a good range of skills so they can produce good PhDs for the future at LSE and Imperial. We also fund old-fashioned style investigative journalism which is dying out in newspapers because the newspaper industry has become incredibly tough. The first people to get fired were the environmental journalists. We had a prize for environmental journalism which we brought in at the top of the market, but we discontinued it last year because there was basically no leverage left for the two-and-a-half environmental journalists left. All we were interested in was the net result of whether it could produce a more effective presentation of the facts. We got going in the nick of time to see that it could drag up environmental journalism, but then all the “dragees” were suddenly looking for different jobs, or put on different beats. Or that they were already working for the handful of independent investigative organisations. We fund about a dozen fledgling journalistic projects. Our argument was they are all fledgling so let’s fund them all first, then winnow them down later – come back in 3-4 years and pick eight and, a couple of years later, pick five. In the end, it doesn’t matter if there are one or two, but that they are the best. They whole point really is to allow these people to do their thing and to play to their skills and to pick the people who are highly motivated and very skilled. None of them would be very happy if we tried to tell them what precisely to do and we don’t know what they should do.
It’s a great problem for philanthropists and NGOs. The problems where you can measure the impact are not common in the environmental field. If you can measure them, they tend to be over decades. One is the wildlife population of Namibia. That is by far and away the most successful [conservation project the foundation has funded], by the way. You can see the population of the various types of antelope have improved. But that is unusual. But the ones you feel are most important are the vaguest of them all. How do measure the shift in attitudes towards processing the data? There are guys working on studying the changes in attitudes in the media. But you have to take a leap of faith that they are smart and dedicated.
No, I don’t. We might discuss such things informally over lunch. There’s a handful of hedge fund managers, mainly, who have decided to be aggressive about the environment, thank heavens. This doesn’t exist in England where you could get them all on the finger of one hand. I can try to persuade them. I gave a talk in London recently at the head office of a major financial player and someone went to considerably effort to make sure a couple of hundred potential philanthropists and wealthy individuals were there for me to have a go at them. A lot of them left their business cards and if you do that you are kind of asking for trouble. [Laughs.] I believe the majority left their cards, which as things go, is a huge potential hit because even if you get one or two that could be significant. They were a receptive audience. I try to paint the picture of how I got to where I am [as an investor] and then of how fact based the issues appear to be to me. I now try to add my thoughts about food and the “carbon math”…
…It’s simple, comprehensible maths, as Bill McKibbenexplained in Rolling Stone last year. There are five times the amount of proven carbon reserves as we can possibly allow to be burned if we want to remain under 2C of warming, which is now not even considered to be a safe margin. We must burn just a fifth of what’s there. We will burn all the cheap, high-quality oil and gas, but if we mean to burn all the coal and any appreciable percentage of the tarsands, or even third derivative, energy-intensive oil and gas, with fracking for shale gas on the boundary, then we’re cooked, we’re done for. Terrible consequences that we will lay at the door of our grandchildren. Some things might change very quickly, though. For example, the business mathematics of alternative energy are changing much faster than the well-informed business man realises.
Read my next quarterly newsletter entitled, “The Race of Our Lives”, [will be available here] on why civilisations fall and why they’ve always fallen and why we may not because we have two advantages that they did not – a voluntary fall in fertility, which is just amazing, and alternative energy. Every wave of technology has seen an incremental increase in energy needed – steam engines, cars, air conditioning, iPads – they all add to our energy needs and mean we dig a deeper hole, but we feel we are making wonderful progress. But now we have a technology wave which protects us from needing to burn every last ton of coal. Solar, wind, biomass, intelligent grids, and storage – please, more storage – protect us. That is the best part of capitalism. The price of solar panels is now 25% of what it was two years ago and that’s the bit people have missed. If these prices were to be held – they may not be – we are competitive, without a carbon tax, in the areas that have the sun – California, North Africa, Spain, etc. You can build a solar farm and it can be commercial. Meanwhile, the price of hydrocarbons are getting more expensive all the time, because you’ve extracted all the easy stuff first and with China rising and still growing at 7% a year. And that’s just China. Don’t forget India which actually has more coal power plants down to be built on the books at the moment than China. Now you start to get an idea of, wow, why this does not compute. If it computes, it’s only at the enormous increase in cost of digging and shipping coal. Meanwhile, back at the ranch, solar and wind power are getting cheaper and cheaper. Those lines are going to cross big time in the next 20 years. There is no such thing as “locked in and committed” because you can reverse. They might build a few more coal-fired plants, but then they will stop completely. The pay-off for China of getting out of the way of those lines crossing is so great.
China is my secret weapon. I call them the Chinese cavalry riding to the rescue. They have the capital. They have an embarrassment of capital – 50% of their GDP is capital investment. We have a shortage of capital and also have debts. Their problem is how to invest all that capital. My partners worry all the time about them wasting their money. What better programme could they possibly have, with huge social pay-off, than a massive replacement of sustainable energy? When you think what it would mean to them – it would get rid of their pollution – it makes sense. Because of that pollution, they announced recently an incredible increase of 65% in their plans to install by 2015 – just three short years away – 36GW, which is equivalent to 20 vast, state-of-art coal plants, of solar. Throw in wind, too. And, by the way, we will have many breakthroughs in storage. If I had to make a bet, I would say that’s the most promising, important breakthrough of the next several years. Everyone is working on this. If you have a big smart grid – and all the desert of Xinjiang and all the wind of Inner Mongolia – and it’s all swirling around with relatively little loss and you have a grid smart enough to go in there Chinese-style and turn your fridge off for half an hour to save energy, and do this and do that, you don’t need nearly the back-up. The bad guys will tell you that you need 100% back-up and messianic environmentalists will tell you that you need 0%. But maybe 20% back-up will be needed as everyone is working on storage. I’m certain it will happen. Some technologies take time then go, “Bang!”. Look at video conferencing. It has been around forever and the quality was terrible. But now it is so clear and instant. Technology has a habit of boring you to death and disappointing you for 20 years then suddenly it delivers a new world…
I have very high hopes for China because they have embedded high scientific capabilities in their leadership class. And that is huge. They know this is serious. They can calculate the social threat of getting this pollution, weather instability, water out of control. And they are acting much faster now than we are. They have it within their capabilities of coming back in 30 years with the guarantee of complete energy independence – all alternative and sustainable forever. They have an embarrassment of capital. We have an embarrassment of debt. So they can set a stunning pace, which they are doing. And they could crank it up. To hell with their five-year plans, they should move up to 25-year plans for alternative energy – energy security, reducing pollution and low cost. They would have such low-cost energy at the end of it they will be the terror of the capitalist system. With low energy and low labour, that’s the ball game. Five years into a 25-year programme and any capitalist will be urging their government to copy them.
I am inspired by [them]. They have to cope with short-term election cycles and a parliamentary system and all four of them nevertheless act responsibly, not just on alternative energy and environmental issues, but also on social issues that matter. They are, by and large, models of good behaviour. They say in America to me what’s the solution to all this, I say cede your government to Denmark. [Laughs]. They are good enough that they would get the job done.
Go and read Limits to Growth, which I did recently. They pretty much predicted doom and gloom 20 years from now. They have been grossly misinterpreted and are pretty much on schedule. There are details that are over and under, but it is amazingly accurate. The William Ophuls model is that we are hard-wired to collapse. Given half a chance we will over-reach. We are over-confident that we will solve every problem. But we will leave it too late and we will crash. All the confidence that people try to give you – the “infinite capacity of the human brain”, unquote – all of that hinges on the apparent infinite supply of hydrocarbons. No civilisation looked durable and resilient until coal and then we acquired this amazing power. We are now coming to the end of that era. If we don’t use that window to fix it and have a sustainable replacement, we are toast. Don’t worry about peak oil, worry about peak temperature. All our flora and fauna has thrived in the last 10,000 years since the end of the last ice age, a period which has seen unbelievable stable weather by long-term standards. Now it is becoming unstable. If you drive the temperature above 40C, well-known brands of corn will not produce. They just stop. You might be able to twist and turn and get it to produce at 41C, and you might move further north in latitude, but temperatures rises are very bad news for grain. The wider point is it [temperature rise] is generally bad for everything that evolved in one stable environment. It has no resilience to produce outside the temperatures experiences during this 10,000 year period. Quite a few grains are now topping out in terms of productivity. I look around and I say just look at the food-producing problems we face. In fact, let’s make it even simpler: look at the grain-producing problems we face around the world. We’ve just had three consecutive monster-bad grain harvests. Not one of those three poor harvests was more likely than a one-in-25-year harvest. But the terrible thing is they went, “whack, whack, whack”. I took some grief when I wrote about the first one and said next year was bound to be less bad, but the next year became a monster. I’ve done more research and reading in the last two years than I ever did at college. I’ve read all the classics. All the limits to growth, all the end of civilisations stuff, all the peak everything stuff, all the soil destruction stuff.
Asking, “Are we too late?”, is not the logic for this problem. It is too late for the dodo. It is too late for the one third of arable land that we have destroyed in 10,000 years. It’s too late for 10% of global biodiversity, and almost certainly another 10%, and 50/50 for yet another 10% after that. But it would be nice to end up with a planet that we can still relate to, that still has a fairly handsome biodiversity. We can still do that. There is one chance that the real pessimists are right. The chance that on our way to a 4-8C rise, and a 10-15ft rise in the oceans, which is probably what’s going to happen over the next two centuries, that things will get worse before they get better, because there is inertia built into the system. You can easily imagine resource wars breaking out unless we put our best foot forward on alternative energy. This would buy us time for everything else to be solved. If you can become energy sustainable in the next 40 years and suck up the pain that will have been paid by then, then you have probably bought the time for another 40 years to transfer the whole of global agriculture into a fully sustainable system before we run out of the resources to run old-fashioned agriculture. And if you do that then, in turn, you have probably bought enough time to deal with the intractable long-term issue of metals, which are entropy writ large. No matter how careful you are with them, they slip through your fingers. In the end, you will need to use organic replacements, which will take a long, long time [to develop]. We’d better start working on it now, but not too many are and they’re not getting much funding. You’ve got to get the population down and you’ve got to ignore the Economist magazine and others talking about rising population as a terrible economic problem. It is a necessary, short-term, intermediate pain to pay for the absolute minimum hope of survival, which is a gracefully declining population, because if you don’t do that you will have a rapidly imploding population one day.
Continue to PART 2
The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value. We all need to adjust our behavior to this new environment. It would help if we did it quickly.
Until about 1800, our species had no safety margin and lived, like other animals, up to the limit of the food supply, ebbing and flowing in population.
From about 1800 on the use of hydrocarbons allowed for an explosion in energy use, in food supply, and, through the creation of surpluses, a dramatic increase in wealth and scientific progress.
Since 1800, the population has surged from 800 million to 7 billion, on its way to an estimated 8 billion, at minimum.
The rise in population, the ten-fold increase in wealth in developed countries, and the current explosive growth in developing countries have eaten rapidly into our finite resources of hydrocarbons and metals, fertilizer, available land, and water.
Now, despite a massive increase in fertilizer use, the growth in crop yields per acre has declined from 3.5% in the 1960s to 1.2% today. There is little productive new land to bring on and, as people get richer, they eat more grain-intensive meat. Because the population continues to grow at over 1%, there is little safety margin.
The problems of compounding growth in the face of finite resources are not easily understood by optimistic, short-term-oriented, and relatively innumerate humans (especially the political variety).
The fact is that no compound growth is sustainable. If we maintain our desperate focus on growth, we will run out of everything and crash. We must substitute qualitative growth for quantitative growth.
But Mrs. Market is helping, and right now she is sending us the Mother of all price signals. The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II.
Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution.
Climate change is associated with weather instability, but the last year was exceptionally bad. Near term it will surely get less bad.
Excellent long-term investment opportunities in resources and resource efficiency are compromised by the high chance of an improvement in weather next year and by the possibility that China may stumble.
From now on, price pressure and shortages of resources will be a permanent feature of our lives. This will increasingly slow down the growth rate of the developed and developing world and put a severe burden on poor countries.
We all need to develop serious resource plans, particularly energy policies. There is little time to waste.
Click here to read the most recent macro synopsis from Global Fund Exchange
Jeremy Grantham’s latest quarterly letter, entitled “On the Road to Zero Growth” is out.
The U.S. Department of Agriculture (USDA) issued a report warning every American that U.S. food prices in 2013 will rise 3%-4% — but that jump is just the start of a frightening long-term trend.
The warm weather in the winter months gave farmers hope for a great crop production this year, but a crippling U.S. drought in the summer months covered around 60% of the continental United States. The water shortage has killed crops, pushed corn prices higher, and is now starting to make its way to your local store shelves.
But according to famed analyst Jeremy Grantham, the looming U.S. food price increase in 2013 is just the beginning, and the reasons go far beyond the current drought.
Grantham, the founder of Boston-based institutional money manager GMO LLC, in his July 2012 quarterly letter to investors wrote a report entitled, “Welcome to Dystopia! Entering a long-term and politically dangerous food crisis.”
Grantham explained that rising U.S. food prices have more to do with soaring population growth than this summer’s water shortage.
“We are five years into a severe global food crisis,” Grantham wrote, “that is very unlikely to go away.”
Editor’s Note: Food isn’t alone — shortages of energy and natural resources are inevitable, and the latest data we uncovered is startling. Click here to download our latest macro synopsis
U.S. Food Prices Rise with Population
Grantham explained that as the world’s population rises, global demand for resources will rise exponentially; it’s a mathematical certainty.
“The general assumption is that we need to increase food production by 60% to 100% by 2050 to feed at least a modest sufficiency of calories to all 9 billion+ people, plus to deliver much more meat to the rapidly increasing middle classes of the developing world,” wrote Grantham.
Even today, the average American is responsible for 32 metric tons worth of food, water, minerals, and energy from the environment every single year – and that’s just one person.
Given the interconnectedness between food, oil, and water there is no question prices in all three will rise as the population continues to grow. Grantham points out that you can’t grow food or develop water sources without energy which is why higher food prices and rapidly rising oil are tightly linked.
“Even if we could produce enough food globally to feed everyone satisfactorily the continued steady rise in the cost of inputs will mean increasing numbers will not be able to afford the food we produce.This is a key point that is often missed,” Grantham said.
Over time, Grantham said food shortages “will threaten poor countries with increased malnutrition and starvation and even collapse.”
So the long summer drought which consumed almost 65% of the contiguous U.S. states is just a preview of what can happen as wheat and corn crop shortages escalate in severity.
Grantham warned, “Any price increase from here may cause social collapse and a wave of immigration on a scale never before experienced in peacetime. Another doubling in grain prices would be catastrophic.”
Turns out, Grantham is dead on.
“We’ve uncovered a catastrophic pattern in our nation’s food system,” said Chris Martenson, “One we believe could soon hasten a world food crisis -a chain of events that could lead to massive food inflation, even riots.”
The pattern Martenson identified affects the entire global economic system. It’s eerily similar, he explains, to the kind of pattern you see in a pyramid scheme, one that escalates exponentially before it collapses – with little notice.
Related Articles and News:
Jeremy Grantham’s July 2012 Letter: Welcome to Distopia
Jeremy Gratham’s Nov 2012 Letter: On the Road to Zero Growth
Crisis vs Opportunity: The latest research by Global Fund Exchange
Corn futures surged 58 percent since mid-June, soybeans were up 31 percent and wheat 41 percent. The US drought may push food inflation as high as 4 percent in 2012, the USDA said last week.
The department has declared natural disasters in more than 1,800 counties in 35 states, more than half of the country’s total, mostly because of the dry, hot weather.
The following extract from Jeremy Granthams Quarterly Investor Letter “Welcome to Dystopia” certainly makes a valid point.
“Globally, 2010 looked to me like a 1-in-150-year event with heroic heat in Russia and elsewhere and biblical floods in Pakistan and Australia. It really hurt global grain output. I suggested then that surely the following season had to be at least less bad, and what did we get? Thailand, the largest rice exporter was knee-deep in floods overhalf the country, 80-year floods occurred in the Mississippi, Texas sweltered in way-above record heat, and quite severe droughts gripped many other places. Perhaps in total a 1-in-50-year event globally. So, after all, perhaps Iwas right; it was “less bad” but hardly what I meant. And now, quite suddenly, even while I was thinking about this letter, 1-in-50-year drought and heat have hit our major growing areas. So let’s call this a 1-in-20-year globally, for Brazil, Argentina, Russia, and several other areas are also having unusually bad weather. Any statistician starts to getjumpy when looking at 1-in-150, 1-in-50, and 1-in-20 back to back. Long-term weather records are poor and a lot ofthis is judgmental, but this three-year stretch is, shall we say, very unusual. (The National Oceanic and Atmospheric Administration has said that the chance that this year’s heat in the Midwest was not affected by a warming climate was over 1 in 1 million. Other sources have used much punier odds, such as 1 in 100,000. I will settle for “very unusual.”) We really have to start factoring into the investment equation increased odds of difficult and volatile growing weather.”
Welcome to Dystopia! Entering a long-term and politically dangerous food crisis by Jeremy Grantham
“Them belly full but we hungry …
… A hungry man is a angry man …
… A hungry mob is a angry mob.”
—Bob Marley, “Them Belly Full”
“Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.” —Kenneth Boulding, Economist
Summary of the Summary
We are five years into a severe global food crisis that is very unlikely to go away. It will threaten poor countries with increased malnutrition and starvation and even collapse. Resource squabbles and waves of food-induced migration will threaten global stability and global growth. This threat is badly underestimated by almost everybody and all institutions with the possible exception of some military establishments.
1. Last year we reported the data that showed that we are 10 years into a paradigm shift or phase change from falling resource prices into quite rapidly rising real prices.
2. It now appears that we are also about five years into a chronic global food crisis that is unlikely to fade for many decades, at least until the global population has considerably declined from its likely peak of over nine billion in 2050.
3. The general assumption is that we need to increase food production by 60% to 100% by 2050 to feed at least a modest sufficiency of calories to all 9 billion+ people plus to deliver much more meat to the rapidly increasing middle classes of the developing world.
In the 15 months since my letter on resource shortage, “Time to Wake Up,” I have tried to keep up on the current details and to catch up on the historical background since the ground-breaking “Limits to Growth” was published in 1972. Disturbingly, the more research I did the worse things looked: we indeed seem to be running out of cheap resources, and everywhere – even including China – the problem is underestimated. The consequences are that we continue to squander those lower-cost resources that remain and suffer from the large, unnecessary increase in the associated output of waste, particularly CO2 – which has already begun to have significant effects on our weather stability and, hence, our ability to grow enough food. The price of corn (maize), wheat, and soy in just the last five weeks rallied 30 to 50% to reach and exceed the 2008 crisis levels, this time despite enormously increased planting. Social reaction in poor countries will not be far behind.
The New Food Crisis
Last year’s letter showed that 10 years ago we entered a new era of rising resource prices after at least 100 years of steadily falling prices. It now appears that about five years ago we also entered a period of sustained food crisis for several of the poorest countries. This situation seems likely to continue for the indefinite future. If it does, it will cause the social structure of several countries to break down, resulting in waves of immigration on a scale unknown in modern times, outside of major wars. In the drive for resources, particularly food but also energy, country relationships are also likely to be destabilized, causing risks to global security. China, more concerned with future resource security than others, will find it particularly tempting to throw its increasing economic and military weight around. This risk also seems to be ignored or underestimated by national governments, although the military arms of several, including the U.S., seem to be exceptions. Not needing to be re-elected, military leaders have far longer time horizons than other branches of government and can afford to pay attention to both the long-term consequences of resource shortages – particularly food and water – as well as the growing effects of increasing temperatures and weather instability on the long-term security and well-being of their countries.
The vulnerabilities from food pressure can be easily demonstrated and are already beginning to play out beneath our noses. In developed countries, food accounts for only 10 or 12% of our total budget. For several poorer countries though, including Egypt, food costs have risen to 40% and above of their total expenditures following the surge in global grain prices since 2002. (Wheat is the critical source of calories in Egypt and the rest of North Africa and much of their wheat is imported so they are directly exposed to global price moves.) Global grain prices almost tripled in the last 10 years. If they were to double in the next 20 years it would be painful indeed even for rich countries, but simple arithmetic will show you how impossible the situation becomes for those poorer countries that start out with a 40% share of food in their budget. It is not even clear that the existing 40% share can be easily tolerated: grain prices are thought to have already played a substantial role in the Arab Spring, particularly in Egypt. Any material increases in real grain prices from here on are unlikely to be easily manageable.
Egypt heads into food trouble
Why focus on Egypt? Because it is treated as a more or less serious country by the U.S. for geopolitical reasons, whereas Somalia or Sudan, for example, can be easily ignored and are. Egypt was home to three million people when Napoleon invaded in 1800. Today it crowds 84 million into the limited arable land around the River Nile! Its population age profile and its current family planning practices (which are not particularly bad, merely not particularly good) more or less guarantee that by 2050 the population will swell to a staggering 140 million! Today they feed about 55 million of their people with their own food (with the benefit of several doubts). By 2050, if they behave very sensibly and if their society stays reasonably stable, they might optimistically move this number up to 80 million. But today they already run a $25 billion trade deficit, basically importing food, critically, wheat. With their recent meetings with the IMF and a little help from their friends, no doubt they will finesse this recent year. But as the population grows so will their trade deficit. Who will pay for their increasing need for imported food as the years go by? I believe the short answer is no one. To survive in one piece, let alone thrive, they need inspired sustainable agriculture – it is already very productive by normal standards – and a shift in their fertility rate. They do not appear to have the time to wait for the typical reduction in fertility caused by advancing wealth. In the short term the only possible ace up their sleeve may be undeveloped conventional oil and gas, which might, if developed rapidly, be used to buy them, say, a decade or two of time. If you realize that several countries are in this position and quite a few are worse off, then you realize how perilously thin the veneer of global stability is. The global food crisis is not just a prospect for the distant future, it seems to be well on its way already and better weather in the future would seem unlikely to buy it more than a year or two of reprieve. Food scarcity is the product of many sub factors, each complex issues on their own. Let’s update since last year and expand a little on several of them.
Water constraints are worse than I thought a year ago. Squabbles or even wars over the division of rivers that flow through different countries seem more likely: Ethiopia, Sudan, and Egypt over the Nile; China and India, Pakistan, Bangladesh, Cambodia, and practically all of South East Asia over the flow of Himalayan rivers. Over pumping is also a bigger problem than I represented. About 300 million Chinese and Indians (125 and 175 million, respectively) among many others are fed through the use of declining aquifers. When entirely depleted, these perhaps then half a billion people will be thrown back onto already overstressed surface water. As with some other resource problems, there is an easy enough solution – desalination. And as with other easy solutions, it comes with a dreadful drawback – ultra high cost. (Singapore, ahead of the curve as usual, has addressed its critical water problem correctly: by pricing all of its water at the cost of the next marginal liter. Uniquely, their next liter of water is from desalination plants, so they are paying many multiples of the water price that is paid by the rest of the world, drowning as it is in subsidies.
Even then, despite their Draconian policy with locally generated water, Singapore still benefits from the hugely underpriced water used to produce the majority of their food, which is imported. And Singapore is not representative of our problems with water in one very important way. They are now just about the richest people around with incomes per capita of more than $50,000 U.S.!) That changes from the old normal climate patterns exacerbate water problems seem to be revealed by the week: unpredictable monsoons (that as this year are sometimes weaker), less snow cover to run off in the spring, and unnervingly common severe droughts that we must hope are at least partly non-recurring.
Erosion, at least, is as I thought: it can be remedied through massive adoption of no-till agriculture, but with a starting point currently at under 10% globally, can it be adopted rapidly enough (say, in 40 years) to prevent further critical loss of arable land, every inch of which will be needed? With current unchanged practices and with 1% loss of soil per year the math at least is quite simple: we run through all of our soils in 100 years and starve.
Potential fertilizer crisis and possible organic solution
The risk of phosphate and potash fertilizer running out is the one area in our report of last year that has improved. This is fortunate for you will remember, I hope, how intimidating was the story told then: potassium (potash) and phosphorus (phosphate) are necessary for the growth of all living matter; they cannot be made or substituted for and are mined and depleted. This recitation still gives me goose bumps! But the good news is that there are at least the substantial reserves we showed a year ago and it is likely that there is considerably more. Thus, even with our current prodigal ways, we have 100 years or more to see the light. More importantly there is a very good chance that existing reserves can be greatly stretched out by the adoption of organic farming, which, when done well, can reduce the need for extra doses of potash and phosphates to a very small fraction of that used in current “Big Ag.” Perhaps at its very best, say at least some soil experts, organic farming could totally remove the problem. If true, this would be very good news for if current practices continue, even if it took us 200 years, we would simply run through the onshore reserves and, as with erosion, end up very badly off indeed. Although, with phosphorus and potassium at least, the very rich at that point could retrieve them from the ocean and the ocean bed. My hope – and actually my belief – is that as fertilizer prices rise in the longer term (and they could certainly fall considerably in the short term) we would be forced to be more resourceful and open-minded about organic farming and then would never need the last resort of ocean-based recovery.
Some pros and cons of organic farming
We have talked before about the essence of organic farming. It is the nurturing of the soil’s complexity in microorganisms, insect life, worms, and nutrients without the use of chemical insecticides and pesticides, which have the effect of sterilizing all of the above, leaving just dirt, which is then completely dependent on the new application of all three major fertilizers each year, especially the energy-intensive nitrogen. We have spent considerable time trying to determine the possible reduction in output in the short and intermediate term that you might get from moving to organic farming. The majority opinion (I am not arguing for this as a way of settling research issues, merely passing on facts and opinions) is that immediate output of grains and soy would be reduced by 20 to 30% by moving to fully organic farming. The higher range is applied to irrigated land and the lower range to rain-fed land because organic soil retains more moisture and holds up better as conditions get drier – a very useful trait these days. In a long-term war of attrition, though, because organic soil holds up in quality and even improves, and because it resists erosion better than standard farming, the equation shifts and in several decades may close much or all of the gap, given the starting assumptions.
But to make matters more complicated, some researchers in organic farming3 believe that when organic farming is done well – fine-tuned by both trial and error and scientific research – it can (and has in their 20+ year tests) reach parity with current standard-practice farming. Because the use of increasingly expensive fertilizers in particular is much reduced with organic practices, such farming can be equally profitable also, even without the considerable premium now paid for the modest quantities of organic grain produced. But the key weakness in this argument is the brain intensity required of this kind of farming: it has to be fine-tuned for each crop and each type of soil and there is a skimpy body of existing knowledge, available advice, experienced practitioners, or even good training programs. To compare the best organic farming with ordinary conventional farming is obviously an unfair comparison. And how would you persuade the typical farmer, a 60-year-old, to adopt a much more complex system that is therefore riskier at least initially and harder to insure? The bad news is that to gear up for 100% organic farming is a herculean task that will take decades of effort, including government participation and considerable research. The worse news is that this is a task for which there is absolutely no alternative in the long run for the status quo will guarantee that we will run out of potash and phosphorus as mentioned earlier and eventually come to a very bad end. The good news, though, is that this vital job can without doubt be done and when done would guarantee for the first time a sustainable basis of food production.
The Moroccan quandary: a sting in the fertilizer tail
On the topic of phosphate reserves, last year I mentioned another snag with long-term availability – the extreme concentration of resources in Morocco. Follow-up research confirms that given currently known reserves, as much as 70% of all high-quality, low-cost reserves are in their hands, a number far in excess of the whole of OPEC collectively for oil. (The best dream of the Saudi oil minister is that they would be in that position rather than having so many obstreperous colleagues to deal with.) So, yes, we may have up to 200 years of phosphate reserves even if we continue in our present ultra-wasteful ways. But if we do so, Morocco, already increasingly considered to be the price setter, will have in a relatively few decades the most important quasi-monopoly in the history of man! We should at the very least be very prepared, I believe, for a steady rise in the price of phosphates, and how that will steadily shift the cost benefits toward the more frugal organic farming.
Grain productivity gains slow
A year ago I mentioned the declining rate of increases in yearly productivity per acre for grains. It had fallen from an astonishing 3.5% a year in the Green Revolution, say, 1970, to a still considerable 1.5% in 2010. This rate of increase, I pointed out, was disturbingly close to the same as the growth in global population. The good news here, as we update, is the near certainty that population growth will continue to slow. Indeed, the number of new babies born each year has already leveled off and the global population continues to grow only because earlier cohorts of babies who are now, say, 60-year-olds, were much smaller than more recent ones. This is not because they have died off, but primarily because they had never been born. As the new, larger but now stable cohorts of babies grow old, in 80 years the population approaches a peak of 9 to 10 billion (in 2090). There is also a good probability that fertility (reproduction rate) will continue to decline beyond the current stabilization and that the number of births will start to decline (even without possible help from chronic food scarcity). And it had better do so, for currently we are well beyond the long-term carrying capacity of our planet. The bad news is first that the increases in grain productivity are also likely to decline, and second that as the very rapidly increasing middle class of the developing world continues to demand more meat – one pound of dressed beef currently replaces 30 pounds of grain! – the safety margin between potential supply and future demand would disappear. Indeed, it may have disappeared already.
In grain productivity there is an unexpected problem known as the “glass ceiling.” Each species has a theoretical limit. A real life example is that of race horses, bred for over 5,000 years for speed – nothing was more macho for a chief than a fast horse! Well, horses have apparently reached a ceiling. Despite the ingenuity and expenditures of horse breeders, horses do not run measurably or dependably faster today than they did in the 1920s. They break more legs trying and they get more chemical encouragement, but they just can’t run any faster. Disturbingly, there are signs that this may be happening with grains. Not surprisingly, you would look for this glass ceiling – it is called this because you can’t see it coming until you get there – amongst the farmers who have the greatest output per acre.
Exhibit 1 shows the yield per acre for wheat in England, France, and Germany and the yield for rice in Japan. These top-producing countries for the two most important cereals for direct human consumption have failed in the last 10 or more years to increase productivity. This puts the burden of major increased production on the poorer producers, and there is indeed on paper much more room for improvement. It is important to remember, though, that many of these under-producing acres have been suboptimal more or less forever. If it were easy to correct, it would have been corrected. Yet capitalism has some great virtues: one of them is that high price is probably the best teacher of all.
Diminishing returns from increasing fertilizer use Commercial fertilizer use has increased globally by five times since 1960 and, remarkably, by over 50 times in China! It was the major reason for the Green Revolution: first, selecting seeds that could utilize more inputs of fertilizers and turn them into more plant growth, and second, providing them with the extra fertilizer. But beyond a certain pointmore fertilizer does not improve returns. It does, on the other hand, do increasing environmental damage, mainly by over fertilizing waterways and helping to create dead zones near river mouths. There are still big areas, particularly in Africa, that could process more fertilizer, but in general they are already priced out of the fertilizer market. The net result is that we are deep into diminishing returns with fertilizer and can hope for only modest and decreasing helpfrom this source in the future for increasing the productivity of grain.
The negative effect of climate change on grain production
I used to think that “climate change” was a weak, evasive version of “global warming” but not anymore, for weather extremes – drought, floods, and bursts of extreme heat – have turned out to be more devastating for food production than the steady rise in average global temperatures. Droughts and floods were off-the-scale awful three growing seasons ago, and I forecasted some improvement. But with impossibly low odds – based on the previous weather distribution pattern – severe weather events kept going for two more growing seasons. Just as with resource prices, detailed last year, when the odds get into the scores of thousands to one, it is usually because the old model is broken. So in the resource case, the old model of declining resource prices was broken and a new, very different era hadbegun. Similarly, the odds of three such disastrous years together are just too high to be easily believed and the much safer assumption is that the old weather model is broken and a new era of rising temperature and more severe droughts and floods is upon us. All-time heat records in cities across the world are falling like flies and the months of March through May this year were the hottest in U.S. history. As with the equally unpleasant fact of rising resource prices, this new, less desirable climate has to be accepted and adjusted to. Once again, the faster we do it, the better off wewill be. Several industries like insurance are already deep into the study of the new consequences. Farming mustalso adjust, and not just to the rising prices. With skill, research, and, above all, trial and error, farmers will adjust the type of crop and the type of corn seed they use to the changing weather. And I have no doubt that they will mitigate some of the worst effects of increased droughts and floods. But the worst shock lies out quite far in the future: grains have developed over many thousands of years in an unusually moderate and stable climate (moderate, that is, over ascale of hundreds of thousands of years); and selective breeding of the last few hundred years also was done in that moderate environment. Grains simply do not like very high temperatures. By the end of the century, the expected rise in temperature globally is projected by the IPCC to reduce the productivity of grain in traditional areas by 20% to 40%– numbers so high that the heart sinks given the other problems. Yes, northern climates will benefit (so Canada once again looks like a good ally) but more world-class grain land will be lost than is gained. And do not for a second think that the scientists can be dismissed as exaggerators in the pay of evil foundations as right-wing think tanks would have you believe. The record so far has been one of timid underestimation. Much the majority of scientists hate being in the limelight and live in dread of the accusation of the taint of exaggeration, so severe a crime in the academic world that it is second only to faking data. What the timid scientists forget (this is all driven by career risk just as withinstitutional investing) is that in this unique case it is underestimating that is dangerous! To put the science clearly in the public domain – a task so far totally failed at – is left to a brave handful of scientists willing to be outspoken.
Talk privately to scientists involved in climate research and you find that they believe that almost everything is worse than they feared and accelerating dangerously. A clear example is in the melting of the Northern ice, now down in late summer by 30% from its recent 30-year average to 2005. It is at a level today (and last month was the least ice cover of any June ever) that was forecast 15 years ago for 2050! Dozens of ships last year made commercial voyages across the Northern waters where none had ever gone before 2008. A dangerously reinforcing cycle is at work: the dark ocean absorbs heat where ice reflects it, so the water warms and more ice melts. Other potentially more dangerous loops might also start: the Tundra contains vast methane reserves and methane acts like supercharged CO2. It warms the air and more Tundra melts and so on. For agriculture, which is very sensitive indeed to temperature shifts, it has become a very dangerous world. There is now no safety margin to absorb unexpected hits as we are seeing in the global crisis playing out in the Midwest today.
The one piece of hopeful news for food
Over millions of years, an increasing minority of grass species – now up to 43% – have made a mutating jump into much greater efficiency in processing nitrogen, water, and the sun’s energy. The majority of grasses are relatively inefficient photosynthesizers and belong to the family botanists known as C3. This group unfortunately includes rice and wheat, the two most important grains for human consumption. The smaller family that has made the jump, knownas C4, luckily includes corn (maize) and sugar cane. Among other things, this means that under their present genetic circumstances, however hard you try to grow wheat and rice you will never get more than about half of the output of corn. Up until now, genetic engineering of grains has shown little or no increases in actual yield, despite success in changing other seed characteristics. Nevertheless the “Holy Grail” of seed engineering, according to the Millennium Seed Bank of Kew Gardens, is to engineer efficient C4 genes into inefficient C3 grasses. This, it is thought, could increase productivity of wheat and other C3 plants by up to 50%! The work is apparently going well and has been described as “simply engineering” by involved scientists, without, I hope, too much hubris. They believe it will be done in lessthan 20 years. Even if it is done in 30 or 40 years, it would be that rare bird – a game changer. Hundreds of millions more could be fed, buying time for a more graceful population decline than is currently likely.
Food prospects for 2050
The literature on this topic agrees that a very large increase in global food production is “needed” by 2050. The two most commonly used numbers in the last several years (almost clichés) are that we either need to double food production or to increase it by 70% by 2050 to keep up with expected demand. Recently, U.N. sources have estimated that we are likely to be able to increase food supply by 60%. Given the long litany of farming problems, it will come as no surprise that I believe that even the lower U.N. forecastis highly unlikely to be met and that the higher numbers are complete pie in the sky. Yes, a 60% increase is necessary to meet the realistically forecast 30% increase in population to 9 billion+ together with the anticipated increase in meat consumption. But given all of the difficulties already described, it is just not going to happen, at least on anysustained basis. (I know statements like this love to come back and haunt people but on this one I look forward to an unhaunted life, and afterlife, for that matter.) The increasing demand from a growing population will be there in 2050, although it is far from certain that it will be the full 9 billion+ if some large poorer countries begin to unravel. But this is where Mr. Market intrudes: long before an extra 60% in food supply is reached, rising prices will have made food too expensive for hundreds of millions. To balance the books, a series of serious (but still doable) steps must occur.First, the entire world must consume less meat than is assumed in the estimate of a doubling. Sensible governments will encourage it: poor countries to reduce increasingly expensive grain and soy imports and rich countries to contain the epidemic of obesity that is sweeping outwards from the U.S. and threatening the long-term health costs of each country that catches it. (If any issue needs a “nanny state” feature this is it!) With an aging population, a wave of extra health costs would be likely to break several national budgets. Second, food wastage runs – from farm to stomachs– at a shocking one-third globally. (Some sources claim the number is considerably higher.) This waste must be much reduced if we mean to have any chance at all of muddling through to 2050. Third, major food-producing countries will have to be more serious about investing more in sustainable production with increased investments in irrigation, farm education, and research. Taking serious steps to lower the longer-term costs of fuel and, of course, protecting against continued deterioration in the climate will also be vital. But the main contributor to reducing the food imbalance between supply and demand is once again likely to be price: more of the poor will eat less and some, regrettably, will eat nothing. To deal with food and other resource problems, developed countries could respond early and decisively to economizeon use and improve efficiency. There will no doubt be a little of this, but the price signal is still quite faint for the affluent countries. We have enormous inertia. We are in general badly led on this issue – only Scandinavian countries and China might get even a passing grade. And we in the U.S. are constantly told that all will be just fine. So our collective under-response to these developing problems will cause unnecessarily sharp rises in the prices ofresources, particularly food. Unintentionally, but thoughtlessly, we will cause and already are causing, unnecessary malnourishment and starvation in the poorer countries, which is only bound to get worse. Of course they – the poorer countries – should respond with much increased urgency. Population growth in particular could be more actively discouraged. Educating women and making family planning available have worked well insome countries. Yet there are still 80 million unwanted conceptions a year, often in those very countries whose food future is most perilous. But will many of these countries respond vigorously within the time scale of the problem? As food and energy conditions worsen, they seriously weaken the remainder of the economy and the ability of government and society to respond. Finally, as states fail, they lose all hope for determined action.
Fortress North America
For Fortress North America (ex-Mexico), or what we might call Canamerica, these problems are relatively remote. When corn crops fail we worry about farmers’ income, not about starvation. In the long run, the truth is that Canamerica seen as a unit is in an almost unimaginably superior position to the average of the rest of our planet. Per capita, the U.S. alone has five times the surface water and seven times the arable land of China! And Canada has even more. We are very large exporters of food. Canada, our very, very good friends (please!) has huge deposits of potash and the U.S. has a respectable amount of phosphate, although that probably is our weakest link. (Ironically, perhaps, we have been exporting this relatively limited resource as fast as foreigners demand it and the second largest mine just closed in Florida, reserves exhausted, the month before last.) It is hard when dealing with this kind of problem, which is atragedy of the global commons if you will, to get the winners to worry too much about the losers. And we, the rich countries, do not worry and probably will not as far as the eye can see, for such a broad recognition of the problem would require a profound cultural and ethical change. A perfect symbol of our carefree and careless attitude is in our policy toward corn-based ethanol. It is an indirect, back-door subsidy (disguised as a mandated requirement) for farmers who today, with much higher crop prices, are already relatively well-off compared to normal. Despite cornbeing almost ludicrously inefficient as an ethanol input compared to sugar cane and scores of other plants, 40% of our corn crop – the most important one for global exports – is diverted away from food uses. If one single tankful of pure ethanol were put into an SUV (yes, I know it’s a mix in the U.S., but humor me) it displaces enough food calories to feed one Indian farmer for one year! To persist in such folly if malnutrition increases, as I think it will, would be, to be polite, ungenerous: it pushes the price of corn away from affordability in poorer countries and, through substitution, it raises all grain prices. (The global corn and wheat prices have jumped over 40% in just two months.) Our ethanol policy is becoming the moral equivalent of shooting some poor Indian farmers. Death just comes more slowly and painfully. Once again, why single out Indian farmers? Because it was reported last month in Bloomberg that the caloric intakeof the average Indian farmer had dropped from a high of 2,266 a day in 1973 to 2,020 last year according to their National Sample Survey Office. And for city dwellers the average had dropped from approximately 2,100 to 1,900. It was also reported4 that per capita consumption of food grains had fallen from 177kg in the early 1990s to 153kg in 2004 (about 1934 levels!). These are not drops you would want to repeat in the next 30 years if you wanted a good day’s work! And, perversely, these declines occurred while the official average income of urban dwellers more than doubled. Apparently a free hut in the country became an expensive hut in town for the migrant. Now he has to payfor cooking fuel and transportation to work. And he has to buy food, expensively shipped in from the country, within credible “only in India” quantities of wastage, and too many middle men and, bingo, he is twice as rich as measured by GDP but cannot afford to buy sufficient food. Even more shocking, over 40% of India’s children under the age ofthree are undernourished and underweight, a ratio worse than most even poorer African countries. This is a number that threatens India’s future. And meanwhile there is an amazing increase in new Indian millionaires. Well, good for them. But a little more food for the poor, and a lot less waste and food theft and outright corruption would be a good idea. The point of this story, though, is to reinforce a point: this crisis is playing out now!
To move on (at long last, I can hear you say) in our update to metals, the story is not really as serious in the near term, where price declines are more likely than rises because of growing weakness in the global economy. Nor is it as bad in the 20- to 40-year horizon as food or energy for there are quite a lot of reserves (let’s say about 50-100 years) and there is substantial ability to substitute. Again it is “just a question of price” as economists like to say about everything. High-quality resources are depleted and prices rise, but in my opinion not enough to materially affect economic growth as it does with energy and food, but it is certainly a modest hindrance to growth and one that is an add-on to the other two more immediate constraints.The big problem with metals, though, comes in the long term and the very long term where metal availability becomes the most intractable problem of all. For entropy in metals is merciless. However hard we try to recycle and however low our growth in physical output, metals will still slip slowly through our fingers. They are never replaced. Metals prices will rise slowly if we behave very well. If we behave less than well, which seems much more likely, then metal prices will rise more quickly. Until one day, the price pressure will insist we behave better, recycling close to 100%and raiding those rich 20th century dumps.
Massive capital spending for alternatives
Energy shortages are the easiest to handle of our resource problems. At least on paper. All it takes is real leadership from our leaders; common sense from the general public; a willingness of hydrocarbon interests to back off from politics and propaganda and a herd of flying pigs! We need to build a very large, very smart grid, covering the whole of the U.S. and one day perhaps including Canada. Among many tricks, it needs to be able to reach into smart homes and turn off the refrigerators and so on for a few minutes when needed. It is, in fact, all state–of-the-art already and in the 10 or 20 years it would take to build, the technology and engineering would no doubt greatly improve,given the great scale, helping to drive down the cost. Behind the grid we would need a truly massive investment in storage technologies and all renewables, especially solar and wind power. Solar costs have unexpectedly crashed in the last three years, down by over two-thirds, and finally today, in ideal conditions (even without coal carrying itsfull environmental costs), solar is competitive. In a happy variant of Moore’s Law, solar costs, driven by scale and engineering as much as new technology, will continue rapidly downwards. (Although there is of course a physical limit to how much energy can be extracted from sunlight and the good/bad news here is that we should be close to it in 30 years or so, there is no such limit on price reductions.) Wind power costs will also fall, if substantially less fast, and it too is already competitive in very good conditions. In contrast, the costs of hydrocarbon energy of all kinds will implacably, if erratically, rise. To carry out such a program even in crash mode (son of Manhattan project, if you will, but actually cheaper as a percentage of our current GDP than that remarkable effort) would take 20 or 30 years, but long before then the marginal costs of operating and maintaining such a system would cross the rising costs ofour current system as cheap hydrocarbons steadily disappear. By 2050, cheap hydrocarbon sources will be a distant memory. Electric grids based solely on hydrocarbons would by then, after desperate struggles and brownouts, likely have turned totally black and economies based on such grids would be under very severe stress. If I’m wrong in thisassertion for some countries, simply add 10 or 20 years onto the timeframe.The U.S., as in so many aspects of the resource problem, is relatively blessed in energy resources. The new reserves of natural gas and extra oil from new drilling technology will uniquely allow this country to improve its energy position.The worm in the apple is that it will also allow for complacency. In this we will be encouraged as always by the Cornucopians, telling us we will never need to worry about running out of gas or anything else. It is easy to imagine that this would leave us sticking loyally to depleting hydrocarbons while Germany and others, possibly including China, forge ahead with renewables until they dominate these new, relatively job-intensive industries and eventually end up with much lower marginal costs. Their advantage would steadily increase as renewables fall in price andthose for hydrocarbons rise. Still, with the new fracking reserves it will be exciting for a few years to have some very cheap energy, and it will surely stimulate the U.S. economy in the range of 0.25 to 0.50% a year of GDP for several years. In the longer run, though, it is ridiculous to underprice natural gas, a premium, irreplaceable fuel, just becauseof odd royalty arrangements. The major disadvantage of all of these extra reserves, though, is that they will give usmore rope with which to hang ourselves by frying the planet. (Recent estimates by Cornell University,which are preliminary and therefore, I hope, mis-measured, estimate that almost 8% of fracking gas leaks from drill to stove burner. Anything more than 4% (and it may be as little as 3%) makes natural gas even more dangerous to a warming planet than coal. Methane (which is what natural gas is) is 20 to 100 times worse than CO2 in its greenhouse effect. Depending on the time horizon, it is up to 100 times worse in the very near term, declining to 20 to 1 times worse over 100 years or so. Unlike other environmentalists, I worry less about other of the several negative effects of fracking: boiling the planet makes other negatives seem to me relatively inconsequential.
China’s unique opportunity in energy
Time out here to take a look at China on this point. China has been in a class of its own in taking seriously this topicof future availability of resources. It has a long Confucian tradition of thinking very long term and its politicians donot have to worry about being re-elected or about voters and funders as much as ours do. It has also shown a degree of entirely justifiable panic on this resource issue as reflected in massive agricultural land deals outside of China and in a willingness to acquire foreign-based mineral resources. My colleagues worry that the Chinese save and invest too much, approximately half of all their income, a level never before reached in history. One of the reasons for so high a level is that in their attempts to stimulate their economy, notably after the global financial crisis, they found giant infrastructure-based public spending to be the most scalable and manageable. My colleagues also worry about the capital inefficiency in China: too many roads and fast rail lines and completely unnecessary regional airports and too many empty middle class apartments and even empty cities. (For my money, though, this still compares favorably to using public funds to bail out the banking system’s errors and even protecting bonuses! But, I digress.) But for undertaking a completely renewable energy system, what a set-up! If the Chinese feel they must maintain a 50% capital spending ratio (or at least come down gracefully to avoid an outright depression), there are few projects big enough to both absorb the giant quantities of money available and have a good return on investment at the societallevel in the long term. Building a renewable energy system achieves both aims. As a first mover they would quicklybe able to build fewer coal utilities and, eventually, none. In 30 or 40 years they could phase out the last of them andstop slowly poisoning their urban residents while at the same time helping to stop slowly cooking the Earth. (Perhaps,though, the last coal plants could be kept in carbon capture and recycling mode – in which field they are undertaking today the first semi large-scale test in the world – for such plants would make load balancing that much easier by providing some base load to smooth out the variability of wind and solar.)
The Chinese are already becoming leaders in wind and solar power construction and research. At much higher scale,their cost advantages would be hard to match, and if a renewable energy system were to be completed, their biggest long-term worry of all – energy security – would be gone. Compare their problem – “How do we spend all of our money?” – with ours – “How do we pay back all of our debts?” – and you can see why our hurdles are so much higher. It will, in comparison, need much more heroic leadership from us and plenty of those flying pigs. In the meantime, a major Chinese effort would be both a great example and a commercial goad to encourage others to follow. Go China!
The need for research
As renewable projects for solar and wind go forward they should be accompanied by research and financial encouragement for other promising renewables. This would include converting algae and other vegetal matter into liquid fuels, perhaps research into Thorium-based nuclear, and possibly even fusion, for which the risks (of eventual failure) are high, but so are the returns – almost infinite supplies of incremental energy. (It is probably worth mentioning here that, courtesy of the second law of thermodynamics, you cannot indefinitely heat up the world. All heat must be dissipated through infrared radiation. This is why cities with more waste heat are warmer than the countryside. Given energy growth of just 2.3% a year, for 400 years, even if the supply is 100% renewable or fusion [to remove the need to consider the greenhouse effect], the planet’s temperature would reach boiling point and only a few recently discovered organisms would be left. In this world, where hydrocarbons are still burned and where facts rather than opinions hold – although sometimes you would never know – the greenhouse effect in the next 100 years is likely to be 300 times the thermodynamic effect.) But perhaps the greatest need for research is in power storage,which will become by far the weakest economic link in the desired renewable energy system. There are almost weekly announcements of new, ingenious approaches, but they seem always to be just around the corner. This would be a good area to have some of that “infinite capacity of the human brain” one hears so much about from the perma optimists, and for once even I, a cheerful realist (which is no mean feat!), believe there will indeed be, eventually,some real breakthrough, at least in cost if not heavy science. It would certainly be helpful.
The need for a serious effort now
In earlier pieces I tried to convey the sheer impossibility of any perpetual rate of steady growth in people or physical output: 1% compounded for 3000 years, I noted, would multiply people or possessions by seven trillion times the original number. But for those with shorter horizons, the thermodynamic effect on its own, as we’ve seen, puts aquite separate ceiling of a mere 400 years’ growth in energy use at a modest 2.3% growth a year. Throw in climatechange effects and our species would be toast long before 400 years would pass if present trends continue. We simply cannot have exponential growth on a finite planet, but no politicians (understandably) and almost no economists (almost unbelievably) will deal with this topic. The longer we delay in facing up to resource shortage, especially the need to go to renewables, the more severe the problem becomes. For example, by the time hydrocarbon prices go “critical,” some countries may not have the capability – political, social, or economic – to meet the substantial investments required and they will be left more or less permanently floundering behind. In the late 1930s, Churchill faced intractable unwillingness to deal with unpleasant news – German rearmament and hostile intentions – on the part of both politicians and the general public. Finally, as the problem became obvious even to the most block-headed, he could not resist a little “I told you so.” He said, “The era of procrastination, of half measures … of delays iscoming to its close … In its place we are entering a period of consequences.” This time we can already see the early consequences but we still delay.
But we still delay…
The reasons for delay and even denial are varied. In the U.S., some politicians are understandably desperate to protect jobs, in the short term, in their state. In return for so doing, some receive help from hydrocarbon interests in getting re-elected. They, the hydrocarbon companies, are in turn protecting the value of their huge current and future reserves in the ground, which often represent all of their market value. They also presumably feel that they are acting in their shareholders’ interest, which interest is interpreted in the currently fashionable and extremely narrow sense of maximizing intermediate-term profits. Other possible stakeholders, including the country of origin and the well-being of its current and future citizens, typically play no role at all. Some delayers are libertarians who just hate government intervention regardless of the facts or circumstances. But far, far more numerous are the ordinary people who would just dearly love for everything to work out well and the future to be as easy as it used to be in the goodold days. But thinking and hoping will not make it so, and delay and denial are dangerous, even potentially lethal,games to be playing.
Finally, who are we?
This brings me to my final point on our food and resource problems: all of our resource problems (and most of allof our other problems for that matter) are soluble if we rise to the occasion and use all of the abilities that, on paper,we have. Most of the more optimistic calculations and estimates that I see are based on the assumption that we willdo just that, that we are homo economicus (just as in investing): rational, smart, well informed, well-intentioned, and incorruptible. Well, it just ain’t so. We are badly informed, passionately prefer good news, and easily evade unpleasant facts; our views are easily manipulated by vested interests; we are sometimes desperately inefficient; and we are apparently corruptible as heck. It is on this assumption of ordinary, unenlightened humans that our global food outlook and, in consequence, our future political instability, looks so dangerous. But once in a blue moon we really do rise to the occasion. The last time was World War II in general and The Manhattan Project in particular. Of course, we were a much more cohesive society then and we had a Congress much more willing to compromise. We also had a clear and immediate enemy who brilliantly (for us) galvanized and united the country by a sneak attack. But, all in all, what a magnificent effort and what a rebuttal to those today who think no government can ever do anything right. If that were indeed true, the war would have been lost and the world would have become a very different place. The threat today, though, is more technical and very much slower burning and the enemy seems amorphous. On the other hand, the penalties this time will be even greater and for the whole planet if we collectively do not start to act soon. It is time for another blue moon. Go world!
Updated Investment Implications of Resource Limitations
The one-line summary is this: I am very bearish on the problems we humans face and, sadly, very bullish on resources. Not surprising, I am even more convinced than I was a year ago of the inevitability of rising resource prices (and, unfortunately, associated societal and international instability). Therefore I am more confident in my suggested investment battle plan of a year ago. For any responsible investment group with a 10-year horizon or longer, one should move steadily to adopt a major holding of resource-related investments. For my Foundation (i.e., personally as opposed to institutionally where, reasonably enough, we cannot impose 10-year plus horizons on our clients) I had adopted 30% in resources as my eventual target and was slowly averaging in, nervous of near-term substantial price declines, but even more nervous of completely missing my own point. In my Foundation, I have currently reached about the two-thirds point of 20%. My personal, somewhat arbitrary breakdown of a targeted 30% is to have 15% in forestry and farms, 10% in “stuffin the ground,” and 5% in resource efficiency plays. I will change the mix as I become more comfortable with some of the subsets or as I see exceptional opportunities. I do, though, see farms and forestry as the senior or preferredcomponent, if you will, for the longer term: mining and oil companies benefit a lot from rising prices, but they sufferfrom the need, as capitalist enterprises, to keep replacing their stock in trade every year and this slowly becomes impossible to do completely. Farms, however, also benefit from rising commodity prices but for them their “stuffin the ground” is soil, which, if well managed, has fully renewed growing capacity each year, usually even with amodestly rising trend. There is one component of the potential “stuff in the ground” sub portfolio, though, to whic hI would give a miss: coal and tar sands. This is not primarily because their incredible cost to the environment hurts my conscience; it is because, in my opinion, the odds will steadily grow as climate damage becomes increasingly apparent, that their use will be curtailed. Before I leave this topic I would like to throw in a tidbit concerning the strong relationship between real price increases in stuff in the ground and the relative outperformance of those companies that own the reserves. Imagine in Exhibit 2 that I am clicking through on PowerPoint: Click one “A” would show the steady decline in raw materialprices to 2002. Click two “B” would show the accompanying steady, very long-term underperformance of mining stocks in that previous environment: every year they took inventory markdowns and every year the value of their main asset lost value, a tough environment in which to prosper. Click three “C” would show the dramatic breakoutof resource prices after 2002, and the final click “D” would show the equally dramatic outperformance of the miners.This relationship is a remarkable .52. For other resources it is typically lower – around .3. This is because rawmaterial price rises can help and hurt different parts of a diversified company. Large oil companies, for example, areboth sellers of oil and buyers in their capital-intensive refineries, which mutes the direct relationship with oil pricechanges. In general, though, I think you can confidently expect that if resource prices steadily rise in real terms, thenresource stocks should outperform the market
Last year I warned of what I saw as a strong possibility of a decline in resource prices. The bad weather – perhaps a 1-in-150-year global event in 2010 – would surely get less bad, I argued, and China looked likely to stumble or at least slow down. Some outright momentum speculation had also been attracted by the rapid and large price recoveries from the lows of 2009. I have been persuaded since then that there was likely some deliberate “go slow” on the part of miners to complete capacity and infrastructure extensions – with the prices so high, who could blame them? – and perhaps some genuine oligopolistic, cartel-like behavior, probably of a just legal variety to keep prices up. Yet at bedrock (pardon the expression) the data allowed for certainty that the main input was a paradigm shift, or phasechange, caused by a profound shift in balance between current and potential demand and long-term potential supply:i.e., we are indeed rapidly running out of cheap resources. Today, though, extra metal production is finally comingon line and the boom in new fracking gas and oil production (and reserves) mainly in the U.S. continues. On the demand side, global economic growth, especially in China and Europe, is slowing. As a result prices have fallen byabout 25% to 35% from their peaks for most “stuff in the ground” and, with the weather less bad, have also fallen by a similar average amount for agricultural products up to the beginning of June.
Climate problems intrude
Well, a month is a long time in agriculture, particularly these days apparently. For starting in early June there cameyet another burst of anomalous global weather. The center of this season’s problem is as it was last year: the U.S. Midwest coupled with dry weather around the Northern Hemisphere’s wheat belt. Suffering intense drought and 90-to 100-degree searing heat, the U.S. corn crop, the world’s largest, has been damaged and the price has jumped an astonishing 50% in a month. A similar story exists for soy beans. In almost no time, two of the three most important crops have gone back to the highs of 2008, which were often described as “never to be seen again.” Wheat also iswithin striking distance of its 2008 high and up over 40% in the last six weeks.
Let’s discuss what this means. It is not at all like 2008, when the planted crops were not that exceptionally large. However, since the massive rise of price in 2008 and the unexpected rebound in 2011 from the effects of the crash,unprecedented total acreage has been planted to take advantage of the much higher prices. There was also a strong case back in 2008 that there was an unprecedented speculative momentum element attracted by prices doubling in a single year. This time, though, just plain awful bad weather blindsided the market despite the massive planting. And as for speculation, just a brief six weeks ago speculators were short grains! World demand is now just so high and growing so fast and reserves so modest that the slack in the system appears to have completely gone and vulnerability to bad weather like this year’s has increased enormously.
And let’s talk about the weather, for it is indeed beginning to have investment implications that might be expensive to ignore. Globally, 2010 looked to me like a 1-in-150-year event with heroic heat in Russia and elsewhere and biblicalfloods in Pakistan and Australia. It really hurt global grain output. I suggested then that surely the following season had to be at least less bad, and what did we get? Thailand, the largest rice exporter was knee-deep in floods overhalf the country, 80-year floods occurred in the Mississippi, Texas sweltered in way-above record heat, and quitesevere droughts gripped many other places. Perhaps in total a 1-in-50-year event globally. So, after all, perhaps Iwas right; it was “less bad” but hardly what I meant. And now, quite suddenly, even while I was thinking about thisletter, 1-in-50-year drought and heat have hit our major growing areas. So let’s call this a 1-in-20-year globally, forBrazil, Argentina, Russia, and several other areas are also having unusually bad weather. Any statistician starts to getjumpy when looking at 1-in-150, 1-in-50, and 1-in-20 back to back. Long-term weather records are poor and a lot ofthis is judgmental, but this three-year stretch is, shall we say, very unusual. (The National Oceanic and Atmospheric Administration has said that the chance that this year’s heat in the Midwest was not affected by a warming climate wasover 1 in 1 million. Other sources have used much punier odds, such as 1 in 100,000. I will settle for “very unusual.”) We really have to start factoring into the investment equation increased odds of difficult and volatile growing weather.
Possible price declines and regret minimizing
Moving back to the portfolio, there is probably a risk of another 20% or so relative underperformance in the minersand oil companies (as the new supplies of U.S. oil and gas continue to expand) and as China has gone from our “likely to slow” a year ago to definitely slowing, and the euro and fiscal cliff in the U.S. are enough to make even seasoned cool-cat investors jumpy. (And downside results have a disturbing habit of being twice what you counted on.) Grain prices, having bounced once again, are very vulnerable and land prices typically need a couple of bad grain years in a row to have the effect pass through to them. So farm prices have stayed resolutely high, which for potential buyers is both frustrating and dangerous. Farm buyers are forced to look globally – although I advise safe and friendlycountries only – and hunt for bargains and special cases. Fortunately, though, farms form a very inefficient market and there are always relative bargains to be had somewhere. Resource problems are likely to squeeze the balance of the portfolio So my regret-minimizing advice still holds: average slowly in over the next one, two, or three years depending on developments. But something important in the picture has changed. Not only am I more convinced than a year agothat sensible long-term investors’ 7- to 10-year horizons should overweight resources (30% is about two times marketweight), but I am now also convinced that rising resource prices will worsen the prospects for the balance of the portfolio, by both squeezing profit margins and reducing overall growth. If correct, this will have serious implications for longer-term endowment and pension fund returns: among otherfactors, a lower growth for GDP in the long term may mean lower returns on all capital. That question, along with adiscussion of overall GDP growth and why I think it is likely to be lower in the future than generally expected, will be discussed next quarter. In the meantime, it may be worth asking which kind of company will better resist lower GDP growth, especially in the developed world, and be better able to absorb pressure from higher resource prices. Once again, we prefer “quality” stocks. They have much lower resource costs as a percentage of total revenues than typical companies and they have a higher margin base from which to resist margin pressure.
The economic environment seems to be stuck in a rather unpleasant perpetual loop. Greece is always about to default;the latest bailout is always about to save the day and yet never seems to; China is always about to collapse but insteadteases us by inching down; and I swear the Financial Times is beginning to recycle its reports! In the U.S., the fiscal cliff looms along with debt limits and the usual election uncertainties. The dysfunctional U.S. Congress continues for the time being in its intractable ways. The stock market rises and falls and rises and falls again. It is getting difficult to find anything new to say at client meetings. I, for one, wish that the world would get on with whatever is coming next. One slight change, though, is that fantastic (almost unbelievable) profit margin and earnings gains have finally weakened a little. They, together with Bernanke’s super low rates, have been the twin pillars of the market and not bad ones at all: here we are up 8% for the year in a thoroughly unsettling financial and economic world. With margins weakening, one of the twin pillars is looking shaky and price declines look more likely than before.
Performance data quoted represents past performance and is not predictive of future performance. Returns are presented afterthe deduction of management fees and incentive fees if applicable. Net returns include transaction costs, commissions and withholdingtaxes on foreign income and capital gains and include the reinvestment of dividends and other income, as applicable. A GIPS compliantpresentation of composite performance has preceded this presentation in the past 12 months or accompanies this presentation, andis also available at http://www.gmo.com. Actual fees are disclosed in Part II of GMO’s Form ADV and are also available in each strategy’scompliant presentation. The performance information for the Global Balanced Asset Allocation Strategy is supplemental to the GIPScompliant presentation that was made available on GMO’s website in April of 2011
Disclaimer: The views expressed are the views of Jeremy Grantham through the period ending July 31, 2012, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.