What if Malthus was right?

Jeremy Grantham is a British investor and Co-founder and Chief Investment Strategist of Grantham Mayo Van Otterloo (GMO), a Boston-based asset management firm. GMO is one of the largest managers of such funds in the world, having more than US $107 billion in assets under management as of December 2010. Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets, and is particularly noted for his prediction of various bubbles.

His past couple of quarterly newsletters have focused on resource limitations and I believe that they are spot-on.  The emphasis added to specific bullet points is my own.

(The april link to the GMO site was broken, so I uploaded my copy of the pdf as a google document)

April 2011 - Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever

July 2011 - Resource Limitations 2: Separating the Dangerous from the Merely Serious

Summary from the April 2011 newsletter:

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.

Summary

• 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.

Summary from the July 2011 newsletter:

• We humans have the brains and the means to reach real planetary sustainability. The problem is with us and our focus on short-term growth and profits, which is likely to cause suffering on a vast scale. With foresight and thoughtful planning, this suffering is completely avoidable.
• Although we will have energy problems with peak oil, this is probably an area where human ingenuity will indeed eventually triumph and in 50 years we will have muddled through well enough, despite price problems along the way.
• Shortages of metals and fresh water will each cause severe problems, but in the end we will adjust our behavior enough to be merely irritated rather than threatened, although in the case of metals, the pressure from shortages and higher prices will slowly increase forever.
• Running out completely of potassium (potash) and phosphorus (phosphates) and eroding our soils are the real long-term problems we face. Their total or nearly total depletion would make it impossible to feed the 10 billion people expected 50 years from now.
• Potassium and phosphorus are necessary for all life; they cannot be manufactured and cannot be substituted for. We depend on finite mined resources that are very unevenly scattered around the world.
• Globally, soil is eroding at a rate that is several times that of the natural replacement rate. It is probable, although not certain, that the U.S. is still losing ground. The world as a whole certainly is.
• The one piece of unequivocal good news can be found in the growth of no-till farming. In no-till, the residue of the previous crop is left on the ground and new seeds are planted without plowing. This technique reduces erosion by around 80%, reduces fertilizer run-off, preserves moisture, improves the soil (and, quite possibly, the quality of the food), and reduces the emissions of heat trapping gasses.
• The growth of no-till has been very rapid in South America, rapid in the U.S. (which is now at 35%), and moderate in many other developed countries. But it is used on only about 5% of farms globally.
• Overall, the best farms will have no erosion problems but, on average, soil will continue to be lost across the globe. Together with increased weather extremes and higher input prices (perhaps much higher), there will be increasing problems in feeding the world’s growing population.
• In particular, a significant number of poor countries found mostly in Africa and Asia will almost certainly suffer from increasing malnutrition and starvation. The possibility of foreign assistance on the scale required seems remote.
• The many stresses on agriculture will be exacerbated at least slightly by increasing temperatures, and severely by increased weather instability, especially more frequent and severe droughts and floods.
• These types of slow-burning problems that creep up on us over decades and are surrounded by a lack of scientific precision hit both our capitalist system and our human nature where it hurts.
• Capitalism, despite its magnificent virtues in the short term – above all, its ability to adjust to changing conditions – has several weaknesses that affect this issue.
• It cannot deal with the tragedy of the commons, e.g., overfishing, collective soil erosion, and air contamination.
• The finiteness of natural resources is simply ignored, and pricing is based entirely on short-term supply and demand.
• More generally, because of the use of very high discount rates, modern capitalism attributes no material cost to damage that occurs far into the future. Our grandchildren and the problems they will face because of a warming planet with increasing weather instability and, particularly, with resource shortages, have, to the standard capitalist approach, no material present value. 4

4 An expanded discussion on the failings of capitalism will be in next quarter’s letter. In addition, a discussion on the current market, including any investment implications from this piece, will be posted in two weeks.