The last time we caught up with GMO’s Jeremy Grantham he was bemoaning the ruinous costs of asset price manipulation by the US Federal Reserve.
In his latest quarterly letter he returns to one of those themes — runaway commodity prices — but on a much bigger canvas.
Grantham reckons we are witnessing the most important economic event since the Industrial Revolution.
Accelerated demand from developing countries, especially China, has caused an unprecedented shift in the price structure of resources: after 100 hundred years or more of price declines, they are now rising, and in the last 8 years have undone, remarkably, the effects of the last 100-year decline! Statistically, also, the level of price rises makes it extremely unlikely that the old trend is still in place.
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.
By way of introduction to his thesis, Grantham offers us a chart of world population growth:
X marks the spot where Malthus wrote his defining work. Y marks my entry into the world. What a surge in population has occurred since then! Such compound growth cannot continue with fi nite resources. Along the way, you are certain to have a paradigm shift. And, increasingly, it looks like this is it!
As you can see this equal-weighted index of the most important 33 commodities fell by an average of 1.2 per cent a year (after inflation adjustment) to its low point in 2002 and then boom – the most remarkable price rise, in real terms, Grantham has ever seen.
The primary cause of this change is not just the accelerated size and growth of China, but also its astonishingly high percentage of capital spending, which is over 50% of GDP, a level never before reached by any economy in history, and by a wide margin. Yes, it was aided and abetted by India and most other emerging countries, but still it is remarkable how large a percentage of some commodities China was taking by 2009
And here’s another way of looking at the shift, which according to Grantham shows just how out line with their previous declining trends most commodities are.
Exhibit 4 is headed by iron ore. It has a 1 in 2.2 million chance that it is still on its original declining price trend. Now, with odds of over a million to one, I don’t believe the data. Except if it’s our own triple-checked data. Then I don’t believe the trend! The list continues: coal, copper, corn, and silver … a real cross section and all in hyper bubble territory if the old trends were still in force.
What surprises Grantham, is why there has been so little fuss about these price rises.
I believe that we are in the midst of one of the giant infl ection points in economic history. This is likely the beginning of the end for the heroic growth spurt in population and wealth caused by what I think of as the Hydrocarbon Revolution rather than the Industrial Revolution. The unprecedented broad price rise would seem to confi rm this. Three years ago I warned of “chain-linked” crises in commodities, which have come to pass, and all without a fullyfl edged oil crisis. Yet there is so little panicking, so little analysis even. I think this paradox exists because of some unusual human traits
These traits include our lack of numeracy as a species, inability to deal with long-term issues and deferring gratification.
But it’s the failure to appreciate the impossibility of sustained compound growth that really worries Grantham. And this little vignette shows why.
Four years ago I was talking to a group of super quants, mostly PhDs in mathematics, about fi nance and the environment. I used the growth rate of the global economy back then – 4.5% for two years, back to back – and I argued that it was the growth rate to which we now aspired.
To point to the ludicrous unsustainability of this compound growth I suggested that we imagine the Ancient Egyptians (an example I had offered in my July 2008 Letter) whose gods, pharaohs, language, and general culture lasted for well over 3,000 years. Starting with only a cubic meter of physical possessions (to make calculations easy), I asked how much physical wealth they would have had 3,000 years later at 4.5% compounded growth. Now, these were trained mathematicians, so I teased them: “Come on, make a guess. Internalize the general idea. You know it’s a very big number.”
And the answers came back: “Miles deep around the planet,” “No, it’s much bigger than that, from here to the moon.” Big quantities to be sure, but no one came close. In fact, not one of these potential experts came within one billionth of 1% of the actual number, which is approximately 1057, a number so vast that it could not be squeezed into a billion of our Solar Systems. Go on, check it. If trained mathematicians get it so wrong, how can an ordinary specimen of Homo Sapiens have a clue?
Quite.
Much, much more from this fascinating letter in the usual place.
For the record, Grantham reckons 0.1 per cent rate is probably the highest compound growth that could be maintained for a few thousand years — and even that would sometime break the system.