Friday, April 6, 2012

The failings of capitalism

You expect a lengthy discussion of the problems with our capitalist system from a Ivy League professor, or your typical Occupy protestor.

But you don’t usually get them from a one of the most successful value investors of all time.

Jeremy Grantham manages $97 billion dollars at Boston-based GMO LLC.  He is famous and successful.

Many of his complaints involve how we manage the compensation of executives, our lack of grounding in our expectations, etcetera - All of which are very much on point, and discussed in detail.  He does not refer to it as his “longest quarterly letter ever” without reason.

However, I wanted to focus on an extended portion of it.  Although much of it has been said elsewhere, I think he adds a succinctness to the conversation not generally seen.  It a lengthier quote than I am happy with, but only a small portion of the totality.

Excerpted from: Jeremy Grantham, The Longest Quarterly Letter Ever, February 2012 (Hat tip: Al Lewis, Market Watch via Big Picture) – paragraphs are further sub-divided to make online reading easier. From pages 5 and 6.

Of all the technical weaknesses in capitalism…probably the most immediately dangerous is its absolute inability to process the finiteness of resources and the mathematical impossibility of maintaining rapid growth in physical output. You can have steady increases in the quality of goods and services and, I hope, the quality of life, but you can’t have sustainable growth in physical output.

You can have “growth” – for now – or you can have “sustainable” forever, but not both. This is a message brought to you by the laws of compound interest and the laws of nature. However, you can try to have both.

But many, when given the choice, select “Growth, and to hell with the consequences.” Alternatively they adopt a hear-no-evil approach to life and listen exclusively to good news. The good news for such people is that there are always a few experts lacking in long-horizon vision, simple common sense, or whose co-operation has been rented, like “expert” witnesses at a murder trial, who can be dragged out to reliably say that everything will always work out fine. (One famous professor went seamlessly from saying tobacco smoking was just fine to saying continuously pumping out greenhouse gases would also be without consequences).

The optimists offer as evidence that we will always be in the best of all possible worlds, not our species’ tough million or so years of trial and painful error, but only the last 200 years, when hydrocarbon and other resources have given us a temporary reprieve. This reprieve does not make the finite magically infinite, but the 250 years of the hydrocarbon intermission can feel like forever. Capitalism certainly acts as if it believes that rapid growth in physical wealth can go on forever.

It appears to be hooked on high growth and avoids any suggestion that it might be slowed down by limits. Thus, it exhibits horror at the thought (and occasional reality) of declining population when in fact such a decline is an absolute necessity in order for us to end up gracefully, rather than painfully, at a fully sustainable world economy.

Similarly with natural resources, capitalism wants to eat into these precious, limited resources at an accelerating rate with the subtext that everyone on the planet has the right to live like the wasteful polluting developed countries do today. You don’t have to be a PhD mathematician to work out that if the average Chinese and Indian were to catch up with (the theoretically moving target of) the average American, then our planet’s goose is cooked, along with most other things. Indeed, scientists calculate that if they caught up, we would need at least three planets to be fully sustainable. But few listen to scientists these days.

So, do you know how many economic theories treat resources as if they are finite? Well, the researchers at the O.E.C.D say “none” – that no such theory exists. Economic theory either ignores this little problem or assumes you reach out and take the needed resources given the normal workings of supply and demand and you can do it indefinitely. This is a lack of common sense on a par with “rational expectations,” that elegant theory that encouraged the ludicrous faith in deregulation and the wisdom of free markets, which brought us our recent financial fiascos. But this failure in economic theory – ignoring natural limits – risks far more dangerous outcomes than temporary financial crashes.

Let me pose a simple question. If there were an extra thousand years of oil supply – of onshore traditional oil – available at, say, a production cost of $200 a barrel in addition to the actual 40 years of mixed-cost reserves that we have today, what difference would it make in today’s price? Remarkably, the answer is “none.” Today’s price is concerned only with the intermediate-term workings of current costs of current barrels and current demand. Yet every rational reader knows that this should not be the case: that the existence of huge reserves (or the lack thereof) should indeed influence today’s price in a world concerned about its very long-term well-being. In addition to ignoring the depleting supplies of high quality materials, no concern at all is shown for our current devastatingly erosive and resource-intensive global farming practices.

It is hard to know where to cut the quotation.  The abruptness at the end is not apparent in the original.  I am not going to add my own conclusion but recommend that you look at the original for much more in the way of thoughts and recommendations.
Note that at the front end, in Part I, he also gives some reasonable advise to the common investor. 

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