A Tale of Two Forecasts
By Gregor Macdonald
It was the best of times; it was the worst of times for the American public over the past month, as it was treated to two high-profile, but deeply conflicting, economic forecasts.
In contrast to the IEA's report was the grim outlook recently offered up by legendary investor Jeremy Grantham, of GMO in Boston. Mr. Grantham has been increasingly sounding the alarm on a future of significantly lower growth rates for some years now. It is rather obvious, as well, that Grantham has been methodically making his way through the reading list of resource scarcity scholarship over the past five years, taking in the views of everyone from Joseph Tainter to Jared Diamond. Combined with the available data, Mr. Grantham has come up with the rather unsurprising conclusion that the rate of future growth is set to be much lower than most anticipate. In Grantham’s view, there will be no return to normal growth as was enjoyed in the U.S. in the post-war period (after 1945).
It leaves the rational observer wondering: Why is the media so breathless in its exultation of any optimistic forecast, no matter how poorly supported? And why does it vilify those who attempt to argue the other side?
Where has our objectivity gone?
Grantham's Actual Message
It's clear that very few understood what Grantham was really saying.
Moreover, many were mistaken that Grantham has adopted an ethos of negativity or that he has become ideological in his views. Quite the contrary. He is working with the same data observed by many hedge funds, international organizations, and academic research that shows that, as we entered the past decade, the extraction and production rates of many critical resources began to slow – and slow significantly.
Just to kick off this discussion, let's start with the master commodity, oil:
In the ten years leading up to 2004, global crude oil supply grew at a compound annual growth rate (CAGR) of 1.71%. This rate of supply growth started during the strong economic phase during the 1990s, and only strengthened after the recession of 2000-2002 when countries like Russia came online with fresh oil supply.
However, in the years since 2004, the rate (CAGR) of supply growth has dropped sharply to just 0.53%. This deceleration in the extraction rate -- which is also seen in many other resources, such as copper -- is the secular change that has drawn Grantham's attention. This is empiricism, not ideology.
When We Needed the Resources Most
Just when the world needed oil and copper the most – as China's and India's industrialization kicked into high gear – world supply growth flattened. Hence the upward price revolution in commodities. What Grantham is saying – observing, really – is this: The price revolution in critical resources will not be reversed. Accordingly, economy-wide input costs are now structurally higher, which will lead to structurally lower growth. I mean, really; it's not that complicated.
Remember, Grantham has been trying in vain to explain his developing position to fellow money managers for over four years now. As I wrote in 2009 and also in 2011, few have been paying attention. >From my post last year, Jeremy Has Spoken (But Rest Assured, Pro-Money Management Isn't Listening):
An excellent way to better understand Grantham’s perspective is to simply read what he’s been reading. For example, it’s clear that Grantham has integrated into his own work the ideas of Joseph Tainter, author of The Collapse of Complex Societies. Tainter's ongoing study of collapse and complexity is historical and well-researched. When Grantham writes, "If resources increase their costs at 9% a year, the U.S. will reach a point where all of the growth generated by the economy is used up in simply obtaining enough resources to run the system," he is keying on a signature theme of Tainter’s: as economies mature and become more complex, the natural resources which were originally used to build and grow the economy then have to be used just to maintain it.
If one adds to this phenomenon the extra pressure that comes when natural resources become more expensive to obtain, then there are even fewer inputs available to fund new growth.
This is hardly a revolutionary idea. Companies, states, and countries typically kick off from inception with high rates of growth, and then as they mature, their growth rate slows. Geoffrey West of the Santa Fe Institute has modeled this phenomenon quite well in his work. (So no, Jeremy Grantham has not lost his mind. He is, instead, in full possession of it.)
One of the more important insights that can be derived from West's work, is that growth can continue for a short while even as systems mature through the process of harvesting efficiencies. In other words, systems – such as cities – can continue robust growth after their initial growth phase by turning to economies of scale and other technological improvements. But this phase of a system's growth tends to be terminal.
And it's very likely the phase that the U.S. has now entered.
The Growth Problem is Not Limited to Energy and other Natural Resources
When observers first hear of these ideas, there is a knee-jerk impulse to reject or even attack such views simply because many are not acquainted with the scholarship. But Grantham identifies other trends in a maturing United States economy that should have been more easily recognized.
For example, birth rates in the United States, which have been gently trending downwards for some decades, have undergone a more pronounced decline since 2008. As a result, last year U.S. birth rates fell to their lowest ever recorded. It's hardly a surprise that the greatest economic shock and decline since WW2 would produce a sharp response in U.S. birth rates. But the surprise is that observers in the financial sector, who regard themselves as numerate and data-oriented, would be ignorant of such trends and offer up "bafflement" as to why Grantham was calling for a secular phase of below-trend U.S. growth.
I think the pushback against Grantham, who is really just aggregating the scholarship of other writers, now appears because the tangible experience of "slow growth" is now coming more clearly into view and can be quantified. Therefore the attempts to push back against these views as either doomerish or ideological are not sticking, in part because the OECD has now very clearly trended towards a much lower growth rate, with little prospect of change.
So, let's look at Grantham's numbers. As a result of the various factors discussed here, the rate of US growth is now forecast to run at barely 1.00% until 2030.
Let me make what I think are the two most important points about such a forecast:
Ignoring Grantham and Basking in Energy Abundance
The public does not wish to focus on Grantham's message, but would instead prefer to rely on the IEA's recent forecast for oil supply growth in the U.S. As I have acknowledged in previous essays, while we remain in the domain of Peak Oil, we are not in the domain of Peak BTUs. The world still has plenty of coal and natural gas to burn, as has been proven over the past four years. We are not facing Peak Energy (yet). But we do face a growing liquid fuels crisis.
In Part II, Dissecting the Energy Boom Story, we will review the latest data showing a slight rise in global oil production – the first in nearly eight years. We will critically asses the IEA forecast for U.S. oil production by 2020 and discern whether this changes the Peak Oil story. Moreover, it is also time to make an oil price forecast for 2013, given the probable economic forecast for next year.
Click here to read Part II of this report (free executive summary; enrollment required for full access).
By Gregor Macdonald
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June 10th, 2023
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