AI 15: World faces slowing growth, says GMO's Grantham

As part of our 15th anniversary celebrations, AsianInvestor asked Jeremy Grantham, co-founder of GMO, the Boston-based partnership, to give us his predictions about the global trends that will shape the next 20 years. The second part of the interview will be published tomorrow.

Q You’re famous for long-term outlooks. What factors do you rely on to make such forecasts?
A There are three big issues for a 20-year horizon: population, resources and climate. Let’s talk about population change first. In 20 years it will be a different world. Growth rates for all countries, particularly developed markets, have slowed dramatically since the 1960s. In 1962 or 1963, professional authorities gave no hint that population growth rates were about to slow. It was a huge shock that developed market populations grew below replacement rates. In the future, a declining population will be good for sustainable living, but in the short term it has a wicked effect on GDP.

How does a slowing population rate impact the economy?
GDP is simply population multiplied by productivity, which is everything else. I discovered a few years ago that the Federal Reserve, the World Bank, the International Monetary Fund (IMF) – they all missed the fact that the number of hours worked had dropped by 1%, but their growth forecasts hadn’t changed.

All the big institutions’ forecasts for developed countries were for 3% GDP growth, but there had been a 1% drop in the working-age population profile, especially in Europe and Japan. The analysts blew it.

Blew it by how much?
Productivity in the US has grown over the last 30 years by only 1.3%. I calculate the US has only had an increase in working hours of 0.2%. So together you get 1.5% GDP growth, not the 3% that has been everyone’s assumption.

In the past two or three years, since we first published research about population, other groups’ estimates have started to come down. The IMF and World Bank are now expecting 2.2% GDP growth in the developed world, and the Fed is around 2.5% for the US. I think these estimates will continue to decline until we reach 1.5% or below.

What does that mean for economic activity?
In the US we grew up with aspirations of 3.5% growth, so 1.5% is less than half of that. We’re not used to it. Read the language of business today, you won’t see it.

What about resources?
The only thing Keynesians and Austrians have in common is that neither of them get resources, they ignore it. At GMO we describe their views as “capital plus labour plus a perpetual motion machine”.

There is no inkling in the work of [John Maynard] Keynes or [Joseph] Schumpeter that resources are finite and run out. Their followers disagree on everything else, but someone should realise that resources are a big issue.

In the sense that…?
They have been a big drag on economic growth. Just as a decline in the working-age population came as a surprise, so did the great surge of Chinese growth up to 2008.

The Chinese maintained that surge longer than most people thought they could, and so everything in the world of commodities got tight. China consumed 10% of the world’s coal 20 or 25 years ago, but last year it consumed more than 50%. China uses about 50% of the world’s iron ore, it uses half the world’s cement. These are astronomical numbers; it has been revolutionary.

How does that explain the drop in oil price?
During the height of the China boom, from 2000 to 2008, prices for all commodities went up. Half of the input cost of every commodity is oil. The price of a barrel of oil in 1999 was $16, and it went on to peak at $145 in 2008. Prices for phosphate, copper and other metals doubled or tripled; phosphate pushed up the price of grain, which tripled.

We have an index of 33 commodities, which made a bigger move in 2000 to 2008 than it did during World War 2. You can’t have a country of 1.3 billion people compounding demand for long without burning through cheap resources.

But the US energy revolution continues to add new supply.
The current glut of mad-dog US frackers says nothing about the cost of finding oil. Wells are getting deeper and extraction is getting harder every year.

Shell and ExxonMobil need oil to be at $80 a barrel to break even; to really cover the risks of extraction, they need oil closer to $100/barrel. So we are at the end game for resources. I continue to be impressed by how easy it is to bamboozle stock-market types into thinking we have a surplus because of a temporary glut.

So the energy revolution is a mirage?
We have run out of cheap oil. Fracking is not cheap. We are running through our copper, nickel and zinc.

Oil at $50/barrel is an oddity caused by the economics of fracking. Frackers can put in one well next to another, but each well delivers 40% of its total output within the first year. Compare that to the Saudi oil fields that were dug in the 1940s and are still going strong: they just pump and pump.

Fracking involves blasting the rock to get a big surge, but after three years you’ve extracted 80% of everything you’ll ever get from that well. But you can drill a well in just 10 days, which makes a field look like a reserve. Over the next several years, the surge of fracking will slacken, and the marginal pricing of oil will move back to traditional oil fields, or to offshore oil.

Meaning higher oil prices in the near future.
The price will return to $100/barrel or more, and that will act as a brake on global growth. The next few years won’t be like 2006-2007, when the world economy grew at 4% or 5%. That sort of growth rate is absolutely unsustainable. It was made possible because of an amazing 250-year window of cheap energy. That window is closing.

Will it leave us high and dry? Or will we develop alternative sources of energy that will keep us all going?
It’s a very close race between the loss of cheap fossil fuel resources and the development of brilliant alternatives. I’m more optimistic than [Thomas Robert] Malthus, but more pessimistic than cornucopians who believe human brains will always overcome adversity.

How does limited fossil fuels relate back to the population issue?
How we cope with this situation depends on how we feed 10 billion people given continuing soil erosion and depleting the fertilisers we have to mine. Big Agriculture uses potash and phosphate to fertilise soil that have been sterilised with pesticides. We can’t go on living the way we do without potash and phosphate, but they are finite resources. Soil is eroding at 1% per year.

Therefore we have to change agriculture, because feeding the world will become more difficult; it will become a bigger problem than energy. If we can’t feed people, it could knock a big hole in the capitalist system.

Tomorrow Grantham discusses climate change, India's prospects and the impact of rising US interest rates. The full interview can be read in the current (May 2015) edition of AsianInvestor.