Thursday, August 7, 2008

GMO - Jeremy Grantham: Q2 Letter

In the meantime, we are living increasingly beyond our means, and Mr. Market is about to help us reconsider our behavior. This century will likely see the end of the Industrial Revolution and the age of “limitless resources.” Higher prices and (hopefully) voluntary improved behavior will together usher in the post-Industrial Revolution phase of limited resources and frugality. We will all modify our behavior and probably quite fast. We will all re-adopt Yankee virtues (or Yorkshire virtues, I might add) of “waste not, want not,” and get accustomed to using our brains instead of our hydrocarbon brawn.

The prices of commodities are likely to crack short term (see first section of this letter), but this will be just a tease. In the next decades, the prices of all future raw materials will be priced as just what they are: irreplaceable. Oil, for example, will never again be priced on the marginal cost of pumping a marginal barrel from some giant Saudi oil field, as has been the practice for most of the last 100 years of oil production. Real cost is always replacement cost and oil, a precious feedstock for chemicals and fertilizers, simply cannot be replaced. Using marginal cost as a substitute was ignorant and conducive to wasteful consumption of scarce energy resources. It also enabled us to put our collective head in the sand and ignore the growing need for an enlightened long-term energy and climate policy.

Relatively quickly, in 100 years or so, we will run out of oil, underground water, and most non-fully-renewable resources. At current rates, we will do it very, very fast. A major complication now, though, is that we have been brainwashed by repetition to reject this whole idea as irretrievably pessimistic and defeatist, and just well ...thoroughly un-American.

One of the most unfortunate features of our sustained ability to overcome presumed limitations by applying technology is in the dangerous overconfidence it has given us, particularly in our casual and profligate use of resources. Starting now, higher prices will steadily overcome our optimistic assumptions and change our wasteful behavior. We must remember that, after all, in the wolf story, the wolf finally comes.