Why a Focus on Short-Term Profits Won’t Hold Up Against Climate Change

Dan Lefkovitz: You spend a lot of time thinking about climate and environmental issues more broadly. Renewables have clearly made a lot of strides, electric vehicles, and yet carbon emissions remain stubbornly high. Curious as a climate solutions investor, what you’re excited about these days?

Why a Focus on Short-Term Profits Won’t Hold Up Against Climate Change

Jeremy Grantham: Well, what I consider important is the ability of senior people to miss the point. Climate change is like some giant python. It’s got us gripped, and it isn’t squeezing that tight yet. But each year, it’s getting a little tighter, and it shows no inclination to go away, and we’re ignoring. If we continue to take climate change this lightly, if we continue to protect our short-term profits, and ignore longer-term consequences to the general world, we will have a very hard time maintaining a stable world, stable social, stable corporate, stable anything. And I would say, to me, on a global basis, it looks like we’re quite a handful of years into a destabilizing mode, and the climate change has a lot to do with it.

If you look at a hit list of the billion-dollar weather-related, climate-related penalties, fires, floods, droughts, adjusted for inflation, they’re very low on the left of the exhibit, and they rise dramatically multiple times until last year, this year. World record numbers. Somewhere in the world, there are billion-dollar climate-related accidents, events occurring all the time. So, that’s step one, the reality of it.

But these are all loaded later in time as we approach a level where you can’t go out and farm on the Indian subcontinent. A couple of degrees warmer than this, a bit more humidity, and humidity increases in a mathematically certain way with temperature. The hotter air carries more humidity. Humidity causes more heavy downpours, more dangerous floods. And I think that is the most reliable thing we’ve seen for the last five years is a dramatic, how-could-you-miss-it increase in heavy, expansive, dangerous flooding. And then close behind it, dangerous droughts. And the droughts are not because of less rain. The droughts are because temperatures are so high that they’re taking the moisture out of the soil and the forest so dramatically that you have trouble getting a decent crop. And then of course fires. With the moisture lacking, any accident will start a forest fire, and that is truly obviously dramatically increasing. So, if you live in a big forest in the west, you have to be worried. If you live in a low-lying piece of land, too, then the water level rising already by quite a handful of inches. And down the east coast of America, there are many important cities that are certainly going to have their time cut out building seawalls and protecting. In the case of southern Florida, most of it is indefensible. We are guaranteed to have water-level rises that will make it impossible to live on the water’s edge.

And right up until the other day, you could get insurance. Now you can’t. And right up until the other day, you had a generous increase in housing being developed in these critical, dangerous zones. And even more implausibly in a way, the prices were rising faster than anywhere else. Now for a couple of years, the prices have been rising faster elsewhere. And people are beginning to get the point that insurance is going to be only accessible through state subsidies, that is, load the burden onto the general taxpayer, for you having been nitwitted enough to build and live in the house in the flood zone. And half of Florida is in the flood zone, but almost all of Miami is.

And so, we’ve seen these hazing increases, obvious. And every scientist in the climate business was defining this 30, 40 years ago. These were all inevitable. And yet, we acted as if it was never going to flood in Miami, and so on, as if it was never going to catch fire in the forests of California. And the insurance companies were very slow on the uptake, not now, but they were very slow to get the obvious point. So, everything is changing. And these are very destabilizing forces. And the biggest one waiting in the wings is food and farming. At this rate, it is more than just probable, it is highly probable that in the Indian subcontinent, they will not be able to farm as they currently do with hours out in the hot sun. Three hours of 100 degrees with humidity and your internal organs begin to fail, and you start to die. And if you look at the number of deaths attributed to heat, they’re very small today, but they are rising very rapidly, 15%, 20% the last two or three years. And these things are not gentle. They’re going to explode one day. And we’re going to realize what a high price we pay. Particularly in farming, you’re simply not going to be able to grow food on the Indian subcontinent in a way that can feed your 2 billion people.

What the US Can Learn From China’s Progress on Climate Change

Christine Benz: You’ve made the point that China has made some great strides on the climate front, yet it’s not received much attention. I’m wondering if you can talk about that and also talk about potential takeaways for the US. What can we learn from some of the things that China’s done?

Grantham: Obviously, China has a very different system that gives them certain cards they can play and certain cards they can’t play. But when it comes to the commons, capitalism doesn’t do tragedies of the commons. If you’re allowed to pollute the air, you do. You’re not going to spend more than a penny or two to reduce your CO2 or your methane output if you don’t have to, because they believe the executives that they’re then vulnerable to a suit from their stockholders that they’re not doing their job. So, we only follow the law of the land. The law of the land lets us get away with polluting water and polluting the air, we do. And in China, they can finally say, don’t do this or we’ll put you in jail. And it concentrates the mind wonderfully, and things happen very fast.

The cliché—and politics is kind of a rolling cliché, isn’t it? Some idea gets accepted. And the moment—China is the villain and therefore China can do no right, and why should we worry about climate change because China does this, that, and the other. Point number one is no country, and notably, the US, has ever given up any growth voluntarily in order to improve the climate or to protect a local butterfly or anything ever. You only do what legislation tells you you have to do, or they’ll fine you or slam you in jail. And China has the luxury of many scientifically sophisticated leaders. Sometimes their central committee is dripping with Ph.D.s. Almost no one in Congress fits that description. So, they can at least appreciate and understand the problem. And China is right in the line of fire of so many of these things. It is not a marginal player. It is really going to suffer from climate change more than most people. Its air was super polluted. Now it’s just heavily polluted, but they’re improving very rapidly.

Anyway, they recognize that pollution and smog and deaths and so on was a political issue, which they don’t like. And so, they started to move against it. And the speed with which they are gobbling up the green industry is quite remarkable and has been very obvious to anyone who looked at it. But last year, they installed 75% of the wind that we have ever installed in 60 years, added together. In one year, they did 75% of all the US wind power. But in solar, it’s better because they did measurably more last year than we have ever done collectively over the years in the US. I mean, just think about that. That is amazing, isn’t it? This is perhaps the most obvious long-term, intermediate-term problem. And they’re able to do in one year what we’ve taken 20 years in solar and 40, 50 years in wind. They produce 80% of the world’s solar panels. A solar panel, if we allowed them in tax-free, is a third of the cost that we pay in America: $0.10 per megawatt versus $0.30 or something like that, and in Europe, it’s $0.20.

And there’s so much progress, however. Solar panels have come down so rapidly in price that now the cost of installation and the cost of administration, bureaucracy, are much bigger. Each of those two are bigger now than the cost of the solar panel. And China produces 90% of the material, specialized silicon, that makes solar panels. They have a death grip on all of what I call the green metals. Lithium is processed 80%-plus in China. Cobalt, 80%, 90% processed in China. And nickel, not so much, but still a handsome chunk. They are building, as we said, more than half of the world’s nuclear generation is going up under construction in China. These are not trivial fractions. China is not 50% of the world’s economic GDP. Hydropower, they develop further and faster than anybody else. What can they do that they haven’t done? EVs, they’re building—over half of all the EVs under construction today are in China. Their fleet is now 25% versus, you tell me, 5% or 6% in the US or less.

And that’s what we should be doing. The US should be leading. You can’t lead overnight. I feel for the effort now being made belatedly. But to catch up, when the other guy had a 15-year running start, you can’t do that overnight. You just have to plug away. And it becomes very expensive when you let them get that far ahead. And it is very expensive. So, we will not be putting in nearly as much solar, which is desperately needed, because we are willing to tax them so highly, 100% tax. And I get the point why you would want to tax them. But I also get the point how tragic it is that it will slow down our installation of solar power, because we feel we have to produce everything now in the US. How much better it would have been to maintain a strong position over the last 15 years. But water under the bridge.

How Investors Can Make Their Portfolios More Environmentally Friendly

Lefkovitz: So, Jeremy, what would you suggest for the investors out there who want to make their portfolios more environmentally friendly or align them more with climate?

Grantham: It’s a nontrivial issue. My personal attitude is to try and look out 10 years and try and imagine what the world will be like and dissociate myself from the things that are involved there, fossil fuels, and so on. Recognizing that these are commodities, they will rise and fall and drive you crazy before 10- or 20-year period is gone. But in the end, it’s inevitable. In the end, we’ll all be driving nonfossil fuel vehicles or taking electric buses or whatever. China, by the way, makes 90% of all the electric buses in the world. This is not 19%, this is 90%. These numbers are just crazy.

Many firms out there are tilting portfolios in a useful way. That won’t guarantee you success in one year or even three years. But it will more or less guarantee you some success, I think, over 20 years. At GMO, we have portfolios that overstate green progress, understate fossil fuel, and so on, and don’t deviate from the indexes by more than something like a point and a half. These are very useful products, and I’m sure other firms can try and do them. I think we’ve had something of a start thinking about them. But that’s what you have to do. You have to just tilt and hold it for long periods of time and recognize that in anything that looks faintly like a commodity, you are going to have moments of incredible pain and regret. And you have to play for the long term because commodities just do not, they’re not conducive to short-term guarantees. That’s why incidentally, they’re always cheap because it’s so unbelievably unpredictable. And because they’re always cheap, they have actually a pretty decent lifetime performance.

And for the record, a resource fund such as one at GMO is the only thing you can find that is over 10 years negatively correlated with the balance of your portfolio. Industry subgroups are incredibly highly correlated over one year, three year, five years, 10 years. If you get it down to 0.8, 0.75, that’s massive. But by five years, a resource fund is 0.25, and at 10 years, it’s actually insignificantly negative. It tends to go up when the balance of the portfolio is going down. And you can see why. If you have to pay a massive increase for your metals and your oil and your raw materials and your food, of course, that’s a drain on the balance of the economy. So, the logic is pretty straightforward.