Aaah, the French

–Oh la la! Just when markets were finding their feet again they’ve been slapped down. The slapper this time is a widely circulated rumour that France will be the next country to have its credits guillotined by Standard and Poor’s. French banks sold off. Aaah the French, as Orson Welles might say (very sad).

–US stocks did not react well to the latest chapter in Europe’s debt crisis. The Dow Jones Industrials fell 4.62%. All 30 Dow components fell. And something else noteworthy happened. Apple (NASDAQ:AAPL) became the largest public company in the world, at least in terms of market capitalisation.

–Apple is not a Dow component. But Exxon Mobil (NYSE:XOM) is. And with a market cap of US$337 billion, Apple is, at least for a day, bigger than XOM at $330 billion. Interesting. But useful? Maybe.

–Apple is the quintessential post-industrial company. It outsources the manufacture of its hardware to Chinese robots. Its competitive advantage is in its ability to innovate and always be on the cutting edge of commercial electronics. Its profits come from the value of its intellectual property and its brand loyalty.

–Exxon is an industrial giant. It’s the world’s largest publicly traded integrated oil company. By integrated, we mean it explores for energy at the source (upstream), refines it, and distributes it at the retail level (downstream). Its profits hinge on the price of a barrel of oil. Its market value depends on the oil price and whether Exxon can replace the oil it’s produced with new reserves.

–Apple is the beating heart of the post-industrial West. Its devices mediate the connections made in the limbic economy. A bet on Apple is a bet that technology and innovation are the growth businesses of the next 20 years. It’s been a good bet for the last 20 years.

–That said, we’re going to stick with energy. It’s the one basic input into all economic activity that seems bound to get more expensive as it gets scarcer. Innovation in energy is the Holy Grail for many investors. But a more reliable bet can be made by understanding the shifting dynamics in the old energy economy. To that end…

–“Shale gas shaping up to boom,” reports Angela Macdonald-Smith in today’s Australian Financial Review. “Australia is set to be the world’s biggest shale gas producer after the US and will attract a wave of investment by specialist North American companies seeking to replicate the success they have seen in their home market,” she reports.

–She was quoting Andrew Moorfield, the head of oil and gas at Lloyds Bank in London. She may as well have been quoting from us in Revolution in the Desert! Mr. Moorfield told a group in Sydney, “This century is all about gas; last century was all about oil. If this century is all about gas, it’s all about security of supply, stability of supply, and that really means it’s Australia and Qatar. I would argue that Australia has bigger advantages to Qatar.”

–Naturally we felt the same way. We’ve recommended three potential shale producers in Australian Wealth Gameplan. The last week has not been kind to them. But it’s important to distinguish between the financial markets and the real economy at a time like this. The financial markets are tempestuous. In the real economy, the relentless search for energy goes on. Shale will play a part.

–At least we think it will play a part. We’ve been ruminating on the many letters from readers about shale gas. Some are on board. But for those who aren’t, it comes down to two objections. First, that it’s unethical to profit from an extraction method that’s inherently damaging to the environment. Second, that continued investment in fossil fuels represents a kind of final pillaging and pollution of the Earth.

–These are pretty fundamental objections. We’re not sure we’re going to change anyone’s mind by addressing them. But we’ll have a crack. To the first, that profit is unethical because the method of extraction is deliberately abusive, we think people are confusing exceptions with rules. What do we mean?

–Many of the letters we got about shale gas assume that oil and gas companies (or all companies) will always cut corners to boost profits. When “cutting corners” means polluting the water and poisoning the land, corporate profits come at the expense of public health. This seems to be the argument. Is it true?

–In any market—baking, sushi, pink bat installation—there will always be marginal players who cut corners to boost profits. These marginal players are almost always breaking the law. And when they’re found out, by either consumers or regulators, they’re almost always out of business.

–We’d contend that the vast majority of small businesses and enterprises make their profits the old-fashioned way: they earn them! They don’t lie, cheat, steal, or deceive. We’d further argue this is true of the oil and gas and mining industries. The huge majority of companies comply with a complex array of rules and regulations in order to produce commodities and earn a profit.

–The trouble for the oil and gas industry—which we have no interest in shilling for—is that its profits have been so large in the last 20 years that the public is convinced they must all be illicit and immoral. And that the corners cut to find and produce energy are creating long-term public health problems.

–There are marginal players in the oil and gas industry that cut corners and do environmental damage as a result. But does the whole industry work that way? Definitely not. Should we eliminate the whole industry to address the behaviour of the bad actors within it? Only a moron would say yes to that. There are a lot of morons in politics.

–The second objection to fossil fuels is a kind of world-weariness that we don’t know how to resolve. It’s more of a zeitgeist than an argument. It’s motivated, we think, by a feeling that the world is in danger of tipping into an ecological crisis because of over population and too much fossil-fuelled growth; that we’re running out of resources to physically support this much life on the planet. Hmm.

–There’s certain symmetry between this argument and the collapse of the world’s complex financial system. Both are “complexity catastrophes” where complex systems reach a tipping point and fall into the loving arms of entropy. It’s very romantic in a fatalistic sort of way, like Romeo and Juliet.

–The trouble is, it’s never been true—the part about the planet exhausting its resources. Thomas Malthus said it years ago. And Paul Ehrlich said it in the late 1960s in his book Population Bomb. Were they both wrong? Or were they right but just not yet?

–Ehrlich and Malthus are wrong for the same reason Marx was wrong about capitalism: they all failed to appreciate that human beings have the capacity to adapt. Indeed, adaptation is our chief survival skill. Human action at the individual level—the ability for people to know what’s best for them and act to obtain it—is the variable most consistently forgotten or under appreciated by central planners and Malthusians.

–Take the chart below, for example. It’s what exponential growth looks like in any system. Exponential growth is the regular expansion of something at a fixed rate. In a system constrained by real resources—food and energy—growth has limits. The real question is whether the system will hit those limits, or whether people begin to modify their behaviour before physical constraints start to impair the system.

Population Vs Time

–So, yes, it’s possible the global economy, fuelled by cheap energy and cheap credit, is on a freight train to systemic collapse. But that assumes that all the variables contributing to growth—cheap credit and cheap money especially—stay the same. Clearly they’re not.

–In fact, the increase in the price of money and energy is what’s going to regulate the growth of the system. It’s expansion has been artificial and rapid and unsustainable. The result is trillions of dollars of misallocated capital and real resources. Correcting that misallocation is what the Great Correction is all about.

–We’re not saying it won’t be economically and socially disruptive. It’s already both. But unless the limbic democracy we live in expresses a death wish, we think people will begin doing what you did when you became a Markets and Money reader, opting out of a system that destroys wealth and happiness and critical thinking.

–The scary thing about limbic democracy is that individuals in a crowd do not behave like individuals. The crowd itself becomes a phenomenon and acts in an emotional (usually destructive way). Think of the French Revolution. Aaah the French!

–If THAT is where we’re headed, then the transition from the high-growth years to growth built on sound money is going to be…pretty unpleasant. More next week on how to make it less unpleasant.


Dan Denning
Markets and Money Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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2 Comments on "Aaah, the French"

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I have to wonder, Dan, if you would include companies like BP and Exxon in your list of “marginal players in the oil and gas industry that cut corners and do environmental damage as a result”…hmm? To me, this line of thinking reeks of the old talk about “a few bad apples” back when the Enron debacle exposed the tip of the corporate corruption iceberg. I’m no more inclined to trust in the environmental integrity/sincerity of the shale gas drillers than I am in the oil drillers – and I don’t care how profitable it may be. If we keep… Read more »
Most strawmen are more complete than this one. Firstly, the evidence of damage to ground water is varied and incomplete. The understanding of groundwater systems is really poor. If you can’t model it, don’t play with it, is a conservative and prudent position, not an emotional position. From nearly all sites an aggregation of CSG from several sources is required to make processing feasible (to process into a form that can be transported). These conditions require reserves to be concentrated in 1 district. When we talk about proven reserves we get into the NYT Times case that the figures are… Read more »
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