At last week’s TED 2010 conference in Long Beach, California, I gave a short talk about what I called “the most important bet in history”: the Simon/Ehrlich bet on commodity prices. This year marks the 30th anniversary of that bet’s start date.
By way of refresher, the situation was this: After a decade of soaring commodity prices, plus related worries about resource scarcity, in 1980, Paul Ehrlich, a dour population ecologist, took up Julian Simon, a cornucopian economist, on a bet. Ehrlich (on paper) put equal mounts of money into five commodities (he selected chromium, copper, nickel, tin and tungsten) whose prices would, he thought, be higher a decade later. Higher prices meant Ehrlich won; lower prices meant Simon won. The loser paid the winner the difference.
Ehrlich lost. A decade later, in 1990, all five commodities' prices were lower than they were in 1980. Unhappy at the outcome, Ehrlich complained that he hadn’t really wanted to bet on commodities in the first place. He offered Simon a new and more complex series of decadal bets – including things like carbon dioxide, AIDS prevalence, area of viable farmland, and so on. Simon turned that bet down, comparing it to betting on a football field’s condition rather than on the game’s outcome. There never was a second Simon/Ehrlich bet, and Julian Simon died in 1998.
The bet changed economics and the environmental movement. It made the former even more insufferable than usual, convincing many economists of the god-like power of price in bringing new supply and substitutes in commodity markets. At the same time it made environmentalists jittery, introducing overdue doubts about the entire idea of resource scarcity. If raging population and economic growth don’t cause important resources to be depleted, what will? Today, twenty years after the bet’s end, and three decades after its start, the Simon/Ehrlich bet’s outcome is still widely-cited (just try to bring up “peak oil” with a Chicago-school economist, go on – I’ll wait), even if the bet itself is understood only in superficial terms.
Given its 30th anniversary, and with commodities in the news – especially oil – I thought it was an apropos time (and TED an appropriate venue) to revisit the bet’s context, outcome, controversies and implications.
Without getting into it too deeply, here are some things worth knowing. Given the above graph of the five commodities’ prices in inflation-adjusted terms, it will surprise no-one that the bet’s payoff was highly dependent on its start date. Simon famously offered to bet comers on any timeline longer than a year, and on any commodity, but the bet itself was over a decade, from 1980-1990. If you started the bet any year during the 1980s Simon won eight of the ten decadal start years. During the 1990s things changed, however, with Simon the decadal winners in four start years and Ehrlich winning six – 60% of the time. And if we extend the bet into the current decade, taking Simon at his word that he was happy to bet on any period from a year on up (we don’t have enough data to do a full 21st century decade), then Ehrlich won every start-year bet in the 2000s. He looks like he’ll be a perfect Simon/Ehrlich ten-for-ten.
So, what does all this mean? A few things. First, and most importantly, it means Simon was right but fairly lucky. There is nothing wrong with being lucky, of course, but compulsive Simon/Ehrlich-citers need to be reminded that it is no law of nature (let alone of rickety old economics) that commodity prices (inflation-adjusted or otherwise) trend inexorably downward, even over a decade. Yes, high prices will usually mean low prices, because of substitutes, changed behavior and new supply; but you could equally argue that low prices will mean high prices, especially given rapid population and economic growth globally. In the interim, the volatility – price spikes and price collapses – can break you, whether you’re a commodity trader or merely a user of said resource. It is of precious little use to know that one day prices will be lower if you don’t survive the period when they’re higher.
And that brings us back to oil. As the cliché goes, the oil age will end before we run out of oil, but, cleverness of the construction aside, that phrase is pointless and should be retired. The important thing is not whether the oil age ends, because it will, or whether we will run out of oil, because we won’t; it is how we get from here to there, both in economic and in societal terms.
In the coming years, assuming we don’t sink back into economic depression, energy markets will repeatedly probe big oil buyers’ elasticities of demand – how do you like that high price? yeah, how about this higher one? and this higher one yet? – until it finds a price where supply and demand match up such that inventories rebuild from recent nervousness-inducing levels. That elastic buyer is, for practical purposes, the U.S. – it is the largest per capita buyer of market-priced oil: neither heavily taxed nor subsidized – which means that energy market’s price spikes will hit here hardest over the next few years.
Once the market breaks the largest and most elastic buyer’s back, which it will, whether smoothly or through ugly societal and economic disruption, prices will decline in a way that would have made chipper cornucopian Julian Simon even happier than usual. But you/we/I/them/us have to get there first. And that requires thought and planning, not just the ritual incantation -- “Yeah, but Julian Simon’s bet showed that …” – of a smart but lucky economist’s name.