17 October 2011

The Government of Singapore Investment Corporation (GIC) invested 11 billion Swiss Francs in UBS in Dec 2007 (LINK) and USD$6.88 billion in Citigroup in Jan 2008 (LINK). GIC plans to hold on to these banks for a long time or, in Tony Tan's words, "many years":

We look to continue to hold on to our stakes in UBS and Citigroup for many years to come. - Tony Tan, GIC's former executive director (Bloomberg)
But our investment thesis for Citi and UBS was based on our assessment of their long term business potential. - Ng Kok Song, GIC Chief Investment Officer (Reuters)

These two banks have weathered the crisis; the worst is behind them. Both banks have returned to profitability over the last two quarters. We're long term investors, so we're quite prepared to stay with them. - Ng Kok Song (The Business Times)
How long is "long term"? What is meant by "many years"? The GIC website offers an answer:
As a long-term investor, GIC’s performance should be measured over a suitably long time horizon...A 20-year period is appropriate as it spans several business cycles and hence encompasses a number of market peaks and troughs. Thus our investment horizon of 20 years is matched by the 20-year annualised real rate of return metric, which is the key focus for GIC. (Page 8 of GIC's 2010/11 Portfolio Report)
GIC invested those billions in 2007/08. If they hold on to these two banks for 20 years, what will be the returns in 2028? Most likely a significant negative return; in fact, I got a strong feeling they might loose all the billions that they have put into these two banks.

Why? Simply because Peak oil, which we are at now, means the end of future economic growth. Peak oil entails declining economic activity. Declining economic activity means businesses don't make more money, or instead they lose money. You don't expect the banks' shares to rise in this kind of situation. I believe global economic activity is going to contract permanently. The flat world is going to be smaller and rounder again. Energy is the master resource and oil is the most important energy source today in the industrial world. There are no viable energy substitutes for oil which can match its net energy returns, energy density and versatility.

The break-even oil price for Saudi Arabia is USD$83-$88 per barrel in 2011. Their break even oil price was USD$30 in 2003. So it has almost tripled in the last 8 years. Welcome to the age of expensive oil. If the world's economy does recover, high oil prices will be there to bring it down again. With the end of cheap oil now, it is expensive and hard to do business. Little wonder it was reported that GIC says the investment climate is challenging.
The Government of Singapore Investment Corp., the city’s sovereign wealth fund, said the investment environment remains “challenging” as inflation risks increase and the recovery of developed nations falter.
“The sustainable recovery of the developed economies remains uncertain, while the emerging economies face challenges in restraining inflationary pressure and currency appreciation,” Chief Investment Officer Ng Kok Song said in an e-mailed statement today that accompanied the report. “GIC will continue to respond nimbly to this challenging environment.”  (Bloomberg)
If you disagree that future oil supplies cannot match world demand, or if you think alternative energy sources can be easily ramped-up and substituted for oil, I strongly urge you to read A Guide for the Perplexed Energy Policymaker by Kurt Cobb.

So why did GIC invest in UBS and Citigroup? Fundamentally, I believe GIC has failed to anticipate or understand the paradigm shift in our economies as it relates to net energy returns (EROI), peak oil and the environment. It is no longer "business as usual" for the next 20 years. To quote scientist Chris Martenson, The Next 20 Years Are Going To Be Completely Unlike The Last 20 Years. Whatever dreams of the 5 Cs and secure savings for retirement that you had are going to be just that, dreams alone and not reality.

No amount of monetary stimulus, quantitative easing and interest rate tweaking by central bankers is going to promote real economic growth for any extended number of years because it is going to be kept in check by resource depletion and a finite environment. The "Limits to Growth" book as it was first written in the early 1970s by MIT scientists is going to gain credibility in future years.

I have no idea what the directors in GIC were thinking when they made the plunge into UBS and Citigroup, but one thing I can be sure of is that they were thinking mainly in monetary terms. What do I mean? If you look at GIC's Board of Directors, most if not all of them have (not surprisingly), a background in economics, business and finance. Duh, what did I expect?

Well, here is an axiom for you which is not taught in mainstream economics: the human economy/market is a subset of the ecosystem. This is the foundation of Ecological and Biophysical Economics. Think about all the natural resources that Man extracts from the environment and transforms for his consumption and use. Think about all the energy that we consume that is central to all economic activity. Without energy, there is nothing. Without natural resources, there is nothing. And yet, there is no one on the GIC Board who is a natural scientist and probably not one who applies the natural sciences to economics to advise them on the limits of physical growth. We cannot separate economics and finance from the natural world!!! While the economists and bankers in the GIC Board think of their investments in dollars, scientists are trained to think about the energy inputs needed to make things work and their ecological impacts.

Many mainstream economists attribute the current financial crisis to the US housing bubble, excessive lending, high debt levels and a lack of government regulation as root causes. But ecological and biophysical economists (those who apply the natural sciences to economics) see things differently; they attribute it to the scarcity of natural resources and its inability to keep pace with financial assets and debt as the cause of our present troubles (see Herman Daly).

The environment, energy and economy are inextricably linked. A sustainable future requires not only green and efficient buildings, technologies and machines, but also an overhaul of the financial system and our perception of wealth, work and leisure.

But unfortunately, bankers, economists and financiers run (or should I say rule) the world through the current financial system of Fractional Reserve Banking through which money is created. Thus they have a vested interest in maintaining the status quo of perpetual economic expansion which is necessary to keep this money system afloat, in order that interest-bearing debts may be repaid. Greed and money are their gods. However, growth in the current monetary system and growth in the physical world are incompatible. The originator of the Peak Oil model, M. King Hubbert, had this to say:
For various reasons, it is impossible for the matter-energy system to sustain exponential growth for more than a few tens of doublings, and this phase is by now almost over. The monetary system has no such constraints, and, according to one of its most fundamental rules, it must continue to grow by compound interest. This disparity between a monetary system which continues to grow exponentially and a physical system which is unable to do so leads to an increase with time in the ratio of money to the output of the physical system. This manifests itself as price inflation. A monetary alternative corresponding to a zero physical growth rate would be a zero interest rate. The result in either case would be large-scale financial instability. (Source)
Thus I say, as a layperson, to GIC and also to Temasek Holdings and MAS, reexamine your beliefs in the free market and reconsider your basic assumptions about perpetual economic growth because there is going to be an upheaval in the current monetary system. Whatever hundreds of billions that we have in Singapore's reserves may very well end up as toilet paper because of ecological destruction and resource depletion. Real wealth is found in nature which provides all the goods (metals, energy, soil, air, water) and services (air/water purification, pollinators, recyclers, decomposers) that we need. Mankind is killing the golden goose because of greed. We should rely less on international trade and work towards self-sufficiency and the localization for our economy. There is no way the industrial world with its prodigious use of oil inputs is going to continue for long.

Further Reading: http://www.postcarbon.org/article/178709-the-end-of-growth

End of Growth Videos:

I leave you with this research nugget about peak oil and its impact on the economy by two scientists who conclude the following:
For the economy of the U.S. and any other growth-based economy, the prospects for future, oil-based economic growth are bleak. Taken together, it seems clear that the economic growth of the past 40 years will not continue for the next 40 years unless there is some remarkable change in how we manage our economy. (source: Google Docs)
Adjusting the Economy to the New Energy Realities of the Second Half of the Age of Oil