Bleeding Edge

“It is the mark of an intelligent educated mind to be able to entertain a thought without accepting it.

Of an even higher intelligence is the mind that is able to entertain conflicting thoughts without prejudice and preference until such time that the merits of each are fully manifest and thus allow for the correct choice”

-Aristotle

But that was just the beginning.

Because now you have to brace yourself…

You may not be able to tell yet, but according to global experts and the U.S. intelligence community, the Earth is already shifting under you. Whether you know it or not, you’re on a new planet, a resource-shock world of a sort humanity has never before experienced.

Two nightmare scenarios—a global scarcity of vital resources and the onset of extreme climate change—are already beginning to converge and in the coming decades are likely to produce a tidal wave of unrest, rebellion, competition and conflict. Just what this tsunami of disaster will look like may, as yet, be hard to discern, but experts warn of “water wars” over contested river systems, global food riots sparked by soaring prices for life’s basics, mass migrations of climate refugees (with resulting anti-migrant violence), and the breakdown of social order or the collapse of states. At first, such mayhem is likely to arise largely in Africa, Central Asia and other areas of the underdeveloped South, but in time all regions of the planet will be affected.

To appreciate the power of this encroaching catastrophe, it’s necessary to examine each of the forces that are combining to produce this future cataclysm.

Start with one simple given: the prospect of future scarcities of vital natural resources, including energy, water, land, food and critical minerals. This in itself would guarantee social unrest, geopolitical friction and war.

It is important to note that absolute scarcity doesn’t have to be on the horizon in any given resource category for this scenario to kick in. A lack of adequate supplies to meet the needs of a growing, ever more urbanized and industrialized global population is enough.

We are now in the midst of a Great Extinction period that is wholly man made. It is called the Anthropocene period and as such it will be remembered for it’s colossal loss of millions of species of Life. Untold millions of species up on the evolutionary ladder are shuttered because us humans have no patience with other life forms. Given the wave of extinctions that scientists are recording, some resources—particular species of fish, animals and trees, for example—will become less abundant in the decades to come, and may even disappear altogether. But key materials for modern civilization like oil, uranium and copper will simply prove harder and more costly to acquire, leading to supply bottlenecks and periodic shortages.

Oil—the single most important commodity in the international economy—provides an apt example. Although global oil supplies may actually grow in the coming decades, many experts doubt that they can be expanded sufficiently to meet the needs of a rising global middle class that is, for instance, expected to buy millions of new cars in the near future. In its 2011 World Energy Outlook, the International Energy Agency claimed that an anticipated global oil demand of 104 million barrels per day in 2035 will be satisfied. This, the report suggested, would be thanks in large part to additional supplies of “unconventional oil.”  Canadian tar sands, shale oil, frackin oil, and so on, as well as 55 million barrels of new oil from fields “yet to be found” and “yet to be developed” are the post peak oil outlook.

However, many analysts scoff at this optimistic assessment, arguing that rising production costs for energy that will be ever more difficult and costly to extract, environmental opposition, warfare, corruption and other impediments will make it extremely difficult to achieve increases of this magnitude. In other words, even if production manages for a time to top the 2010 level of 87 million barrels per day, the goal of 104 million barrels will never be reached and the world’s major consumers will face virtual, if not absolute, scarcity.

Water provides another potent example. On an annual basis, the supply of drinking water provided by natural precipitation remains more or less constant: about 40,000 cubic kilometers. But much of this precipitation lands on Greenland, Antarctica, Siberia and inner Amazonia where there are very few people, so the supply available to major concentrations of humanity is often surprisingly limited. In many regions with high population levels, water supplies are already relatively sparse. This is especially true of North Africa, Central Asia and the Middle East, where the demand for water continues to grow as a result of rising populations, urbanization and the emergence of new water-intensive industries. The result, even when the supply remains constant, is an environment of increasing scarcity.

Wherever you look, the picture is roughly the same: supplies of critical resources may be rising or falling, but rarely do they appear to be outpacing demand, producing a sense of widespread and systemic scarcity. However generated, a perception of scarcity—or imminent scarcity—regularly leads to anxiety, resentment, hostility and contentiousness. This pattern is very well understood, and has been evident throughout human history.

In his book Constant Battles, for example, Steven LeBlanc, director of collections for Harvard’s Peabody Museum of Archaeology and Ethnology, notes that many ancient civilizations experienced higher levels of warfare when faced with resource shortages brought about by population growth, crop failures or persistent drought. Jared Diamond, author of the bestselling book,  Collapse, has detected a similar pattern in Mayan civilization and the Anasazi culture of New Mexico’s Chaco Canyon. More recently, concern over adequate food for the home population was a significant factor in Japan’s invasion of Manchuria in 1931 and Germany’s invasions of Poland in 1939 and the Soviet Union in 1941, according to Lizzie Collingham, author of The Taste of War.

Although the global supply of most basic commodities has grown enormously since the end of World War II, analysts see the persistence of resource-related conflict in areas where materials remain scarce or there is anxiety about the future reliability of supplies. Many experts believe, for example, that the fighting in Darfur and other war-ravaged areas of North Africa has been driven, by competition among desert tribes for access to scarce water supplies, exacerbated in some cases by rising population levels.

“In Darfur,” says a 2009 report from the U.N. Environment Programme on the role of natural resources in the conflict, “recurrent drought, increasing demographic pressures, and political marginalization are among the forces that have pushed the region into a spiral of lawlessness and violence that has led to 300,000 deaths and the displacement of more than two million people since 2003.”

Anxiety over future supplies is often also a factor in conflicts that break out over access to oil or control of contested undersea reserves of oil and natural gas. In 1979, for instance, when the Islamic revolution in Iran overthrew the Shah and the Soviets invaded Afghanistan, Washington began to fear that someday it might be denied access to Persian Gulf oil. At that point, President Jimmy Carter promptly announced what came to be called the Carter Doctrine. In his 1980 State of the Union Address, Carter affirmed that any move to impede the flow of oil from the Gulf would be viewed as a threat to America’s “vital interests” and would be repelled by “any means necessary, including military force.”

In 1990, this principle was invoked by President George H.W. Bush to justify intervention in the first Persian Gulf War, just as his son would use it, in part, to justify the 2003 invasion of Iraq. Today, it remains the basis for U.S. plans to employ force to stop the Iranians from closing the Strait of Hormuz, the strategic waterway connecting the Persian Gulf to the Indian Ocean through which about 35 percent of the world’s seaborne oil commerce  passes.

The Economist Intelligence Unit published their list of short term threats and Risk analysis:  ”Rising political risks are combining with fading economic performance in key countries to dampen the global business and financial outlook. A sharp increase in tensions on the Korean peninsula has emerged as the greatest geo-political risk: a military conflict between the two Koreas, which inevitably would involve the US, would shred economic and investor confidence in the region and push key parts of the world economy back into recession. Although we expect Korean tensions to stop well short of war, they come at a time of mounting pressures on other fronts. Virtually no progress has been made between Western powers and Iran over its nuclear programme; China and Japan remain at odds over ownership of a small group of islands, and the civil war in Syria continues to pose a spill-over risk within the region. Tensions within the euro zone over bail-outs and fiscal austerity leave the region vulnerable to political miscalculations. Cyprus is the latest example and the seemingly endless budget showdowns in the US between the two political parties threaten to hold back what otherwise appears to be an improving economic outlook.

Risk scenarios: The main risks are represented by the following scenarios.

Very high risk = greater than 40% probability that the scenario will occur over the next two years; high = 31-40%; moderate = 21-30%; low = 11-20%; very low = 0-10%.

Very high impact = change to global annual GDP compared with the baseline forecast of 2% or more (increase in GDP for positive scenarios, decrease for negative scenarios); high = 1-1.9%; moderate = 0.5-0.9%; low = 0.2-0.5%; very low = 0-0.1%.

Risk intensity is a product of probability and impact, on a 25-point scale.

Negative scenario: One or more countries leave the euro zone

High risk; Very high impact; Risk intensity = 20

Although the general sense of crisis surrounding the euro zone has lessened markedly in recent months, the recent inconclusive Italian election and the botched bail-out of Cyprus are reminders of the continued precariousness of the situation…

Negative scenario: Tensions over currency manipulation lead to a rise in protectionism

High risk; High impact; Risk intensity = 16

Tensions surrounding real and alleged currency manipulation have risen markedly, with the Bank of Japan’s adoption of an ultra-loose monetary policy (following considerable pressure from the country’s new government) prompting a dramatic weakening of the yen. In response, the People’s Bank of China has carefully managed a weakening of the renminbi, prompting protectionist measures elsewhere. Currency manipulations and Large-scale protectionism would seriously slow economic growth.

Negative scenario: The global economy falls into recession

Moderate risk; Very high impact; Risk intensity = 15

With the debt crisis in the euro zone continuing to fester, the US economy underperforming and growth in several major emerging markets (including India) remaining weak, the risk of another global recession cannot be discounted. Indeed, a combination of policymaking paralysis and geopolitical uncertainty could depress sentiment once again, weakening hiring and spending and pushing the euro zone deeper into recession. The US is also at risk: the president and Congress have repeatedly failed to address comprehensively the country’s substantial fiscal problems.

Positive scenario: A sustained decline in oil prices provides a global economic fillip

Moderate risk; High impact; Risk intensity = 12

We are expecting oil prices to soften somewhat this year, before gently rising to around US$115/barrel in 2017. There is, however, a significant chance that oil prices could fall well below our present projections, reflecting structural shifts on both the demand and supply side. In the latter case, the impact on the market of steadily falling Iranian oil exports has been mostly offset by a ramping-up of Saudi output, which, although declining in recent months, remains some 1m barrels/day (b/d) above its level in 2010. The combined economic stimulus would more than offset any revenue losses for the large oil producers in the Middle East and elsewhere (which generally save most of their excess oil earnings).

Negative scenario: Social and political disorder undermine stability in China

Low risk; Very high impact; Risk intensity = 10

The power transfer at the top of the Politburo Standing Committee is now largely complete, with Xi Jinping installed as the new Communist party leader and the country’s president. However, the transition was preceded by considerable intra-party manoeuvring, including the purging of Bo Xilai, the high-profile Communist Party chief in Chongqing province, which shed light on the shifting power struggles within the country’s opaque leadership. With this in mind, there remains a risk that the arrival of a new set of leaders will prompt a renewed purging, potentially under the guise of the recently stepped-up anti-corruption campaign. Moreover, should the Communist Party become distracted as the new leaders seek to establish themselves, opponents of the present order ranging from aggrieved minorities (including Tibetans and Muslim Uighurs) to online democracy campaigners and Chinese activists dormant since Tiennamen Square, may take the opportunity to step up their activism. This may be further encouraged by the unwillingness of the Chinese Politburo to ease its grip over the affairs of state: although Mr Xi has sought to portray himself as a moderniser, he has continued to stress the pre-eminent importance of stability over reform. Given that China has been the largest contributor to world economic growth in recent years, any signs of instability would damage global economic confidence, precipitate a sell-off in stockmarkets and severely depress prospects for major commodity exporters.

Negative scenario: The US economy stumbles following a wave of fiscal tightening

Low risk; Very high impact; Risk intensity = 10

Concerns about political gridlock in the US, which have prevented the passage of a credible, long-term budget consolidation programme, rose last year as Republicans and Democrats grappled over the so-called fiscal cliff a wave of fiscal tightening that included the expiry of Bush-era tax cuts, the ending of various tax breaks and a phased series of automatic spending cuts at end-2012. Although a deal to avert most of the tax increases was reached on January 1st, a decision on revising planned spending cuts was delayed until March a deadline that has now been missed. As a result, some US$85bn in cuts is now being rolled out this year, focused on the defence budget and domestic (non-welfare) spending. Adding to the economic uncertainty, although Congress has voted to extend the government’s debt ceiling until mid-May (it was initially scheduled to be breached in February), any further extension is likely to involve an intense level of haggling over future federal spending. This issue last came to a head in mid-2011, when Republicans sought to extract spending cuts from the president. Although they eventually backed down, the uncertainty generated by the squabble, and the partisan nature of the row, contributed markedly to the decision by Standard & Poor’s, a ratings agency, to downgrade the US’s credit rating. Given the continued softness of the economy, elevated levels of unemployment and the fragility of consumer confidence, a failure to roll back the sequester (in addition to the fiscal tightening already agreed) could push the economy back into recession. Although the US Federal Reserve (the central bank) would no doubt seek to lessen the economic impact, its minimal room for monetary manoeuvre would limit its effectiveness. A recession in the US, the largest economy in the world, would only compound the drag on global growth being exerted by the ongoing crisis in the euro zone, bringing the emerging-market economies down with it.

Negative scenario: Economic upheaval leads to widespread social and political unrest

Moderate risk; Moderate impact; Risk intensity = 9

The global economic downturn had a severe social impact, which has been compounded periodically by high food and fuel prices, as well as, in some cases, aggressive fiscal austerity. The Middle East has experienced unprecedented upheaval, and small-scale protest camps (“Occupy Wall Street”, for example) have been set up across a host of Western cities. Instability overall has been limited but, given higher unemployment and poverty, weak growth (or renewed recession), prolonged fiscal austerity and high commodity prices, protests could increase in frequency and intensity (a trend already in evidence in some of Europe’s more economically stricken southern states). In some cases, this could bring the survival of governments and even nation states into question. Indeed, even if the global economy recovered meaningfully, resentment over high and rising income inequality in developed and many emerging economies is unlikely to dissipate in the foreseeable future. The risk is that instability becomes systemic, with political crises in certain countries affecting others through contagion or through the actions of populist new regimes seeking to assert themselves. Widespread social and political unrest would carry a considerable economic and financial cost.

Negative scenario: An attack on Iran results in an oil price shock

Low risk; High impact; Risk intensity = 8

The risk of an air strike on Iran’s nuclear facilities either by the US or, more probably, Israel persists, despite continuing, albeit inconclusive, talks over the nuclear issue between Iran and the P5+1 (the five permanent members of the UN Security Council and Germany), and intense divisions within Israel over the issue. The imposition of EU sanctions on Iranian oil exports (and US measures on Iran’s central bank) came into force on July 1st, prompting more than 120 Iranian members of parliament to sign a petition calling on the country’s leaders to make good on their threat to close the Strait of Hormuz (through which 20% of all the world’s oil passes). Although such a move by Iran would cause a great degree of economic self-harm, the country could be prompted to act if Israel, which has maintained a more aggressive posture than the US, launched unilateral air strikes. Alternatively, there is a growing risk that the two sides could become embroiled in the civil war in Syria, with Iran warning Israel that it would regret its recent bombing of a military target in Syria. Even if Iran sought to confine its retribution to asymmetric measures (for example, by calling on proxies in the region, most notably in Lebanon), any military confrontation between Iran and Israel would add markedly to the political risk premium already in the oil price. Indeed, if the US were involved in strikes on Iran, and Iran responded by firing missiles at US military bases on the Gulf peninsula, the oil price could conceivably head towards US$200/barrel. Even in the more benign asymmetric case, the resulting surge in oil prices would weigh on consumer demand in many countries, and would also have a knock-on impact on other commodities, including food prices.

Positive scenario: Co-ordinated monetary stimulus kick-starts a global economic recovery

Low risk; High impact; Risk intensity = 8

With many Western governments weighed down by wide fiscal deficits and growing public-sector debt, the task of stimulating economic recovery is increasingly being shouldered by central banks. In September the Fed announced a third round of QE, pledging to purchase at least US$40bn of mortgage-backed securities each month. It raised its planned purchases to US$85bn a month in December to offset the expiration of another liquidity programme. The ECB, for its part, has announced its intention to buy the short-term bonds of struggling euro zone economies, in theory in unlimited quantities, to hold down interest rates and improve the workings of monetary policy. More recently, the Bank of Japan has committed itself to doubling the monetary base after the government raised its inflation target from 1% to 2%. The prospect of increased central bank activism helped to drive a global equity rally towards the end of 2012, which has continued into 2013. Significantly, most of these monetary programmes have yet to feed through fully into the global economy; when they do, they will amount to a potentially massive surge of liquidity that could boost asset prices, potentially including housing, and in turn lift confidence in the global economy. Although the impact would probably be short term and the risk of asset bubbles would no doubt increase the positive wealth effect from rising asset prices could result in a virtuous circle whereby consumers’ perception of increased spending power lifts private consumption, in turn boosting employment and thus the economy as a whole.

Negative scenario: War breaks out on the Korean peninsula

Very low risk; Very high impact; Risk intensity = 5

Even by North Korean standards, the country’s latest wave of threats is exceptional. Among other things, the country’s leaders have repeatedly warned of thermo-nuclear war, threatened to fire missiles at the US and, more visibly, promised to restart the Yongbyon nuclear plant responsible for producing the country’s plutonium. The North Korean government has also suspended operations at the Kaesong Industrial Complex the last functioning inter-Korean joint business venture. Concerns over North Korea’s intentions are heightened by the seeming lack of a clear motive for its current behaviour. The North’s young and inexperienced leader, Kim Jong-un, might still feel the need to prove himself by flexing his muscles. However, there are signs that he may be overreaching, and his threats have reached such a level that backing down will be difficult. The risk of an incident, on the scale of North Korea’s sinking of a South Korean warship in 2010 or its bombardment of Yeonpyeong island the same year, is high, and there are realistic fears of something far worse. Although a nuclear war is highly improbable, given North Korea’s inability at this stage to fit its nuclear weapons onto a rocket, a conventional war would still be catastrophic. The South Korean capital, Seoul, is just 50 km from the border, and is thus within easy range of the North’s rockets and much of its artillery. In addition, Japan is comfortably within the scope of North Korea’s longer-range rockets, although the US mainland is out of range. Should a conventional war occur, North Korea’s hopelessly antiquated military would be quickly defeated. However, as well as providing a severe shock to global well-being, it would also no doubt result in considerable economic disruption in South Korea and probably Japan, with serious consequences for global supply chains. Indeed, even with the defeat of North Korea, a host of new problems would arise: West Germany spent an estimated US$2trn modernising East Germany a sum that would be dwarfed by the cost of rebuilding North Korea’s hermit economy.” — Economist Intelligence Unit

And although these above are all Economist’s short term risk scenarios the overwhelming majority is all negative. Seems the Bears are eating up the Bulls in droves… and so are your earnings eaten up too.

Yet in my eyes the medium to long term risks are far more complex and devastatingly negative:

Recently, a set of resource conflicts have been rising toward the boiling point between China and its neighbors in Southeast Asia when it comes to control of offshore oil and gas reserves in the South China Sea. Although the resulting naval clashes have yet to result in a loss of life, a strong possibility of military escalation exists. A similar situation has also arisen in the East China Sea, where China and Japan are jousting for control over similarly valuable undersea reserves. Meanwhile, in the South Atlantic Ocean, Argentina and Britain are once again squabbling over the Falkland Islands (called Las Malvinas by the Argentinians) because oil has been discovered in surrounding waters.

By all accounts, resource-driven potential conflicts like these will only multiply in the years ahead as demand rises, supplies dwindle, and more of what remains will be found in disputed areas. In a 2012 study titled Resources Futures, the respected British think-tank Chatham House expressed particular concern about possible resource wars over water, especially in areas like the Nile and Jordan River basins where several groups or countries must share the same river for the majority of their water supplies and few possess the wherewithal to develop alternatives. “Against this backdrop of tight supplies and competition, issues related to water rights, prices, and pollution are becoming contentious,” the report noted. “In areas with limited capacity to govern shared resources, balance competing demands, and mobilize new investments, tensions over water may erupt into more open confrontations.”

Tensions like these would be destined to grow by themselves because in so many areas supplies of key resources will not be able to keep up with demand. As it happens, though, they are not “by themselves.” On this planet, a second major force has entered the equation in a significant way. With the growing reality of climate change, everything becomes a lot more terrifying.

Normally, when we consider the impact of climate change, we think primarily about the environment—the melting Arctic ice cap or Greenland ice shield, rising global sea levels, intensifying storms, expanding deserts and endangered or disappearing species like the polar bear. But a growing number of experts are coming to realize that the most potent effects of climate change will be experienced by humans directly through the impairment or wholesale destruction of habitats upon which we rely for food production, industrial activities or simply to live. Essentially, climate change will wreak its havoc on us by constraining our access to the basics of life: vital resources that include food, water, land and energy. This will be devastating to human life, even as it significantly increases the danger of resource conflicts of all sorts erupting.

We already know enough about the future effects of climate change to predict the following with reasonable confidence:

• Rising sea levels will in the next half-century erase many coastal areas, destroying large cities, critical infrastructure (including roads, railroads, ports, airports, pipelines, refineries and power plants) and prime agricultural land.
• Diminished rainfall and prolonged droughts will turn once-verdant croplands into dust bowls, reducing food output and turning millions into “climate refugees.”
• More severe storms and intense heat waves will kill crops, trigger forest fires, cause floods and destroy critical infrastructure.

No one can predict how much food, land, water, and energy will be lost as a result of this onslaught (and other climate-change effects that are harder to predict or even possibly imagine), but the cumulative effect will undoubtedly be staggering. In Resources Futures, Chatham House offers a particularly dire warning when it comes to the threat of diminished precipitation to rain-fed agriculture. “By 2020,” the report says, “yields from rain-fed agriculture could be reduced by up to 50 percent” in some areas. The highest rates of loss are expected to be in Africa, where reliance on rain-fed farming is greatest, but agriculture in China, India, Pakistan and Central Asia is also likely to be severely affected. In reality all areas of this Earth will be affected…

Heat waves, droughts, and other effects of climate change will also reduce the flow of many vital rivers, diminishing water supplies for irrigation, hydro-electricity power facilities and nuclear reactors (which need massive amounts of water for cooling purposes). The melting of glaciers, especially in the Andes in Latin America and the Himalayas in South Asia, will also rob communities and cities of crucial water supplies. An expected increase in the frequency of hurricanes and typhoons will pose a growing threat to offshore oil rigs, coastal refineries, transmission lines and other components of the global energy system.

The melting of the Arctic ice cap will open that region to oil and gas exploration, but an increase in iceberg activity will make all efforts to exploit that region’s energy supplies perilous and exceedingly costly. Longer growing seasons in the north, especially Siberia and Canada’s northern provinces, might compensate to some degree for the desiccation of croplands in more southerly latitudes. However, moving the global agricultural system (and the world’s farmers) northward from abandoned farmlands in the United States, Mexico, Brazil, India, China, Argentina and Australia would be a daunting prospect.

It is safe to assume that climate change, especially when combined with growing supply shortages, will result in a significant reduction in the planet’s vital resources, augmenting the kinds of pressures that have historically led to conflict, even under better circumstances. In this way, according to the Chatham House report, climate change is best understood as a “threat multiplier … a key factor exacerbating existing resource vulnerability” in states already prone to such disorders.