The Simon-Ehrlich wager: 40 years later it still holds lessons for commodity investors

Paul Ehrlich (Stanford University biologist and and author of the 1968 book “The Population Bomb”) thought that overpopulation would cause disaster and widespread scarcity. Ehrlich’s bleak vision was anything but that of a lone crank. Countless experts made similar forecasts in the 1950s and 1960s. In his book, Ehrlich declared that:

“the battle to feed all of humanity is over. In the 1970s, the world will undergo famines – hundreds of millions of people will starve to death in spite of any crash programs embarked upon now.”

Neo-Malthusian Ehrlich thought like a biologist. He believed that there was an inverse relationship between population growth and the availability of resources, i.e. as population grows, resources become scarcer. In the animal world at least a sudden increase in the availability of resources leads to a population explosion. The population explosion then leads to the exhaustion of resources. The final act is the exhaustion of resources which leads to population collapse.

“Currently there are very large supplies of many mineral resources, including iron and coal. But when they become “depleted” or “scarce” will depend not simply on how much is in the ground but also on the rate at which they can be produced and the amount societies can afford to pay, in standard economic or environmental terms, for their extraction and use. For most resources, economic and environmental constraints will limit consumption while substantial quantities remain… For others, however, global “depletion”—that is, decline to a point where worldwide demand can no longer be met economically—is already on the horizon. Petroleum is a textbook example of such a resource.”

University of Maryland economist, Julian Simon thought differently. He suggested people would find substitutes for scarce resources, employing technological improvements to adapt to their environment and that everything would turn out fine.

Source: https://www.humanprogress.org/luck-or-insight-the-simon-ehrlich-bet-re-examined/

To resolve their dispute, the two sides (Simon on one side and Ehrlich and two of his partners on the other) agreed to have a $1,000 bet on the price of a basket of commodities. The wager was based on the inflation-adjusted prices of five metals: chromium, copper, nickel, tin, and tungsten, and lasted from October 1980 to October 1990. Ehrlich predicted that because of population growth these metals would become more expensive. Simon argued that because of population growth, the incentive to find more or use an alternative would increase, and so metal prices would become cheaper.

If the sale price of the commodities, adjusted for inflation were higher, then Ehrlich and his two partners would win and reap the profit. If the proceeds were lower, Simon would win and Ehrlich’s side would pay him the difference. Ten years passed and the Earth’s population grew by 800 million, yet the basket of metals were worth 36% less.

Simon won. Ehrlich lost. Ehrlich sent a cheque to his rival for $576.07. There was no note congratulating his rival or recognition of his insights.

The tale of their encounter was retold by the author Paul Sabin in his book “The Bet: Paul Ehrlich, Julian Simon, and Our Gamble Over Earth’s Future“. Simon originally proposed that the bet should be for $10,000. But after Ehrlich agreed to the idea, Simon reduced the amount to $1,000. Simon argued that the purpose of the wager was the principle, not the amount. This didn’t stop Ehrlich and his partners complaining about the reduced size of the wager.

Simon was so confident in his lower for longer prognosis for commodity prices that in the two editions of his book “The Ultimate Resource”, published in 1981 and 1996, he wrote the following:

“This is a public offer to stake $10,000, in separate transactions of $1,000 or $100 each, on my belief that mineral resources (or food or other commodities) will not rise in price in future years, adjusted for inflation. You choose any mineral or other raw material (including grain and fossil fuels) that is not government controlled, and the date of settlement.”

Simon was lucky with his bet. The spike in oil prices in the late 1970s was one factor that contributed to the slowing in industrial growth in the 1980s, which in turn resulted in lower prices for the five metals. As the maxim goes, “The cure for high prices, is high prices”.

Although the principle of the bet was correct, we all know now that commodity prices go through cycles. Simon was either lucky or he knew where we were in the commodity cycle, and bet accordingly.

A comprehensive study by Kiel et al. looked at price changes of the five metals in ten-year intervals between 1900 and 2007. They used nominal price data collected and reported by the U.S. Geological Survey, and then adjusted those prices for inflation using the US Consumer Price Index (CPI). Using 98 ten-year intervals based on successive years between 1910 and 2007, they found that Ehrlich would have won the bet 61.2% of the time with an average return of 10.5%.

A more recent study by Pooley at al. expanded the period to cover 1900 to 2019, but made two modifications to the Kiel et al. methodology. First, they argued that prices ought to be compared with income in order fully to understand changes in abundance. Time prices are equal to nominal prices divided by nominal hourly compensation. When analysed with time prices, Simon wins the bet 54.2% of the time. The average return over this 110-year range also favours Simon at 2.22%.

The second modification related to the clause underpinning the original bet between Simon and Ehrlich. This clause said that the wager would be null and void if the USA should be at war on 24th September 1990. Stripping out the years that the US has been at war the researchers found that Simon would have won 69.9% of the time with a return of 18%.

And what about Ehrlich’s dire warnings? Well, there weren’t mass famines in the 1970s, or in the 1980s. Thanks to the dramatic improvements in agriculture collectively known as “the Green Revolution” (which were well underway by the time Ehrlich wrote his book), food production not only kept up with population growth, it greatly surpassed it. Between 1961 and 2000, the world’s population doubled and the calories of food consumed per person increased 24%. Ehrlich said it was impossible.

Even today, many people still insist that Paul Ehrlich was essentially on the mark in “The Population Bomb”. One of those people is Paul Ehrlich himself! In a 2009 essay, Ehrlich acknowledged that the book:

“underestimated the impact of the Green Revolution” and so the starvation he expected wasn’t as bad as he predicted. However, he insisted that the book’s grim vision was accurate, stating that its “most serious flaw” was that it was “much too optimistic about the future”.

Ehrlich never did acknowledge the superiority of his opponents outlook and that cost him. For while commodity prices are prone to prolonged and sometimes dramatic increases, over a long enough time period human ingenuity wins out.

The lesson for investors to draw from the Simon-Ehrlich wager is first to be humble and to not be wedded to a certain world-view, and second to know when the odds are in your favour and to have the fortitude to act.

(Visited 64 times, 64 visits today)