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More Great Thoughts from Jeremy Grantham

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I always look forward to Jeremy Grantham’s Quarterly Letter.  Grantham is the Co-founder and Chief Investment Strategist of Grantham Mayo Van Otterloo (GMO), an investment management firm, entrusted to oversee approximately $97 billion in client assets.

Unlike many asset managers, Jeremy Grantham has a social conscience.  As a result, during the past few years we have seen him direct some sharp criticism at President Obama, Tim Geithner, Ben Bernanke and – of course – Goldman Sachs.  Grantham fell behind schedule when his Third Quarter 2011 Letter was delayed by over a month.  As a result, Grantham’s Fourth Quarter 2011 Letter was just released a few days ago.  At 15 pages, it earned the title “The Longest Quarterly Letter Ever”.  As usual, Grantham has provided us with some great investment insights – along with some pointed criticism of our ignorant legislators and mercenary corporate managers.  What follows are some selected passages.  Be sure to read the entire letter here (when you have time).

To leave it to capitalism to get us out of this fix by maximizing its short-term profits is dangerously naïve and misses the point: capitalism and corporations have absolutely no mechanism for dealing with these problems, and seen through a corporate discount rate lens, our grandchildren really do have no value.

To move from the problem of long time horizons to the short-term common good, it is quickly apparent that capitalism in general has no sense of ethics or conscience.  Whatever the Supreme Court may think, it is not a person.  Why would a company give up a penny for the common good if it is not required to by enforced regulation or unless it looked like that penny might be returned with profit in the future because having a good image might be good for business?  Ethical CEOs can drag a company along for a while, but this is an undependable and temporary fix.  Ethical humans can also impose their will on corporations singly or en masse by withholding purchases or bestowing them, and companies can anticipate this and even influence it through clever brand advertising, “clean coal” being my favorite.  But that is quite different from corporate altruism. Thus, we can roast our planet and firms may offer marvelous and profitable energy-saving equipment, but it will be for profit today, not planet saving tomorrow.

It gets worse, for what capitalism has always had is money with which to try to buy influence.  Today’s version of U.S. capitalism has died and gone to heaven on this issue. A company is now free to spend money to influence political outcomes and need tell no one, least of all its own shareholders, the technical owners.  So, rich industries can exert so much political influence that they now have a dangerous degree of influence over Congress.  And the issues they most influence are precisely the ones that matter most, the ones that are most important to society’s long-term well-being, indeed its very existence.  Thus, taking huge benefits from Nature and damaging it in return is completely free and all attempts at government control are fought with costly lobbying and advertising.  And one of the first victims in this campaign has been the truth.  If scientific evidence suggests costs and limits be imposed on industry to protect the long-term environment, then science will be opposed by clever disinformation.

*   *   *

Capitalism certainly acts as if it believes that rapid growth in physical wealth can go on forever.  It appears to be hooked on high growth and avoids any suggestion that it might be slowed down by limits.  Thus, it exhibits horror at the thought (and occasional reality) of declining population when in fact such a decline is an absolute necessity in order for us to end up gracefully, rather than painfully, at a fully sustainable world economy.  Similarly with natural resources, capitalism wants to eat into these precious, limited resources at an accelerating rate with the subtext that everyone on the planet has the right to live like the wasteful polluting developed countries do today.  You don’t have to be a PhD mathematician to work out that if the average Chinese and Indian were to catch up with (the theoretically moving target of) the average American, then our planet’s goose is cooked, along with most other things.  Indeed, scientists calculate that if they caught up, we would need at least three planets to be fully sustainable.  But few listen to scientists these days.  So, do you know how many economic theories treat resources as if they are finite?  Well, the researchers at the O.E.C.D say “none” – that no such theory exists.  Economic theory either ignores this little problem or assumes you reach out and take the needed resources given the normal workings of supply and demand and you can do it indefinitely.  This is a lack of common sense on a par with “rational expectations,” that elegant theory that encouraged the ludicrous faith in deregulation and the wisdom of free markets, which brought us our recent financial fiascos.  But this failure in economic theory – ignoring natural limits – risks far more dangerous outcomes than temporary financial crashes.

*   *   *

As described above, the current U.S. capitalist system appears to contain some potentially fatal flaws.  Therefore, we should ask what it would take for our system to evolve in time to save our bacon.  Clearly, a better balance with regulations would be a help. This requires reasonably enlightened regulations, which are unlikely to be produced until big money’s influence in Congress, and particularly in elections, decreases.  This would necessitate legal changes all the way up to the Supreme Court.  It’s a long haul, but a handful of other democratic countries in northern Europe have been successful, and with the stakes so high we have little alternative but to change our ways.

*   *   *

Capitalism, by ignoring the finite nature of resources and by neglecting the long-term well-being of the planet and its potentially crucial biodiversity, threatens our existence.  Fifty and one-hundred-year horizons are important despite the “tyranny of the discount rate,” and grandchildren do have value. My conclusion is that capitalism does admittedly do a thousand things better than other systems:  it only currently fails in two or three.  Unfortunately for us all, even a single one of these failings may bring capitalism down and us with it.

Keep in mind that the foregoing passages were just from Part II of the Quarterly Letter.  Part III is focused on “Investment Observations for the New Year”.  Be sure to check it out – it’s not as bearish as you might expect.  Enjoy!



 

Scary Economic News

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The information which I’m passing along to you today might come as a shock to those listening to the usual stock market cheerleaders, who predict good times ahead.  Let’s start with economist John Hussman of the Hussman Funds.  For quite a while, Dr. Hussman has been warning us to avoid drinking the Kool-Aid served by the perma-bulls.  In his latest Weekly Market Comment, Hussman offers yet more sound advice to those under the spell of brokerage propagandists:

I want to emphasize again that I am neither a cheerleader for recession, nor a table-pounder for recession.  It’s just that given the data that we presently observe, an oncoming recession remains the most probable outcome.  When unseen states of the world have to be inferred from imperfect and noisy observable data, there are a few choices when the evidence isn’t 100%.  You can either choose a side and pound the table, or you can become comfortable dwelling in uncertainty, and take a position in proportion to the evidence, and the extent to which each possible outcome would affect you.

With most analysts dismissing the likelihood of recession, I have been vocal about ongoing recession concerns not because I want to align myself with one side, but because the investment implications are very asymmetric.  A slow but steady stream of modestly good economic news is largely priced in by investors, but a recession and the accompanying earnings disappointments would destroy some critical pillars of hope that investors are relying on to support already rich valuations.

Yale Professor Robert Shiller is the guy who invented the term “irrational exuberance”, which was title of his bestselling book – published in May of 1996.  Although the widely-despised, former Federal Reserve Chairman, Alan Greenspan is often credited with creating the term, Greenspan didn’t use it until December of that year, in a speech before the American Enterprise Institute.  Shiller is most famous for his role as co-creator of the Case-Shiller Home Price Indices, which he developed with his fellow economists Karl Case and Allan Weiss.  While many commentators decried the idiotic economic austerity programs which have been inflicted across Europe, Professor Shiller investigated whether austerity is at all effective in spurring economic growth, seeking a better understanding of austerity’s consequences.  In a recent essay on the subject, Dr. Shiller cited the work by Jaime Guajardo, Daniel Leigh, and Andrea Pescatori of the International Monetary Fund, who recently studied austerity plans implemented by governments in 17 countries in the last 30 years.  The conclusion reached by Professor Shiller should sober-up the “rose-colored glasses” crowd, as well as those aspiring to implement similar measures in the United States:

The austerity plans being adopted by governments in much of Europe and elsewhere around the world, and the curtailment of consumption expenditure by individuals as well, threaten to produce a global recession.

*   *   *

There is no abstract theory that can predict how people will react to an austerity program.  We have no alternative but to look at the historical evidence.  And the evidence of Guajardo and his co-authors does show that deliberate government decisions to adopt austerity programs have tended to be followed by hard times.

Policymakers cannot afford to wait decades for economists to figure out a definitive answer, which may never be found at all.  But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.

The really scary news concerning the state of the global economy came in the form of a report published by the World Bank, entitled Global Economic Prospects (Uncertainties and vulnerabilities).  The 157-page treatise was written by Andrew Burns and Theo Janse van Rensburg.  It contains more than enough information to induce a serious case of insomnia.  Here are some examples:

The world economy has entered a very difficult phase characterized by significant downside risks and fragility.

*   *   *

The downturn in Europe and weaker growth in developing countries raises the risk that the two developments reinforce one another, resulting in an even weaker outcome.  At the same time, the slow growth in Europe complicates efforts to restore market confidence in the sustainability of the region’s finances, and could exacerbate tensions.

*   *   *

While contained for the moment, the risk of a much broader freezing up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains.  In particular, the willingness of markets to finance the deficits and maturing debt of high-income countries cannot be assured.  Should more countries find themselves denied such financing, a much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out.  The world could be thrown into a recession as large or even larger than that of 2008/09.

*   *   *

In the event of a major crisis, activity is unlikely to bounce back as quickly as it did in 2008/09, in part because high-income countries will not have the fiscal resources to launch as strong a countercyclical policy response as in 2008/09 or to offer the same level of support to troubled financial institutions.

*   *   *

Developing countries need to prepare for the worst

In this highly uncertain environment, developing countries should evaluate their vulnerabilities and prepare contingencies to deal with both the immediate and longer-term effects of a downturn.

If global financial markets freeze up, governments and firms may not be able to finance growing deficits.

*   *   *

One major uncertainty concerns the interaction of the policy-driven slowing of growth in middle-income countries, and the financial turmoil driven slowing in Europe.  While desirable from a domestic policy point of view, this slower growth could interact with the slowing in Europe resulting in a downward overshooting of activity and a more serious global slowdown than otherwise would have been the case.

In other words, Europe’s economic austerity programs could turn another round of economic contraction into a global catastrophe (as if we needed another).

This is what happens when economic policymaking is left to the plutocrats and their tools.  “Those who fail to learn from the past are doomed to repeat it.”  It appears as though we are well on our way to a second financial crisis – with more severe consequences than those experienced as a result of the 2008 episode.


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How States Can Save Billions

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We’ve been reading a lot about fallout lately.  The Fukushima power plant disaster is now providing a lasting legacy all over the world.  This animation from the French national meteorological service, Météo-France, illustrates how the spread of the Fukushima fallout is migrating.

For the past three years, we have been living with the fallout from a financial “meltdown”, which resulted from deregulation, greed and the culture of “pervasive permissiveness” at the Federal Reserve, as discussed in the Financial Crisis Inquiry Report.  The fallout from the financial meltdown has also spread across the entire world.  Different countries have employed different approaches for coping with the situation.  In Ireland, the banks were bailed out at taxpayer expense, crippling that nation’s economy for generations to come.  As a result, the Irish citizens fought back, went to the polls and ousted the perfidious politicians who helped the banks avoid responsibility for their transgressions.   On the other hand, in Portugal, the government refused to impose austerity measures on the citizens, who should not be expected to pay the price for the financial mischief that gave rise to the current economic predicament.  Given the additional fact that Portugal, as a nation, was not a “player” in the risky games that nearly brought down the world economy, the recent decision by the Portuguese parliament is easy to understand.

In our own country, the various states have found it quite difficult to balance their budgets.  High unemployment, which refuses to abate, and depressed real estate valuation have devastated each state’s revenue base.  Because the states cannot print money, as the Federal Reserve does in order to pay the federal government’s bills, it has become necessary for the states to rely on creative gimmicks to reverse their misfortunes.  Most states had previously deployed numerous “economic development projects” over the years.  Such projects are taxpayer-funded subsidies to attract corporations and entice them to establish local operations.  Rex Nutting of MarketWatch recently took a critical look at those programs:

And yet, study after study show that these subsidies create few, if any, net jobs.  For instance, California’s Enterprise Zone program – which is supposed to boost business in 42 economically distressed communities – has cost the taxpayers $3.6 billion over 27 years, but to no avail.  A legislative analyst report in 2005 found that “EZs have little if any impact on the creation of new economic activity or employment.” Read more from the legislative analyst report.

California Gov. Jerry Brown has proposed to kill the EZ program and the even-more expensive redevelopment agency program, but he faces an uphill fight in the Legislature.  Such subsidies are popular with the legislators who receive boatloads of campaign contributions from businesses lucky enough to find a government teat to latch on to.

Nationwide, such giveaways from state and municipal governments amounted to more than $70 billion in 2010, according to Kenneth Thomas, a political scientist at the University of Missouri at St. Louis, who has specialized in studying these subsidies.  That’s more than the states collect in corporate income taxes in a good year.  Read about Thomas’s book: “Investment Incentives and the Global Competition for Capital”

And that $70 billion is twice as much money as would be required to fully fund the pensions owed to state and local government workers, the very same pensions that budget-cutting politicians across the country claim are responsible for the fiscal hole we’re in.

What Rex Nutting has suggested amounts to the elimination of a significant number of corporate welfare programs.  He has also dared to challenge the corporatist mantra that corporate welfare “creates jobs”.  We are supposed to believe that the only way states can balance their budgets is through the imposition of draconian austerity programs, designed to force the “little people” to – once again – pay the tab for Wall Street’s binge.  Because the voters have no lobbyists to protect their own interests, venal state and local politicians have set about slashing public safety expenditures (through mass layoffs of police and firefighters), closing parks and libraries, as well as under-funding public school systems.

Never mind that state and local governments could save $70 billion by cutting just one form of corporate welfare.  They would rather let you watch your house burn down.  You can’t afford that house anyway.


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The Home Stretch

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October 27, 2008

We are entering the final week of the longest Presidential campaign in our nation’s history.  At the same time, the world economy continues to flirt with chaos and our nation’s equities market indices are diving at a faster pace than Superman’s swooping down from the sky to save Lois Lane from a potential rapist.  Some stockbrokers believe that an abrupt and decisive nosedive in the markets might have a cathartic effect and finally bring us to the long-awaited “bottom”, from which there would be only one place to go:  up.  Rock musician Tom Petty wrote a song about the death of his mother, called: Free Fallin’.  That song has recently become the theme for America’s stock markets.  The situation has become so bad that many fear it may be necessary for the feds to suspend equities trading until all of the nervous investors and frenzied hedge fund managers have a chance to gather their wits.  Would the government really intervene and close the stock markets for a day or more?

There is one authority who earned quite a bit of “street cred” when our current economic crisis hit the fan.  He is Nouriel Roubini, an economist at the Stern School of Business at New York University.  He earned the nickname “Doctor Doom” when he spoke before the International Monetary Fund (IMF) on September 7, 2006 and described, in precise detail, exactly what would bring the financial world to its knees, two years later.  As reported by Ben Sills and Emma Ross-Thomas in the October 24 edition of Bloomberg:

Roubini said yesterday that policy makers may need to shut down financial markets for a week or two as investors dump assets. Trading in futures on the Standard & Poor’s 500 Index and the Dow Jones Industrial Average was limited today after declines of more than 6 percent.

This week brings us more earnings reports and new housing starts that could send already skittish investors (as well as terrified hedge fund managers) on a “panic selling” binge.  Could this trigger a market shutdown by the government as predicted by Dr. Roubini?  If so, we may find the markets closed for the final days before the Presidential election.  The Republicans and their media trumpet, Fox News, would likely seize upon such a development, characterizing it as validation of their claim that the investing public fears a “socialist” Obama Presidency.  In reality, there would be no way to measure the impact of the election results on the equities markets under such circumstances.  If the markets were kept closed until after the election, there would be quite a number of investors, chomping at the bit to dump their portfolios during the hiatus, ready to do so as soon as the markets re-opened.  On the other hand, Stuart Schweitzer, global market strategist at JP Morgan Private Bank appeared on the October 24 broadcast of the PBS program, Nightly Business Report, and explained what to really expect about the impact of the Presidential election on the securities markets.  Schweitzer believes that regardless of who is elected, once we get past Election Day, there will be a sense of certainty established as to who will be making economic policy going forward into the new Presidential term.  This fact in itself, regardless of what that economic policy might become, will eliminate the element of uncertainty that breeds some degree of the fear in the hearts of investors.

If the stock markets really end up being closed during the final days before the election, we would likely see more havoc than calming.  The timing would prove too irresistible for conspiracy theorists to ignore.  Some would see it as a plot by the Republicans to conceal how bad the economy really is.  Others might see it as a ploy by “Washington elites” (a term used by some in reference to Obama supporters) to conceal widespread fear of putting a “communist” in charge of our nation.  The smartest course from here would be for the Federal Reserve Board’s FOMC (Federal Open Market Committee) to undertake a responsible, public relations role when it meets on Tuesday.  They should be ready to explain to the public what has really been happening in the markets:  an unregulated species of investments called “hedge funds” has been causing mayhem on the trading floors.  Many (if not most) of these hedge funds are going broke and they are attempting to secure a place in the line for Federal bailout money.  They have caused equities trading to function more like eBay:  the only market movement that matters over the course of any given day is what takes place during the final three minutes before the closing bell, when the hedge fund managers dump stocks.  On eBay, the winning bid for an item is usually made during the minute before an auction ends.  Unlike eBay, the stock market numbers can go up or down.  These days, the index movement prior to the closing bell is usually seismic (in one direction or the other).   It was never like this before.  These trading patterns often trigger pre-established “stop loss orders” to sell stocks, usually established by individual investors upon purchase of those stocks.  The result is an avalanche of “sell” orders at the end of the day.  The FOMC needs to explain this disease to the public and let us know the Fed is working on a cure.  Closing the markets in the final days before a Presidential election will not be a cure.  Such a move will just create a scab that will quickly be picked away by an investing public that needs to ease up on the caffeine and go out for a walk.

McCain Loses His Chance

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October 2, 2008

It was the opportunity for a “game-changing move” in the 2008 Presidential campaign.  Just as John McCain was dropping back in the polls, providing Barack Obama the chance to “close the deal” even more decisively than he did with Hillary Clinton, McCain missed the opportunity to turn the game around.  Last week, he arrived in Washington (after the pseudo-suspension of his campaign) on a mission to save us all from the crisis declared by Treasury Secretary Henry Paulson.  After McCain arrived, he found a number of both Republican and Democratic members of the House of Representatives opposed to the revised, 110-page, economic “bailout bill” (the Emergency Economic Stabilization Act of 2008).  At that point in time, McCain had the opportunity to break with the unpopular Bush Administration and band together with the 133 Republican and 95 Democratic House members (who eventually voted against the bill) to form a “coalition of mavericks” (oxymoron, non-sequitur or both?) resisting this bailout of the big banks and other “fat cats” on Wall Street.  He didn’t.  He chose instead, to copy whatever Barack Obama was doing.  Besides, his move dovetailed well with the pseudo-“bipartisan” duet he had been playing, throughout the entire campaign, with Joe “The Tool” Lieberman.  Had McCain stood with those 133 young Republican members of the House and the 95 Democrats (many of whom consider themselves conservative, “Blue Dog” Democrats) he could have re-ignited his flatulent campaign.  (Is it really safe to do that?  —  Let’s ask Johnny Knoxville.)

Howard Fineman provided an interesting retrospective of this phase in the evolution the economic “bailout bill” at the Newsweek website on September 30:

The Paulson Plan is not great. Some two hundred academic economists have ridiculed it, and so have the House Republicans, by a 2-1 margin.  Public opinion (and not just the angry phone callers) is turning against the measure—to the extent that anybody understands it.

But the consensus is that Washington has to do something, and that the current version is far better than what the lawmakers started with.

McCain made a show of returning to Washington to try to jam the original measure through.  He deserves credit for the instinct. An old Navy motto is: Don’t just stand there, DO something!  That is McCain to the core, and so much the better for it.

But when he got to town, he realized something that no one had bothered to tell him, apparently:  the grassroots of his own party (the grassroots that has never really trusted him) hated the Paulson Plan.  They weren’t about to support it and risk their own necks.  McCain worked the phones, but fell back in the ranks.

When the second revision of this bill (at over 400 pages) finally made it to the Senate floor for the vote on Wednesday, October 1, there were 9 Democrats, 15 Republicans and Independent Senator Bernie Sanders of Vermont, voting against it.  McCain again missed the opportunity for a truly bipartisan resistance to this measure.  Such an act would have demonstrated genuine leadership.  He could have rejoined his old buddy, Wisconsin Senator Russ Feingold, as well as Florida Democrat Bill Nelson and rising Democratic star, Maria Cantwell from the State of Washington, all of whom voted against this measure.  Such a move would have emboldened resistance to the “bailout bill” in the House of Representatives, where the term of office lasts only two years.  (The short term results in greater accountability to American voters, who are believed to have notoriously short memory spans.)

Is this bill really necessary?  On the October 1 edition of MSNBC’s Countdown with Keith Olbermann, Paul Krugman, Economics Professor at Princeton University, admitted that:

…  it will be relatively ineffective, although rejecting it will cause a big run on the system.  Then we will come back and do it right in January or February  …

When Keith Olbermann asked Krugman about the likelihood that nothing consequential would happen if this bill did not pass, Krugman responded by saying that such possibilities have “shrunk in the past week”.  Krugman went on to claim that “the credit crunch has started to hit Main Street”, using, as an example, the rumor that: “McDonald’s has started to cut credit to its franchisees.”  McDonald’s has issued a press release stating that this was not the case.  What is really happening is that the banks are acting like spoiled children, holding their breath until the government gives them what they want, using the threat of unavailable credit as a gun to the head of Congress.

Public opposition to this bailout was best summed up by Peggy Noonan, when she appeared on The Daily Show with Jon Stewart on October 1:

But we are in a real economic crisis and the American political establishment said we must do A, B and C to deal with it and the American people  …  said:  “No.  We don’t trust you to handle this.  We don’t trust you to do the right thing.”

John McCain had the opportunity to stand with those people, as well as the 133 House Republicans and 15 Senate Republicans, to do “the right thing”.  He decided to forego that opportunity.  Barack Obama said, on the Senate floor Wednesday, that it was not worth risking the American economy and the world economy by challenging this bill.  John McCain decided that it was not worth risking his Presidential campaign on such a challenge.  That’s too bad for him.  The gamble probably would have paid off.