Grantham: European and American policy makers are clueless

The banana republic-style dysfunction in the US which was rewarded with a sovereign debt downgrade – and will lead to more downgrades in due course – is rivalled by the European policy dithering which could eventually lead to a breakup of the single currency.

Jeremy Grantham gets it right about what ails the developed economies in the US and Western Europe. He says:

  • “I am not an expert in euro finance by a wide margin. But I know one thing. Forget the debt for a second: the current uncompetitiveness of Greece, Ireland, Portugal, Spain, and Italy did not occur quickly. It took 10 long and obvious years. They had to work at it. The cure was always going to cause a lot of pain and threaten the well-being of the euro. So why didn’t the bosses attempt to fix it early on when it would have been so much easier? There was no material squawking by the Germans or the ECB. In fact, the Germans back then were themselves busy weaseling on their own rules of good financial behavior. Along the way, the local bosses – just like Greenspan here – were cheerleaders for the disastrous behavior of excessive spending. Today these problems have become much tougher, but still the decisions are only half made and the cans get kicked and kicked again.”
  • “Also challenging strongly to assume the can-kicking title (having already snatched “The Most Dysfunctional Government” title from Argentina) is the United States. Exhibit 1 shows the build-up of U.S. gross national debt as a percentage of GDP. The shading shows the data by presidential term. The debt ratio rose rapidly under Reagan and Bush II and fell rapidly under Clinton. No doubt, there were extenuating circumstances for all of them: unnecessary wars, etc. (There certainly was for the current incumbent. By the way, where is the current incumbent? In any case, he definitely inherited a dreadful mess courtesy of Greenspan, Bernanke, Paulson, Bush II, Rubin, and an army of greedy corporate short-term profit maximizers.) To go with all of their other failings they were, above all, engaged in wishful thinking. For all of them there appeared to be no housing bubble, no need to regulate subprime, no fear of an extra million houses being built. But most importantly, there was no willingness to take preemptive and tough decisions. Everyone appeared to be hoping for the best. At the extreme there was Greenspan expecting responsible behavior from bankers! This is all old hat, but it is important to remember that most of the current problems for the U.S. stem from an earlier refusal to deal with the U.S. housing bubble at an early date.”

children at playEdward here. In America everyone has been bellyaching about the S&P ratings downgrade like its an affront to the greatness of America. This is absolute rubbish. It’s pure denial and economic nationalism.

Do you think the Germans would threaten to default on their bonds for purely political reasons? The Swiss? How about Singapore? Even the Belgians aren’t threatening to default for political reasons and they don’t even print their own money. That’s not the hallmarks of AAA. I say S&P should have downgraded the U.S. even more – maybe to Ba for Banana Republic!

The whole debt ceiling charade was an embarrassment which will be repeated during the coming budgeting process and the next debt ceiling – that much you can bet. And in case you think this whole kabuki theater is not just political posturing, This is what happens when there is a public record. This is what happens when there is a public record, part 2. Welcome to third-world dysfunction, Americans.

I say we need a world reserve currency that is controlled by adults, please.

Here’s the chart 1 from Grantham’s piece:

Notice the hockey stick-style uptick post-credit crisis – an ex-post recognition of the failed economic policy of the years prior aka the doom loop.

In any event, Grantham updates his seven lean years thesis, writing amongst other things:

  • “The growth rates and general economic well-being and resilience of emerging economies, especially China and India, have been nothing short of remarkable.”
  • “There is a U.S. personal savings rate once again.”
  • “Corporate profits are a bonanza that would allow in principle for substantially increased hiring and a consequent stimulus to GDP. President Hoover bitterly railed at senior businessmen in 1930 and 1931 for sitting on their cash. President Obama would have felt sympathetic. Corporations today are doing very little hiring despite unusually high cash reserve.”

Those are the positives. There are negatives though too – a lot of them. And there’s a lot more commentary and investing advice as well – another must read piece.

The bottom line: “At the close on August 8, a slightly cheap equity portfolio could be put together comprised of U.S. high quality, emerging markets, Japan, Italy, and European growth stocks. On our data, the imputed 7-year return of the package today would be about 6.5% real!* Quality stocks, especially in the U.S. but almost everywhere, continue to handsomely outperform. Regrettably, this means that they have declined very considerably less than the indices. In its asset allocation accounts, GMO is modestly underweight equities, partly because of the desperately unattractive yields on fixed income. We are now very modest buyers for the first time since mid 2009.”

Source: Danger: Children at Play – Jeremy Grantham, GMO

  1. Sigrid Hintz says


  2. Dave says

    “I say we need a world currency which is controlled by adults, please.” Edward you get this stuff better than anyone anywhere but that is a terrible solution.

    First off, there are no adults.

    2nd, look what a mess these Euro states are in giving up their currency sovereignty. If there are imbalances now, how do you balance that globally?

    3rd, are you going to set a global tax system? Or tie it to commodities again? Is this just some sneaky Austrian gold standard mumbo-jumbo?

    4th, what evidence is there that that makes things any better? And what would the World look like if that fell apart too?

    I know it’s a monumental task, but I’d really be interested in having you lay out your thoughts on how that would work sometime. Clearly this isn’t working so well but as an American I’m thinking this is working a hell of a lot better than having a global currency.

  3. David Lazarus says

    I think on the basis of US politics that the US deserves junk status. Who would want to invest in a country that will be simply willing to default for political reasons. Though in reality if you are willing to accept dollars then it still warrants AAA status. The mismanagement by the Fed does warrant a downgrade to AA.

    Longer term the US needs to address its trade deficit as it will impact on the creation of jobs in the US. Maybe credit controls will allow the dollar to fall to a level that will actually encourage US manufacturing, and hence US jobs. As for the deficit maybe the use of unitary taxes will mean corporations cannot use tax havens to evade US taxes. If this was agreed on at the G20 it might solve much of the funding problems for many governments.

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