Wednesday, November 21, 2012

Jeremy Grantham's Quarterly Newsletter November 2012 Summary

Jeremy Grantham, GMO, has just released GMO Quarterly Newsletter which includes 2 parts:

  • On the Road to Zero Growth by Jeremy Grantham (16 pages)
  • "Help, Help, I’m Being Repressed!" by Ben Inker (3 pages)
The first section Jeremy Grantham explains that GDP growth in excess of 3% a year for the US is a thing of the past, and going forward growth is likely to be within 0.9%  a year. Even this estimate is optimistic as resources price increases are not taken into account, and those could eventually lead us to growth very close to 0%.

Here are the key points brought forward by Jeremy Grantham:
  • The U.S. GDP growth rate that we have become accustomed to for over a hundred years – in excess of 3% a year – is not just hiding behind temporary setbacks. It is gone forever.
  • Going forward, GDP growth (conventionally measured) for the U.S. is likely to be about only 1.4% a year, and adjusted growth about 0.9%.
  • Population growth that peaked in the U.S. at over 1.5% a year in the 1970s will bob along at less than 0.5%.
  • Productivity in manufacturing has been high and is expected to stay high, but manufacturing is now only 9% of the U.S. economy, down from 24% in 1900 and 15% in 1990. It is on its way to only 5% by 2040 or so. But growth in service productivity in contrast is low and declining. Total productivity is calculated to be just 1.3% through 2030, if we use current accounting methods.
  • Current accounting cannot accurately handle rising resource costs. Spending $150-$200 a barrel in offshore Brazil in the future to deliver the same barrel of oil that cost the Saudis $10 will result perversely in a huge increase in (Brazilian) GDP. In reality, rising resource costs should be counted as a squeeze on the balance of the economy, as they lower our total utility.
  • Measuring the non-resource balance of the economy produces the correct effect. The share of resource costs rose by an astonishing 4% of total GDP between 2002 and today. It thus reduced the growth of the non-resource part of GDP by fully 0.4% a year.
  • Resource costs have been rising, conservatively, at 7% a year since 2000. If this is maintained in a world growing at under 4% and a developed world at under 1.5% it is easy to see how the squeeze will intensify.
  • The price rise might even accelerate as cheap resources diminish. If resources increase their costs at 9% a year, it would take just 11 years before the economic system would be in reverse in the US! If, on the other hand, our resource productivity increases, or demand slows, cost increases may decelerate to 5% a year, giving us 31 years to get our act together.
  • Increasing climate damage, reflected mainly in food prices and flood damage, is going to increase. With  any luck this will not be severe before 2030 but it is very likely to accelerate  between 2030 and 2050.
  • U.S. real growth, according to GMO forecast, is 0.9% a year through 2030, decreasing to 0.4% from 2030 to 2050.
  • GDP measures must be improved so that they begin to measure output of real usefulness or utility. The  current mish-mash of costs and of “goods” and “bads” produces poor and even damaging incentives. 
  • Investors should be wary of a Fed whose policy is premised on the idea that 3% growth for the U.S. is normal.  Remember, it is led by a guy who couldn’t see a 1-in-1200-year housing bubble! Keeping rates down until productivity surges above its last 30-year average or until American fertility rates leap upwards could be a  very long wait! 
In the second part, Ben Inker talks about the Federal Reserve monetary policy, and even though QE managed to increase assets value, it did not really succeed in creating a wealth effect. The only one who benefited are households owning a house and carrying mortgage debt. as they could refinance their debt.  However, the other side is the coin, is that banks (such as Fannie and Freddie) have to pay the bill, and since those are owned by the government (i.e. taxpayers), as a whole there is no wealth effect. Due to low interest rates. this policy actually hurts prudent investors.

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