Jeremy Grantham: Summer Essays
Jeremy Grantham’s latest missive is out, and as always, its well worth a read: The 2Q Letter is a collection of six essays on topics ranging from “Finance Goes Rogue (But Volcker Wins a Round,” to “The Fearful Speculative Market,” to “Everything You Need to Know About Global Warming in 5 Minutes.”
I particularly liked this part:
“In 1965, 3% of GDP that was made up of financial services [and that] was clearly sufficient to the task, the proof being that the decade was a strong candidate for the greatest economic decade of the 20th century. We should be suspicious, therefore, of the benefits derived from the extra 4.5% of the pie that went to pay for financial services by 2007, as the financial services share of GDP expanded to a
remarkable 7.5%.This extra 4.5% would seem to be without material value except to the recipients. Yet it is a form of tax on the remaining real economy and should reduce by 4.5% a year its ability to save and invest, both of which did slow down. This, in turn, should eventually reduce the growth rate of the non-financial sector, which it indeed did: from 3.5% a year before 1965, this growth rate slowed to 2.4% between 1980 and 2007, even before the crisis.”
Yes, the bottom line is that we over-extended on leverage, driving the finacial sector to be an outside chunk of the economy. The deleveraging process should take that back down, if not to 3%, well then certainly towards 5%.
>
Source:
Summer Essays
Jeremy Grantham
GMO, July 1010
https://www.gmo.com/America/MyHome/
Tweet
Facebook
Reddit
Digg this!
July 20th, 2010 at 12:03 pm
I think instead of outside chunk, you mean outsized chunk, BR. That is unless you were consciously pointing out the elements of alchemy finance gone rogue during the last paper mania…
July 20th, 2010 at 12:08 pm
“This extra 4.5% would seem to be without material value except to the recipients.”
He’s forgetting the trickle-down effect to the politicians.
July 20th, 2010 at 12:53 pm
“This, in turn, should eventually reduce the growth rate of the non-financial sector, which it indeed did…”
Correlation, it is true. The cause, though, might also lie in demographics, maturing technologies or expansion elsewhere on the globe.
July 20th, 2010 at 1:14 pm
QOTD:
“There was a time when a fool and his money were soon parted, but now it happens to everybody.” —Adlai Stevenson
~~
though, more seriously, what better way is there to grind down the Productive Economy, then, by increasing its Transaction Costs?
~~
and, wally, given the head-start of the U.S. Economy–especially, Post-WWII–one, as We’ve seen, would have had to, literally, ‘throw a Wrench in its Works’..
July 20th, 2010 at 1:23 pm
If the diagnosis (financial sector is too big) and the prescription (we need to shrink it) are correct, then why don’t Barry and Mr. Grantham lead the way by exiting said financial sector?
I know, I know… the money’s good, and this is obviously one of those situations where the stable equilibrium is Pareto-suboptimal. Still: if one has already made enough money to retire (as I imagine Barry might have by now), why not direct one’s prodigious intellect and energies into a sphere more useful to humanity?
~~~
BR: And leave the charalatans to run the sector . . . ?
July 20th, 2010 at 1:24 pm
We tend to think that from 3% to 7.5% is not that big a leap. But in mathmatical terms it’s a whopping 150% increase. The question is for this huge increase that we have all paid for, what in economic terms have we recieved in return?
July 20th, 2010 at 1:29 pm
BR-
how about this from the same article-
global warming will be the most important investment issue for the foreseeable future. But how to make money around this issue in the next few years is not clear to me.
ok then
July 20th, 2010 at 1:34 pm
So, what does that do NYC and surrounding economy? Hope you enjoyed the ride BR….
July 20th, 2010 at 1:40 pm
The events of Au08-Sep08 might have led to a correction downward in the 4.5%, instead they were used to guarantee yet another 4.5%.
July 20th, 2010 at 1:49 pm
The trend (of increasingly more of the economic pie going to the financial sector) is bound to continue. Production of real products languishes, while Ph.D physicists toil away at devising the next flash-trading algorithms, and otherwise intelligent humans at devising the next method of alchemizing crappy promises on paper to supposedly risk-free, above-market returns. The only difference now with before the crash is the role the government plays in backstopping feckless promises.
July 20th, 2010 at 1:58 pm
In the spirit of the earlier post comparing the housing price rises of various countries… to what may we attribute the economic malaise of Japan? Did they also have a burdensome financial sector?
July 20th, 2010 at 2:14 pm
Link:
http://www.gmo.com/websitecontent/JGLetter_SummerEssays_2Q10.pdf
July 20th, 2010 at 2:23 pm
Along with other excesses, the financial sector now also enjoys unprecedented political power. Good Luck bringing this beast back down to 5% gdp.
July 20th, 2010 at 2:37 pm
Time for a real economy index based on production, employment and the standard of living.
GDP is very convenient for a certain elite creating nothing and leeching on everybody else perpetuating the grand illusion of positive growth.
July 20th, 2010 at 2:41 pm
Barry,
Some back of napkin calculations:
Unites States Total GDP in 1965 (#1) $712,082,000,000.00 / per capita (#2) $3,664.80.
United States Total GDP in 2006 (#1) $13,201,820,000,000.00 / per capita (#8) $44,155.00.
United States Total GDP in 2009 (#2) (est.) $14.260,000,000,000.00 / per capita (#11) (est.) $46,400.00.
Inflation adjustment (Jan 1965 to Jan 2010): 594.51%
Inflation adjustment (2006 to 2010): 9.27%
Inflation adjusted:
US Total GDP in constant 1965 US$ – $4,945,480,698,200.00 /per capita $25,452.40
Where does the almost trebling of US Total GDP and doubling of per capita GDP come from?
sources:
CIA Factbook: https://www.cia.gov/library/publications/the-world-factbook/geos/us.html
Nationmaster. com: http://www.nationmaster.com/graph/eco_gdp-economy-gdp
Inflation Calculator: http://inflationdata.com/Inflation/Inflation_Calculators/Inflation_Rate_Calculator.asp#calcresults
(Yes I know this is Consumer Price Index – but for government work it suggests my point.)
July 20th, 2010 at 2:55 pm
The lawyers seem to stay under the fray in all of the crisis discussions …
QUESTION: What was the % of lawyers in 1960′s and % of GDP for legal compared to what this would look like now ??
July 20th, 2010 at 3:18 pm
Easy, the added GDP went exactly where Grantham says it did, to the added 41/2% of the financial sector (and government).
It certainly didn’t go to added wages of the general populace/middle class, which is a shell of it’s 1965 self.
The inflation numbers are a joke. I suggest anyone thinking they are even remotely accurate go shopping for something simple. NO, it’s not fair to send your wife, that’s why you are out of touch to begin with. Try toilet paper (over 25% inflation/shrinkage) or even ice cream (a half gallon is now 1.5 quarts? That’s 25% inflation/shrinkage too). That’s just two simple examples amongst thousands.
594% inflation is off by a lot. A pick-up truck with all the extras was $5000 in 1972. Now it’s over $35,000. That’s more like 700% inflation. A house in L.A. 1965 was maybe $30,000, ($16,000 in 1959 in a real example) now it’s over $375,000 (even after the recent housing mess, the same real example). That makes 594% look like child’s play.
July 20th, 2010 at 4:18 pm
to farfetched:
U.S. Families Median Income in 1965: $6,900.00
U.S. Families Median Income in 2009: $52,029.00
Adjusted for inflation: $46,695.06 in 1965 US D$
U.S. Unrelated Individual Median Incomes in 1965: $2,100.00
U.S. Unrelated Individual Median Incomes in 2008: $31,335.00
Adjusted for Inflation: $12,111.54 in 1965 US$
Of course the median household income has not increased as much as the per capita numbers in my earlier post suggested – merely approx. $5,000.00 in constant 1965 USD$. Some factors may include:
1. The widening distribution gap between the rich, the middle class and the poor. The bulk of which is attributable to increases in income for the very rich.
see: http://en.wikipedia.org/wiki/Income_inequality_in_the_United_States
(Yes I know it is Wikipedia but for a short one off it should be acceptable.)
2. The obscene “compensation” of CEO’s.
“In 2005, the average CEO in the United States earned 262 times the pay of the average worker, the second-highest level of this ratio in the 40 years for which there are data. In 2005, a CEO earned more in one workday (there are 260 in a year) than an average worker earned in 52 weeks.”
from: http://www.epi.org/economic_snapshots/entry/webfeatures_snapshots_20060621/
As noted in http://en.wikipedia.org/wiki/Median_household_income GDP per capita is a weak correlative to income. However, as a general measure of economic activity, which the referenced letter spoke of, it is usually considered a reasonable measure.
See:
http://www2.census.gov/prod2/popscan/p60-051.pdf
http://www.census.gov/prod/2009pubs/p60-236.pdf
July 20th, 2010 at 6:28 pm
I love reading Grantham’s stuff… it’s like lying in warm butter.
Got a good chuckle from this line — page 11: “To be fair, we did modestly extend the age to receive Social Security and I, for one, had to wait an extra four months. Rage, rage.”
Picturing Jeremy Grantham checking his direct deposit every month for his SSI is just plain entertaining.
July 20th, 2010 at 6:50 pm
farfetched:
“594% inflation is off by a lot. A pick-up truck with all the extras was $5000 in 1972. Now it’s over $35,000. That’s more like 700% inflation. A house in L.A. 1965 was maybe $30,000, ($16,000 in 1959 in a real example) now it’s over $375,000 (even after the recent housing mess, the same real example). That makes 594% look like child’s play.”
While I agree that the CPI is a lousy way to measure inflation, it’s probably not fair to compare automobiles. That 1972 truck had lousy brakes, got horrible gas mileage, spewed pollution, and had almost no safety features. A 2010 truck has all the same functionality of that 1972 truck, but has 4 wheel disk ABS, airbags, gets better fuel economy that an economy car from 1972, and pollutes a heckuva lot less. It has satellite radio iPod dock CD player with satnav instead of a transistor AM radio. It has air conditioning from the factory. And it seats 4 instead of 2. Yes, it’s 7 times the price instead of 6 times but it is a vastly improved product.
July 20th, 2010 at 7:50 pm
“The widening distribution gap between the rich, the middle class and the poor. The bulk of which is attributable to increases in income for the very rich.”
Formerlawyer, one man’s debt is another’s wealth. All debt is the obverse side of savings. The large amount of debt today is only possible if there is a large amount of wealth… and the concentration of wealth is the ying to the yang of debt. The are the mirror of each other. To lower debt, we must decrease wealth and, since that is now so concentrated, the decrease must come at the expense of a small part of the population.
Have at it.
July 20th, 2010 at 9:38 pm
Great stuff, by and large. Thanks, BR, for pointing the way.
One extrapolation that Grantham didn’t mention and that I thought was obvious: from his penultimate paragraph:
“All of [the problems mentioned here] owe too much to a common cause: an inadequate supply of wise long-term planning by our leadership in Congress and the rest of government. One of our central problems in investing and in economics in general is our default assumption that “they” (the government) know what they are doing. Unfortunately, nothing could be further from the truth.”
Um, the know-nothings he’s complaining about… we elected them. We chose them. We the people. We’re Congress’s bosses, and we’re the largest and most important part of “the rest of government.” We are responsible, jointly and individually, for each and every government we have ever had. In fact, I bet patterns of election reveal much more about the people voting than the people running (if history is any guide, politicians have pretty much been the same since voting was invented). The problems, quite obviously, aren’t with the Federal government, but with us, the people. It’s well within our power to have competent, farseeing government. On the evidence, that’s not what we really want for ourselves.
(I have the surreal sense sometimes that most USians–but especially business school grads–have this awkward and frustrating feeling that they’re automatically entitled to high quality government with no personal expenditure or effort required.)
July 21st, 2010 at 7:36 pm
Grantham and GMO have pretty piss-poor performance.
He liked the SPX at 750 in Mar 09 (nice call!). But then thought it was overvalued at 900 in June ’09 (tough!).
Like I said, his 5-year and 10-year and 20-year numbers are shit. Turns out bearish-ness does not pay.
While we on the topic… you know who is worse? Gartman. I just checked his ETFs… down 10% since early ’09 or something. That sucks.
July 21st, 2010 at 7:43 pm
This relates directly to your other post on “ego”. The way to take ego out of it is to constantly quote performance – MTD, YTD, 1-yr, 3-yr, 5-yr and risk numbers (volatility, max drawdown).
Its doesnt really matter if you have a huge ego, or no ego. The only thing that matters is risk-adjusted performance.
And the goal is… SAC/Steve Cohen. Outside of 2008 (down 20%)… Stevie has produced 70% annual returns (before fees) with only 5 months worse than -1% since 1985!
Somebody recently gave me the numbers from his days running prop at Gruntal in the 80s.