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Jeremy Grantham: This Time is Different

March 20, 2012

by Michael Edesess

The problem with Malthusianism – and neo-Malthusianism – is that almost every time a Malthusian thinker has predicted disaster within a certain time frame, those predictions have turned out to be wrong – including Malthus’ own. For example, in 1968 biologist Paul Ehrlich predicted wrongly that in the 1970s widespread famines would kill at least 100 million people. Challenged by business professor Julian Simon, Ehrlich then went on to bet – in partnership with two other scientists – that the inflation-adjusted price of a basket of five commodities would increase from 1980 to 1990. That turned out to be ludicrously wrong – the prices fell by more than half. (Grantham notes, however, that if the bet had been extended to 2011, Ehrlich et al. would have won by a large margin.)

In opposition to Malthusians are what are often called “cornucopians,” who believe that human ingenuity will always lead us to new resources and innovative ways to use them – much faster than they will run out. For example Stanford economist Paul Romer has written:

“Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. … And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. The difficulty is the same one we have with compounding: possibilities do not merely add up; they multiply.”

Reversion to the mean?

Grantham’s position in this debate is inconsistent with his investing philosophy.

Reversion to the mean is Grantham’s investing watch-phrase. He believes that market parameters will revert to their means in the long run, which usually means within his forecasting horizon of seven years. For example, if equity price-earnings ratios depart appreciably from their norms, then we’re either in a bubble or a panic, and prices will return to normal within that timeframe.

This simple philosophy has stood Grantham’s investment management firm, GMO, in good stead. He is esteemed for having avoided several investment bubbles. (Also, one senses that at his firm, clients would never be thought of “muppets” or easy marks.) Even in his February 2012 quarterly letter – after expounding on the short-term thinking of capitalism, and its inability to realize that a sea-change is coming – Grantham reveals GMO’s 7-year equity forecasted returns (an attractive 7% real for non-US equities), which are calculated based on the assumption of reversion to the mean.

It is incongruous that Grantham projects future equity returns in the normal way, while at the same time forecasting that everything is about to change. Perhaps seven years and 50 years (his long view of choice for illustrations of intergenerational inequities) are not comparable time periods, and Grantham’s apocalypse is penciled in for some time between 2019 and 2062? Or maybe he just believes that we will muddle through – there are intimations of that in his writing – but only because we will, in the end, heed warnings like his.

Or perhaps his new “reversion to the mean” has a yet longer time horizon, over which both human civilization and the planet will revert to the status quo that prevailed not that long ago, before we began to plunder the Earth’s resources in earnest.