Stop Press Addendum

My worst fears about the potential loss of confi dence in our leaders, institutions, “and capitalism itself” are being realized. We have been digging this hole for a long time. We really must be serious in our attempts to resuscitate the “average hour worked” and the fortunes of the average worker. Walking across the Boston Common this morning, I came to realize that the unpalatable (to me) option of some debt forgiveness on mortgages looks increasingly to be necessary as well as the tax changes I discuss here.

To go further, if we mean to prosper long term, I am sure we need to act to make debt less attractive to everybody: it really is a snare and a delusion.

“Peace in our Time” 1 and the Art of Can-Kicking

Tough decision-making is never easy, and wishful thinking and trying to postpone the day of reckoning is always tempting. The British of the late 1930s probably hold the world record for wishful thinking, and the agreement signed in Munich in 1938 certainly provided the ugliest example of expensive can-kicking: Czechoslovakia was sold out to Hitler to, at best, buy a few months of peace. More recently, Japan has been the reigning world can-kicking champ for 20 consecutive years. But today Japan is suddenly being challenged by both the U.S. and the Euroblock. (The Brits, in contrast, with their draconian cost-cutting program at a time of acute economic weakness, look brave. Possibly recklessly conservative, and probably with rotten timing. But certainly very brave, Mr. Minister.)

Climbing the Greecey Pole

I am not an expert in euro fi nance 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 fi x 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 fi nancial 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 defi nitely inherited a dreadful mess courtesy of Greenspan, Bernanke, Paulson, Bush II, Rubin, and an army of greedy corporate short-term profi t 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.

So now (July 30), the U.S. – with a dysfunctional Congress – has to decide between two of the ugliest choices seen in a long time. Should they cut government expenditures and therefore cut aggregate demand at a time of a critically weak economy on the cusp, perhaps, of a double dip? Or should they do nothing and allow a technical default, compromising the integrity of the dollar and sending a powerful signal to the world that the U.S., at least for now,

Exhibit 1

U.S. Gross National Debt as % of GDP

is not a serious country and is probably past its prime. Ouch! Nobly trying to resolve this impasse, a small chunk of Republicans has seized the mantle of blackmailers and turned out to be very good at it. Certainly too good for President No-Show. Come to think of it, the choice was between technical default and looking like a Banana Republic and technical blackmail and looking like a Banana Republic! Just different bananas perhaps?

Update on “Seven Lean Years”

I wrote in early 2009 2 that “we probably do face a period that will look and feel painfully like seven lean years.” And “I expect that, at least for the seven lean years and perhaps longer, the developed world will have to settle for about 2% real GDP growth (perhaps 2.25%) down from the 3.5% to which we used to aspire in the last 30 years ... It makes it very unlikely … that we will get back to the old highs in the stock market … anytime soon.” And perhaps most seriously: “We have all lost some confi dence in the quality of our economic and fi nancial leadership, the effi ciency of our institutions, and perhaps even in capitalism itself.” (Emphasis added.)

So here we are more than two years later, at the one-third mark in the seven lean years. Profi t margins, as we will see later, are far above what I expected then. But everything else is perhaps at least a little worse. First, when I talked about 2% growth I was talking about a reduction in our trend line growth. I did not intend to count from the dead low of the economic recession. In fact, I argued that of course there would be an economic bounce with all of the spare capacity and unemployment. Had we averaged 2% growth from 2007 until now, GDP would be up 7% today. It is actually just under dead fl at. To make up this 7% shortfall in the remaining 3.5 years (December 2007 to December 2014) would take an extra 2% a year, that is, 4% annual real GDP growth. Given our current headwinds, this would seem to need a miracle. Even to average 1.5% growth for the seven years from 2007 to 2014 would take 3% a year growth, which seems at the upper end of a reasonable range. So, unfortunately, at the end of the fi rst period (in hockey terminology), my dismal seven-lean-year forecast looks all too accurate and, perhaps, even optimistic. To this point, there has never been such a weak and slow recovery from a steep decline. The revised numbers show that at the 2009 low we had had by far the biggest drawdown in GDP (-5.1%) since the Great Depression. The reasons that I thought it would take at least seven years to get back to normal are still mostly in place. Some have modestly improved, but many are worse.

“Seven Lean Years:” The Plus Side

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1 “My good friends, this is the second time in our history that there has come back from Germany to Downing Street peace with honor. I believe it is peace in our time.” Prime Minister Neville Chamberlain upon his return from Munich in September 1938 after he had met with Hitler and signed the Munich Pact, a treaty that he publicly represented as avoiding war.

2 Jeremy Grantham, “The Last Hurrah and Seven Lean Years,” 1Q Letter, 2009.

 

 

(c) GMO

www.gmo.com