When it comes to the art of being a silver-tongued purveyor of doom, Nouriel Roubini can't hold a candle to Jeremy Grantham. So when Grantham voices concerns that Europe is jettisoning the economic policies of Keynes for those of Herbert Hoover, I take him more seriously than, say, Paul (One-Note) Krugman.
I was on vacation in England and Scotland for two weeks in late June and it was pretty amazing to see the new U.K government roll out its austerity plan. We all know a crisis is an opportunity not to be wasted but Grantham is right that Europe's embrace of belt-tightening may be admirable but ill-timed.
Talk about sharing the pain. Tax rates going through the roof, with the VAT going from 17.5% to 20% and capital gains tax rates going to 40%. Businesses and the wealthy are hardly alone when it comes to getting socked. There could be no raises for three years for public employees, while benefits for the disabled are getting slashed, schools are hit with big budget cuts and the government is telling everyone to work into their 70s. I suspect they are talking a tougher austerity plan than they'll deliver.
But most people seemed willing to accept it. Some like Grantham question the wisdom of raising taxes and cutting spending before an economic recovery is established, but polls in a variety of European nations reveal a surprisingly large percentage of the population realizes austerity is necessary and that their welfare states are reaching the limits of entitlement.
In his quarterly letter to investors, Grantham writes:
"The worrying news is that most European countries, led by Germany (not surprisingly in this case), are coming on more like Hoover than Keynes. More surprisingly, Britain and half of the U.S. Congress are acting sympathetically to that trend, which is to emphasize government debt reduction over economic stimulus. Yet, after a relatively strong initial recovery, the growth rates of most developed economies are already slowing, despite the immense previous stimulus. You don't have to be a passionate follower of Keynes to realize that to rapidly reduce deficits at this point is at least to ?irt with a severe economic decline. We can all agree that we had a ?nancial crisis, a drop in asset values, and an economic decline, all three of which were global (although centered in the developed countries), and all three of which were the worst since the Great Depression. All three were destined to head a whole lot deeper into the pit without the greatest governmental help in history, also global. Yet despite this help, the economic recovery was merely adequate, unlike the stock market recovery, which was sensational and, as often happens, disproportionate to the fundamental recovery. But in the last three months, more or less universally in the developed world, there has been a disturbing slackening in the rate of economic recovery. (Perhaps Canada and Australia on their own look okay, propped up by raw materials and, so far, un-popped housing bubbles.)
"I am still committed to my idea of April 2009 that there would be a "last hurrah" of the market, supported psychologically by a substantial economic recovery but then, after a year or so, that this would be followed by a transition into a long, dif?cult period that I called the "seven lean years." I had, though, supposed that the economic re?ex recovery-how could it not bounce with that ?ood of governmental help to everyone's top line?-would last longer or at least not slow down as fast as we have seen in the last few weeks. And with unexpectedly strong ?scal conservatism from Europe and perhaps from us, this slowdown looks downright frightening."
Other investment professionals like Ray Dalio, CEO of Brigdewater, the giant hedge-fund complex, share Grantham's fears and think the risk of deflation is rising. But the austerity skeptics, including advocates of a new stimulus like Krugman, face a crisis in their own credibility. Back in early 2009 when the first stimulus was under construction, Krugman argued not only that a bigger stimulus was necessary but also that it didn't matter how the funds were spent. Great idea, Paul.
Now when most Americans, spooked about soaring debt levels, think we just threw a trillion dollars down the drain, Krugman has only himself, and those whose listened to him, to blame for mounting doubts about future stimulus. Regardless of ideology, the protracted character of de-leveraging that the developed world currently is experiencing is likely to undercut the efficacy of most fiscal and monetary policy moves.
In fairness to Hoover, austerity skeptics, including Krugman, also point to 1937 when FDR suddenly contracted the austerity bug, cutting spending and raising taxes, which led to a dramatic return to depression-type conditions in 1938. A more sensible approach for the U.S. today might involve simply deferring the expiration of the 2003 capital gains tax cut for a few years. Right now most Americans are hardly awash in capital gains so the government can't expect much revenue from that source. It would send a badly needed signal to businesses to come out of their bunkers.
The scenario unfolding across Europe should serve as a cautionary warning to the U.S. Whether one questions the timing of the austerity program or not, the public in Europe seems ready to listen to the message of curbing government bloat, save for a few rioters in Greece and striking protesters in Paris (but then the French soccer team went on strike for a day during the World Cup).
Former President Bush was criticized by everyone from Pimco's Bill Gross to Sen. John McCain for failing to use 9/11 as a chance to ask for some kind of national sacrifice from all citizens. Likewise, President Obama could have used the Great Recession to ask for sacrifice but has avoided it. If he won't do it, someone in America will. It's a message citizens are willing to hear.
When it comes to the investment landscape, Grantham is as gloomy as ever, and he casts doubts about the equity markets' flight to speculative trash and institutional investors' lemming-like embrace of the "Let's all look like Yale" endowment model. His favorite asset classes for the next seven years are: U.S. high-quality equities, expected to return 7.3% on an annualized basis and emerging markets, which he pegs at 6.6% for the next seven years.
As for now, however, he doesn't like much. What a surprise.