Saturday, November 24, 2012

Jeremy Grantham "On the Road to Zero Growth" as His Co-head of Asset Allocation Does the Full Monty

We'll have commentary on the letters next week, it always takes me time to chew over what Mr. Grantham is saying.
From Grantham Mayo Van Otterloo:

On the Road to Zero Growth
Jeremy Grantham
  • The U.S. GDP growth rate1 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. Yet most business people (and the Fed) assume that economic growth will recover to its old rates. 
  •  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 half a percent. This is pretty much baked into the demographic pie. After adjusting for fewer hours worked per person, man-hours worked annually are likely to be growing at only 0.2% a year.
  • 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. There is a limit as to how much this small segment can add to total productivity. 
  • 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. 
  • However, 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, the U.S. will reach a point where all of the growth generated by the economy is used up in simply obtaining enough resources to run the system. It would take just 11 years before the economic system would be in reverse! 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. Of course, with extraordinary, innovative breakthroughs we might do even better, but we certainly shouldn’t count on that. (Bear in mind that we don’t even know precisely why the prices started to rise so sharply in 2000.) Excessive optimism and doing little could be extremely dangerous.
  • For a few years fracking will add helpfully to growth: my guess is that the benefit will peak at about 0.5% within five years, but be modest over longer periods. The key concept here for understanding growth is to know when the maximum upward push will occur. (See Appendix A.) 
  • Increasing climate damage, reflected mainly in food prices and fl ood damage, is going to increase. With any luck this will not be severe before 2030 (we allow for a 0.1% setback) but it is very likely to accelerate between 2030 and 2050. A great deal will depend on our responses. 
  • The bottom line for U.S. real growth, according to our forecast, is 0.9% a year through 2030, decreasing to 0.4% from 2030 to 2050 (see table on Page 16). This is all done presuming no unexpected disasters, but also no heroics, just normal “muddling through.” 
  • 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.
  • Accurate measurements of growth must eventually include the full costs of running down our natural assets. 
  • True income (said Hicks) is meant to allow for sustained productive capacity, which our current measures clearly do not. If they had done so the developed countries might well have been in reverse for the last 20 years. 
  • 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! 
  •  Some of the investment implications of this low growth outlook and the Bernanke optimism will be addressed next time (with luck!).
Introduction: Wishful Thinking
Attitudes to change are sticky. We cling to the idea of the good old days with enthusiasm. When offered unpleasant ideas (or even unpleasant facts) we jump around looking for more palatable alternatives. Critically, the tech boom and bust and the following housing boom and housing and financial busts helped camouflage the recent unpleasant economic development lying below the surface: the steady and important drop in long-term U.S. growth. Someday, when the debt is repaid and housing is normal and Europe has settled down, most business people seem to expect a recovery back to America’s old 3.4% a year growth trend, or at least something close. They should not hold their breath. A declining growth trend is inevitable and permanent and is caused by some pretty basic forces. The question here is not “Has the growth rate dropped?” (yes, it has) or “Will it continue to drop?” (yes, it will). The question is

“At what rate will it drop?”
(20 page PDF)

That's the Full Monty (Python):