Jeremy Grantham – Charlie Rose 03-11-13

Salient to Investors:

Jeremy Grantham at Grantham Mayo Van Otterloo says:

The US is muddling through reasonably well in the short-term, but long-term we are in a slowdown unappreciated by most economists – because they are not interested in the long-term.

US growth won’t ever return to previous levels because it is determined by population growth plus productivity. US population growth – a huge component of GDP growth – often hit 1.5% but has now fallen to 0.2%-0.3%. Workers work a little less each year. Women, who hardly worked in 1950s, entering the workforce was a big boost to GDP but their acceleration peaked in 2000 and is now over. We should not expect more than 0.2%  increase in hours offered to the workforce.

Bernanke’s erroneous belief that we can return to 3 percent growth implies productivity will increase by 1% and offset the decline in workplace hours growth, but productivity will continue to decelerate modestly going forward. In the 40 years following WWII, productivity was 1.7%-1.9%, and in the last 30 years was 1.3%. So even assuming we can hold 1.3%, which is optimistic, then adding in 0.2% population growth gets you to 1.5% versus Bernanke’s 3% and the IMF and World Bank’s 2.5%.

Even that 1.5% assumes that an increase in resource cost is a boost to GDP – if you drill a more expensive well then GDP goes up but that cost of resources is a cost of doing business for the rest of the economy. The more people it takes to get one barrel of oil is counted as a contribution to GDP and make the economy look stronger when in actually it is weaker. If you take out the resource component in the last 10 years, the economy grew 0.4%- 0.5%  less than is measured by GDP, thus bringing our 1.5% down to 1%.

The cost of resources declined – the typical commodity dropped by 70 percent – for the 100 years prior to 2000, so GDP was understated by 0.25%.  From 2002-2008 we gave the whole decline back as resources went up more steeply than in WWII – no one talked about it despite overnight running out of cheap resources because of steady population growth and the enormous surge in Chinese demand for resources – growing 10% per year.

China uses 53% of all cement, 47% of all coal, 46% of all iron ore. If China slows to 7% it means 10 years from now we need to find another 47% of coal just for China.

China shifting to a domestic demand economy would be a good engine for economic growth in the US and Europe and Latin America in the short-term, but long-term the problem is that growth is incredibly energy intensive and burning coal and oil has enormous environmental consequences as well as pushes up the price of oil in the short-term. Oil was $25 in 2000 and is $100 today and makes up half the cost structure of producing the other resources – e.g. mining copper combined with lower quality ore means the price of oil is going up . Resource prices are rising faster than global GDP growth.

The carbon math shows global temperatures have increased 0.8 degree centigrade – spring comes 2 weeks earlier. Scientists say 2 degrees is the critical boundary – above that brings dire consequences which will worsen for a long time.  A rise of below 2 degrees means we might limp through. The carbon in our proven reserves is five times that needed to raise global temperatures 2 degrees and guarantee starvation and floods for our grandchildren. We will pump all the easy oil and gas. Pumping tar sands and digging coal is extremely costly and ruinous to the environment – we are racing toward getting rid of the earth’s bio diversity. We have done enough to frighten the Scientists but not the average man in the street. In a real crisis, we will belatedly do something.

Since most of the stock value in oil companies is in their reserves, they have to pump and promote oil.

Oil was $16 a barrel for 100 years until OPEC in 1934, then moved to $35 where it traded for 30 years before moving to $80-85 in the last few years. We are never going back to $35 because the price is cost driven – Shell will tell you it costs $80-85 to find and drill for a barrel of good oil.

There is no substitute for water, soil, potassium and phosphorus. Phosphorus has no substitute and no living thing grows without it, yet we will run out of non-Moroccan reserves in 50 years. Water desperately tries to recycle, but phosphorus stays underground and requires a lot of energy to extract it.

Malthus described the past very accurately. Coal arrived at the time of his treatise and with oil and gas bought us a 250-year timeout with virtually infinite energy – 1 gallon of oil is equivalent to 200 man hours of labor. Science has helped us in this 250 year window but not before that? Coal and oil have given us superman power. Before coal came along, every civilization from Rome to the Mayans collapsed due to their arrogant self-belief and overreach once the weather turned against them.

Every wave of technology has been hugely energy intensive – coal and steam for railroads, oil for cars, energy for refrigerators and air conditioning, and to power iPhones and iPads.

There are 2 gifts that we have that none of the prior civilizations had that might get us off the hook. The first is our dramatically declining fertility rate which has fallen contrary to all predictions – 1.8 children per couple in developed countries. Even Iran has gone from 7 per woman in 1960 to 1.5-1.6 today. The global population has to drop to a level that can be sustained by our reserves of carbon fuel. Science will give us an out if we can maintain  the population decline from 10 billion today to 4 billion in 200 years – very doable – and ensure complete self-sufficiency.

The second gift is alternative energy sources like solar and wind power, and a storage grid system that is happening faster that people realize, all suppressing demand for finite resources.

The rich half of world, including China, is pricing out the poor half. The rich half consumes wheat while the Moroccans, Libyans and Tunisians who live on wheat cannot afford it.

Was able to spot the prior bubbles by focusing on the numbers. Every asset bubble in the financial world has burst. There is enormous pressure in the investment business to deliver good news – stockbrokers, investment houses thrive on it. To talk about gross overpricing and downside risk in asset bubbles is an invitation to get fired because people just don’t want to hear it. Doing so cost my firm half its book of business in the great tech bubble. Being bullish sells but you won’t easily hear honest advice when it is bearish.

The stock market P/E in 1929 of 21 times earnings was exceeded in late 1997 by a market that eventually reached 35 times in March 2000. In the tech bubble most of my investment committee thought we were in a golden new era of tech and that the internet would drive away the dark clouds of ignorance.

Markets can be from time to time become crazily inefficient  because economic theory doesn’t work with humans: like incredibly well-informed buyers know as much as sellers which is complete nonsense. Bernanke has inherited complete academic view that markets are efficient – he did not see the housing bubble in 2007, unlike all of the couple of dozen of newsletter writers,  economists, stock advisors we listen to.

Japan real estate was the biggest bubble in history – land under the Emperor’s palace was worth more than all of California. Right behind was the Japanese stock market bubble which went to 65 times earnings versus the previous record of 25 times.

The statistical definition of a bubble occurs every 44 years in a random world but occurs every 30 years in the real world. Black swans are not as common.

Citigroup was insolvent and should have been allowed to fail in order to show that we would not bail out ludicrous bets.

Investors can make good money in cheap stocks in the long-term. However, while valuations for the great franchise companies like Coca-Cola are a little expensive, the rest of the market is very expensive and assumes profit margins will return to normal. Overseas emerging markets offer better returns.

Currently slightly underweight global equities and heavily underweight US equities excluding the 25% of the market which are great franchise companies.

Bernanke is whipping an economy that can only grow at 1% thinking it can grow at 3%, and does not have the tools to generate employment, which should not even be in their mandate. Creating jobs requires fiscal policy. 74 year-olds should still be working because they are not the 70-year olds of 100 year ago. The unemployed should do useful projects that bring societal benefit, like  installing insulation in cold areas, redoing the grid system.

Debt is vastly exaggerated and we have been conned by the financial world that it is everything. Debt is in the accounting, paper world and distracts us from the real world, which is the quantity and quality of your people , capital spending being inventive, training, education relative to South Koreans. In 1982, total debt was 1.25 times GDP and then it shot up at a a 45 degree angle over the next 30 years to 3.5 times GDP, yet the growth of economy has slowed proving debt doesn’t create long term growth despite Bernanke thinking it does.

Housing explains why this recovery slow – there is nothing more dangerous than messing with housing. Just going back to trend would have tripled oil, triple food, triple copper so don’t need debt.

By keeping interest rates low, the Fed is hurting retirees and transferring money from the poor to the rich, to the banking system, hedge funds, speculators, corporations, who are spending less than at any time in history. It is better to stimulate the economy through government spending than to play games with the monetary system and interest rates and transferring money to people who don’t spend it.

View the full video at http://www.charlierose.com/view/interview/12812

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