Another Brilliant Letter By Jeremy Grantham

By on April 26, 2010

Jeremy Grantham has recently published his views in his quarterly letter which exposes the lopsided unfairness of the current situation, and past manipulations, inflicted upon investors by the Fed. Grantham recognizes a decision has been made to opt out of true capitalism into a bastardized form of crony-bank-sponsored socialism. It is aptly titled Playing with Fire (A Possible Race to the Old Highs). Excerpts:

Bernanke is, in fact, begging us to speculate, and is being mean only to conservative investors like pensioners who cannot make a penny on their cash. Collectively, we forego hundreds of billions of potential interest, but at least we can feel noble because we are helping to restore the financial health of the banks and bankers, who under these conditions could not fail to make a fortune even if brain dead.

Grantham recognizes the costs of this wrongheaded Fed and government intervention:

The massive bailout program stopped the meltdown of the financial system and engineered at least a temporary economic recovery. We know the obvious cost of this bailout: unprecedented deterioration of the Federal balance sheet. But what of the less obvious costs incurred by taking away the rewards of caution by saving the reckless and incompetent? These weak enterprises, financial and other, were not gobbled up by the stronger, more prudent, and more competent natural survivors, and there is a longterm cost in that.

Grantham exposes what could go wrong:

Should unemployment linger at high levels, which I think is likely, and I get these things right better than half the time (I believe about 52%), then we had better hope that something lucky turns up to break the speculative spirit. This is perverse, but so is Bernanke. What could go wrong, preferably in the next few months? Some combination of the following: an unexpected second leg down in house
prices and a continued rise in the level of defaults, leading to a crisis at Fannie, etc.; a wash-out in commercial real estate and private equity caused by refunding problems (along the lines of Goldman’s and Morgan Stanley’s recent real estate fund wipe-outs) that result in a chain of major defaults in properties like Stuyvesant Town; a crisis in the euro where Portugal or Spain or Greece, or all three, default and strange things start to happen; a rapid rise in commodity prices, despite the anemic growth of the developed world, which, with the same caveats, I also think is quite likely; competitive devaluations leading to a serious trade war; or my colleague Edward Chancellor’s favorite, two or three wheels falling off of the Chinese economy, which today acts as the main prop to global growth. Okay, enough. We all know that there is plenty that could go wrong. Some combinations would be enough to break the market but still leave the economy limping along. This would be far better than having the market rise through the fall of next year by, say, another 30% to 40%, along with risk trades similarly flourishing and then all breaking. The possibilities of this happening seem nerve-wrackingly high. The developed world’s financial and economic structure, already none too impressive,
would simply buckle at the knees.

Grantham resigns himself to the strong possibility that the market will move to new highs by October 2011 because of historical precedent:

In October we enter the third year of the Presidential Cycle, the year every Fed except, of course, Volcker’s, helped the incumbent administrations get re-elected. Since 1932, there has never been a serious decline in Year 3. Never!

Grantham includes a long and valuable section on the disadvantages of strict Graham and Dodd-type investing and ignorance of bubbles and busts.

Source: GMO

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