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Grantham's words of wisdom: Part III - Views on News from Equitymaster

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Grantham's words of wisdom: Part III
Apr 29, 2013

This is the third and final part of our three-series article on Jeremy Grantham's thoughts as revealed on the Charlie Rose show. The write-up would focus on Jeremy Grantham's views with regard to elevated debt levels in America making an attempt to answer two questions: Have elevated debt levels in the US helped to promote real economic growth in the US? Is monetary stimulus the only solution to promote US economic growth?

Have elevated debt levels in the US helped to promote real economic growth in the US? Grantham goes back to as early as 1982. Ronald Reagan was the US President then, and the debt to GDP ratio in the US was 1.25 times. Over the course of the next 30 years, the debt to GDP ratio nearly tripled to 3.5 times. However, contrary to expectations, the US growth rate dropped from around 3% in the 1980s to an average of less than 2% in the last ten years.

Thus, Grantham believes that it is a myth that growth in GDP can be achieved by pumping more money into the system through cheap debt. By keeping interest rates artificially low, money is being transferred from the retirees to people who run hedge funds and the banking system in general. The required amount of capital expenditure to boost the US economy is not happening and the money supply is unnecessarily chasing financial assets and propping up their prices artificially.

Is monetary stimulus the only solution to promote US economic growth? Grantham dismisses the fact that the debt levels should be brought down by hook or by crook in a hurry. He believes that there should be a twenty years plan to get out of the 'rat hole'. Debt at the end of the day is a 'paper' while the 'real world' comprises of the quality and the quantity of people and the quality and quantity of capital spending. Money supply should chase productive assets and he goes on to add that the common assumption that there is very little scope for capital spending on the Government account in a developed country like the US is devoid of any merit. Projects like installation of solar panels, insulation of every cold area and redoing the grid system would not only be productive but also have a high societal return.

Grantham concludes the conversation with Charlie Rose on a humorous note by saying that usual economic assumptions that markets take care of themselves and that people are rational and that their behaviour is guided by common sense have failed to hold true in the real world and therein lies the difference between sophisticated economic theories and functioning of the real world.

We agree with Jeremy Grantham's answers to both the questions as illustrated above. Thus, we continue to remain circumspect with the recent surge in US stock markets and false hopes of economic revival connected with it.

However, as pointed out in Part II of this series, there is always a possibility that while an economy may look dismal, a portfolio of carefully picked stocks based on their fundamentals can still do very well.

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