James Montier’s latest missive from GMO is about the macro-economic scenario and whether the new austerity movement will ultimately help or hinder a recovery.
Montier points to the paradox of thrift: if everyone attempts to save more, then this reduction in spending will cascade through the economy, lowering incomes and negating any gains and instead hurling the economy into a vicious downward spiral.
The danger is that austerity could plunge a fragile recovery back into a deflationary tailspin. Montier cites the Japanese experience where fiscal tightening caused several needless recessions:
Montier is worried that “policy error” - that is, removing monetary and fiscal stimulus - will likely cause a deflationary spiral. As well, you can’t go wrong fading Alan Greenspan who’s recent jeremiad in the Wall Street Journal urged the US to “rein in budget deficits”.
If there is one thing I’ve learned watching Greenspan over the years, it is that he is as perfect a fade as you’ll find. Whether it is about the price of natural gas, Adjustable Rate Mortgages, the housing market, etc. just listen to what he says and do the exact opposite to come out ahead.
The question of inflation or deflation, is correctly, a major preoccupation of most market participants. I’ve been saying for a while that the ultimate question is whether deflation or inflation will win. If you can nail the answer to this one question, you’re set for basically every single major financial decision whether it is about equities, bonds, commodities, etc.
Montier believes that deflation will win or has won but that since it will cause Bernanke to institute a second round of quantitative easing, inflation will eventually rear its head. In any case, I’m glad to find out that Montier agrees with me that bonds are overpriced:
Generally, we simply can’t bring ourselves to own bonds at the yields on offer in most markets today.
In fact, US government bonds are the second worst asset class (1%) in GMO’s projected 7 year forward forecast. Naturally, this is also the sentiment that Jeremy Grantham shared in his own latest quarterly letter.
Finally, to reconcile the ongoing battle between the Austerians and the Keynesians, Montier quotes Blanchard and Cottarelli who have offered “10 Commandments” to reconcile. You can read Montier’s complete message below:
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