The latest from Whitney Tilson:
My favorite authors are out with new missives. First, is Howard Marks with What’s Behind the Downturn Here’s an excerpt:
I feel the prosperity we enjoyed in the final decades of the twentieth century was
considerably better than “normal,” and better than we’re likely to see up ahead.
I’m not implying a world without growth or otherwise permanently negative. Just
one without the prosperity, dynamism or positive feelings of past decades.In
addition, the newness of the macro picture and some of the problems – and the opacity of
the solutions – certainly make it less clear in which direction we’ll go.
It’s my belief that things went better in the late twentieth century than we have reason to
expect in the years ahead. We could get lucky again, of course, but it would be
downright imprudent to make investments predicated on that assumption. Thus at
Oaktree we’re making allowance for things that may go less well than they did in
past periods. Cheapness provides a margin of safety today, but only so much.
We’re moving forward, but cautiously.
2) Here’s GMO’s Jeremy Grantham with Danger: Children at Play:
My worst fears about the potential loss of confidence in our leaders, institutions, “and capitalism itself” are being
realized. We have been digging this hole for a long time. We really must be serious in our attempts to resuscitate the
“average hour worked” and the fortunes of the average worker. Walking across the Boston Common this morning,
I came to realize that the unpalatable (to me) option of some debt forgiveness on mortgages looks increasingly to be
necessary as well as the tax changes I discuss here.
To go further, if we mean to prosper long term, I am sure we need to act to make debt less attractive to everybody: it
really is a snare and a delusion.
At the close on August 8, a slightly cheap equity portfolio could be put together comprised of U.S. high quality,
emerging markets, Japan, Italy, and European growth stocks. On our data, the imputed 7-year return of the package
today would be about 6.5% real!* Quality stocks, especially in the U.S. but almost everywhere, continue to
handsomely outperform. Regrettably, this means that they have declined very considerably less than the indices. In
its asset allocation accounts, GMO is modestly underweight equities, partly because of the desperately unattractive
yields on fixed income. We are now very modest buyers for the first time since mid 2009.
3) Re. my comments about Japan in my last email, attached is a more optimistic piece by GMO from April. Excerpts:
Japan’s fiscal situation has little in common with Europe’s PIIGS. For a start, sovereign defaults tend to afflict
countries that depend on foreign capital. This was the case for Greece and other countries in the European periphery.
Japan, on the other hand, remains the world’s largest international creditor and the overwhelming bulk of its public
debt (roughly 94%) is domestically held. It is very rare for democratic countries to default on debt held by their own
nationals. Sovereign defaults may also be prompted by economic contraction in countries that are locked into an
uncompetitive exchange rate. But unlike the PIIGS, Japan has its own currency, controls the central bank, and can
devalue if necessary. Japan also runs a large current account surplus, whereas the PIIGS sport deficits. Banking crises
can induce sovereign debt crises, as Ireland and Iceland have recently shown. But after huge write-offs during the past
two decades, Japan’s leading banks have robust balance sheets.
The focus on the downward trend in household savings is highly misleading. Unlike Greece and, for that matter, both
the US and UK, Japan’s gross savings rate (at 23% of GDP) remains high. In fact, Japan’s fiscal deficit is the result
of too much saving. Since the bubble burst in 1990, Japanese companies have been paying down their debts and
raising cash. The financial surplus of the private sector has produced a shortfall in aggregate demand, which has been
plugged by government deficits.15 Once corporate deleveraging ends and the Japanese start spending more and saving
less, then (everything else being equal) the government deficit should automatically contract.
There are other reasons to be relatively sanguine about Japan’s sovereign credit. The headline debt figure at more than
twice GDP overstates the problem. This number includes debt held by various government entities and sterilization
bonds, but excludes the government’s large foreign exchange reserves. A more appropriate figure is the net debt,
which stands at 114% of GDP (see Exhibit 4). By this yardstick, the debt is only four times tax revenues.
One should also take into account the fact that government revenues are currently depressed (see Exhibit 5). After
two decades of deflation, the tax take is lower today than in 1990. Corporation tax receipts are around half their 1990
level. Economists often refer to the “inflation tax,” which occurs when the effective tax rate increases with inflation.
Japan’s public finances have suffered from the opposite effect – a “deflation tax rebate.” The Japanese are not heavily
taxed by modern standards. Government revenues are approximately 30% of GDP, compared to an average of around
40% in Western Europe. Consumption tax in Japan is much lower than in the West. The greatest beneficiaries of the
deflation rebate have been the elderly who, directly or indirectly, own most of the government debt but aren’t paying
their share of the fiscal burden.
Nor is it true that Japan’s public finances must necessarily collapse if interest rates were to rise. This would only be
the case if rates rose while tax revenues remain unchanged. In fact, Japan’s tax revenues have shown themselves to
be sensitive to changes in nominal GDP. If rates rise because deflation has ended and economic growth is picking up,
then revenues may well rise faster than any increase in debt service. Under these circumstances, the government’s
ratio of debt to GDP would rise initially but start falling after a few years. Interest payments on the outstanding debt
would never become unmanageable.
And here’s the conclusion:
In the 1980s, “Japan is different” was a proud boast. The last two decades have shown Japanese differences in a less
flattering light. But some of its achievements have been glossed over. Japan still compares favorably to the US on
many measures: its energy efficiency is far greater; the population enjoys greater longevity while spending far less on
healthcare; income inequality is much less pronounced; since 2000, Japanese GDP per capita has even outpaced the
US. Japan’s car industry still leads the world and, as recent events have shown, Japanese components manufacturers
continue to occupy many vital niches in the global supply chain.
Nevertheless, Japan has been slow to adapt to changing realities; whether to the collapse of the bubble economy,
the decline in its population, or the rise of its Asian neighbors. Far from conforming to Schumpeterian notions
of economic development, Japan has followed its own unique path of “creative self-destruction.” If the country
continues on its recent path, the doomsters’ dire predictions will eventually come to pass. Tokyo needs to get its fiscal
house in order. The country needs to improve its trend growth rate. Deflation must be dispelled. Japanese companies
must generate better returns.
These are not impossible demands. The fiscal situation can be rectified. Taxes can be raised on consumption and on
the elderly. Tax revenues will rise once deflation ends and the economy starts growing again. With sufficient political
pressure, the Bank of Japan might be persuaded to