GMO’s commentary for the month of July 2016, in which Jeremy Grantham discusses immigration and Brexit by Jeremy Gratham


I set myself a task this quarter to give my views on why suddenly so many strange things are going on in the US and in the UK and what they might mean. We in the US can see the turmoil resulting from the Brexit vote, which seems to have been undertaken almost casually, without the normal planning for consequences. It has been likened to a dog that to its amazement catches the car – now what? The consequences for the remarkable experiment of the European Union are unknowable but potentially profound.

The US political scene seems to me to have plenty of similarities and perhaps we, too, will have our “now what” moment before long.

The economic and financial background to these apparently uncontrolled political experiments is also novel and risky. In a way never seen before, our financial establishments are driving interest rates toward zero and beyond. How will this end? I think of these political, social, and financial experiments as Black Hole Experiments in which the further we push them, the more the laws of physics, finance, or politics begin to change in unknowable ways. We live in interesting times.

[On the investment front the equation remains the same: pushing stock prices higher are the twin forces of the Fed’s policy and corporate buybacks. Trying to push prices down is an impressive array of everything else: disappointing productivity, growth, and profit margins together with all our domestic and international political uncertainties. And now Brexit! It is a testimonial to the strength of those two bullish forces that they can steady the US market near its high, regardless, apparently, of what is thrown at it. I therefore remain, on the basis of those two remarkable pillars of support, for at least one more quarter where I have been for the last two years; despite brutal and widespread asset overpricing, there are still no signs of an equity bubble about to break, indeed cash reserves and other signs of bearishness are weirdly high. In my opinion, the economy still has some spare capacity to grow moderately for a while. All the great market declines of modern times – 1972, 2000, and 2007 – that went down at least 50% were preceded by great optimism as well as high prices. We can have an ordinary bear market of 10% or 20% but a serious decline still seems unlikely in my opinion. Now if we could just have a breakout rally to over 2300 on the S&P 500 and a bit of towel throwing by the bears, things could change. (2300 is our statistical definition of a bubble threshold.) But for now I believe the best bet is still that the US market will hang in or better, at least through the election. P.S.: Having admitted my error in commodities, I would like to clock in the seventh anniversary of my “7 Lean Years” prediction for the economy back in 2009. The speed of the recovery, and particularly productivity gains, has been very lean indeed.]

Immigration From Outside Europe Is The Potentially Explosive Problem And Brexit May Be The Fuse

  • There is a consensus that social cohesion is the key to a successful society. It brings with it the broadest range of advantages: greater economic mobility; longer lives and better health; fewer babies born to teenagers; fewer traffic deaths, murders, suicides and robberies; a smaller percentage in prison; and less stress and higher levels of contentment, amongst others. Not bad.
  • The biggest simple input to social cohesion turns out to be income equality, which is correlated highly with every individual measure of social cohesion listed above. The exhibit below provides an example. Conversely, income inequality leaves the impression, probably correctly, that the political voice of the poor has been lost or weakened.

GMO, Immigration, Brexit

  • Gluttons for data on this issue must read The Spirit Level: Why Greater Equality Makes Societies Stronger by Kate Pickett and Richard Wilkins. It will make income equalizers out of all of you.
  • According to the authors, both professors of sociology, Japan tops the list for both income equality and social cohesion. It is closely followed in both by the Scandinavian countries. At the other end, the US has deteriorated rapidly in both measures and now ranks dead last among developed countries, with the UK not too far behind.
  • Economic growth, in fact, has been tilted sharply toward the better-off in both countries. In the US, which for once is worse than the UK, there has notoriously been no material progress since 1970 (45 years) in the real hourly wage, even as the income of the top 1% has more than tripled. Tax rates have not attempted to balance this but have actually changed to lower the relative burden on the well-off! Blue-collar work, especially in manufacturing, has been hard to get in both countries. Since 2009 in the US about 10 million new jobs have been created and a remarkable 99% have gone to workers with at least some college education.
  • It might be expected that blue-collar and less well-educated workers would be disappointed in both countries, and they are. Parents now widely believe for the first time (ex the Great Depression) that their children will not be better off than they themselves are. In these circumstances, social cohesion has rapidly decreased and immigration has risen in importance, which we see in both the Trump campaign and the pro-Brexit arguments.
  • Moving on to other data, when asked point blank in polls, “Do you think there are already too many immigrants?” over 40% of the general public of most European countries have answered “Yes” for decades.1 (The Scandinavian countries and Germany were more favorably inclined in recent years.)
  • In the UK in the 1960s and 1970s, an admittedly difficult time for them, the “Yes” vote ran around 80% with a high of 90% in 1974! In the 1980s and 1990s, with better economic times, the “Yes” vote steadily declined. Ironically, in light of Brexit, by 2015 it measured its lowest at about 55%. But still 55%. If the issue of a referendum can be tilted toward immigration, 55% is obviously still a dangerously high number.
  • Looking at the effect of immigration on social cohesion, one must deal with a lot of obliqueness in academic work: most papers seem to be reluctant to appear antiimmigrant or racist. Yet most conclude that trust is usually lower in diverse groups than homogeneous groups: that religious and visible differences – dress and skin color – are less easily dealt with, not surprisingly, than immigrant groups with similar cultures. My interpretation of various carefully stated conclusions is that when times are good immigrant flows are perceived as a moderate and manageable stress to social cohesion. This is true even among groups that are not happy with the general principle of steadily increasing immigration.
  • When times are seen as bad, though, especially when jobs are scarce as they are for blue-collar workers now, new immigrants are seen as far more problematic. When combined with steady increases in income inequality (as they
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