Friday, April 23, 2010

Jeremy Grantham: Playing with Fire

It’s spring, and this spring a young man’s fancy lightly turns to thoughts of speculation. The Fed’s promises look good and, as long as you’re not a small business, you can borrow to invest or speculate at no cost. The market has had a near record rally, sprinting far past our estimated fair value of 875 for the S&P 500. 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. We are also lucky to have a tiny fraction of our foregone interest returned by the banks as loan repayments with “profit.” Some profit! Oh, for the good old days when we could just settle for a normal market-clearing rate of interest. But that, I suppose, would be wicked capitalism, and we had better get used to bank- and speculator-benefiting socialism.

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 long- term cost in that.

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