Ireland, PIGS, QE2, the euro and the melting pot

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Ireland, PIGS, QE2, the Euro and the melting pot
Today, I am going to reflect on the continuing crisis within the eurozone and the
usefulness QE to spur the economy, a nice melting pot.
Greece is back behind the curtains and Ireland is on the stage under the spotlights for the
continuing show of the eurozone crisis.
Summary of the previous acts
Policy makers did not want to face the harsh consequences of 20 years of easy
money that led to over-indebtedness (act 1) and take the tough measures needed
due to cronyism and the human nature of politicians who prefer to spend money to buy
votes instead of telling voters the difficult reality of past policy mistakes. There is one
reality that central bankers did not want to see is that excess liquidity leads to mal-
investment, since lower returns are deemed reasonable and outright speculation becomes
the norm (from individual with real real estate or stock markets - some succeeded, most
failed - to CEOs who engaged in huge M&A deals to flatter their ego and grow their
bank account - most created value for themselves).
The act 2 started with the financial crisis in August 2007 which reached its peak in the
aftermath of Lheman’s debacle and the collapse of the real estate market. Central bank
opened without any restraint the liquidity tap (should I say fire hose…) for banks
1) to get rid of junk assets (they still have quite a bit in their accounts) and 2) play
the yield curve to repair their balance sheet and gain time via short term financing
at no cost and investment in longer dated Government securities (you know, the famous
riskless sovereign debt), making a couple of hundreds of basis points (by the way the most
profitable business since you only need a couple of people to do it and you can leverage!).
There is no reason to stop since Ben Bernanke QE2 is a clear signal that the FED will
continue managing the yield curve to limit the cost of financing of the US Treasury whilst
letting banks carry on playing the curve.
Banks (European ones in particular) poured cheap money given by central banks
into government securities, without properly analyzing the inherent risks of such
assets, replicating with Greece, Ireland and other PIGS (add France and Belgium),
that same mistake as for CDOs and et al to gain some tens or hundreds of
basis points of additional return: complacency at best...

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This led to the eurozone debt crisis during H1 this year with Greece. Now, Ireland is taking
the stage. In both cases, the sins lied with them, even if they are of a different nature: on
one hand a cheater which did not reform itself and is totally uncompetitive and on the
other hand a country that had balanced budgets and let its success running away with real
estate speculation that drove its banks to the knees, hence their costly rescue and a
spiraling budget deficit expected to reach 32% of GDP in 2010 despite austerity measure
taken in 2009 (the first country in Europe to do so)!
This profitable yield curve play had in itself the seeds of a contradiction: why should banks
lend money to a depressed real economy when they have to be more strict in their lending
practice (well, financing a speculative property market is not really the same as financing
the real economy, but this is an other part of the debate) and can easily make money at “no
risk”.
Ant now we arrive to act 3.
Act 3
Germany had enough to pay for the sins of profligate countries; after all, and until
proven differently, Germany is not a Charity. Merkel, with a reason, is fed up for Germany
to become the tax payer of last resort and wants other stakeholders to pay
their share of the burden: shareholders should be wiped out and bondholders (banks
among the largest ones…) take a haircut. I would add, and it may be the most important
act for any sustainable recovery, Boards and management should be fired
(politicians too - an other story).
Large European countries, Brussels and weak eurozone countries are
bullying Ireland to accept a rescue package from Europe and the IMF, while
Ireland has no immediate need for funds (EUR 22 billion in their coffers). Different reason
for the same objective: weak eurozone countries fear contagion and the Franco-German
axis together with Brussels are targeting Ireland’s low corporate tax rate. This
is the first clear of arm twisting to impose a converging taxation (upwards of course)
within the eurozone. This is stupid: Ireland will be able to get out of this mess quicker
than most via its competitiveness and attractiveness for foreign companies, and a low
corporation tax rate is part of the solution; not the case wit Greece which has not much to
show and seems however better treated than Ireland...
Between Irish and Greek bonds, you know where I would go for if I had to choose between
the two. If I were Irish, I would play hard balls with the French, Germans and Brusselites
to get as much as I could: this is the annoyance power since arm twisting is more or less
the only language understood in Brussels, Berlin and Paris.

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QE 2
The second QE decided by the FED will fail to stimulate the economy. Whilst it
allowed interest rates to substantially decrease during QE 1, and therefore release pressure
on many homeowners and relieve banks as well as spur the stock market, QE 2 will not
add much to consumers who are either out of job with no prospect of a rapid
improvement, and the wealth effect is more than dubious this time (after the crisis we are
muddling thought which demonstrated that not only assets cab go down as they go up, but
also collapse, who, with some sanity, is going to borrow in order to consume on the back
assets that went up thanks to the FED actions?).
QE is merely boosting asset classes, not the real economy, and attempting to
inflate in order to reduce the US debt burden and debase the USD to increase export will
not work, but may be temporarily - and I even have doubts (Germany have always had a
revaluing currency in relative terms and continued to be the world n° 1 or n° 2 exporter;
they got the products clients want: consumers want BMWs not GM cars). Playing the
currency card only works if at the same time structural reforms are undertaken to become
competitive on the international stage by offering the right products at the right price.
On sure thing, savers and pensioners are going to loose at this game.
I attach an interview with Jeremy Grantham, Chief Investment Officer of GMO, one of the
best value investor in a generation or two, who discusses QE 2 and prospects for asset
classes.
http://www.cnbc.com/id/15840232/?video=1640401359&play=1

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Sources:
The Economist: Saving the euro
http://www.economist.com/node/17525741
CNBC: Interview with Jeremy Grantham
http://www.cnbc.com/id/40131748/

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Legendary investor Jeremy Grantham, Chief Investment Strategist of Grantham, Mayo, Van
Otterloo sat down with Maria Bartiromo in an extremely rare interview.
Grantham recommended institutional clients to sell into this rally. He is convinced that stocks are
overpriced and cash is now the avenue for investors.
As an investment strategist for the past 30-years, Grantham has long been known for his timely
calls.
In 1982, he said U.S. market was ripe for a "major rally."
And in 1989, he correctly called the top of the Japanese economy. In January 2000, he warned of
an impending crash in tech stocks which took place two months later. And in April 2007, Grantham
said we are now seeing the first worldwide bubble in history covering all asset classes.
When we sat down with Mr. Grantham earlier this week, he expressed worries about various
pockets of the global markets, including emerging markets and U.S. stocks. Grantham is betting on
a strong cash position and being patient about when to get back into the market.
Check out the complete transcript of Maria Bartiromo’s interview with Jeremy Grantham, or watch
the complete interview here.
MARIA BARTIROMO: Great to have you on the program. Thanks so much for joining us.
JEREMY GRANTHAM: Very nice to be here.
BARTIROMO: Time and time again, your writings and your predictions have been right on in
terms of investing and where we are in this market. From the tech bubble to beyond. Can you talk
to us about where we are today in the stock market and what trends you see developing?
GRANTHAM: What I worry about most is the Fed's activity and — QE2 is just the latest
demonstration of this. The Fed has spent most of the last 15, 20 years— manipulating the stock
market whenever they feel the economy needs a bit of a kick. I think they know very well that what
they do has no direct effect on the economy.
The only weapon they have is the so-called wealth effect. If you can drive the market up 50
percent, people feel richer. They feel a little more confident, and the academics reckon they spent
about three percent of that. So, the market went up 80 percent last year. They should be spending
2.4 percent extra of— of the entire value of the stock market, which is about two percent of GDP.
And that's a real kicker.

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You don't see it because of the enormous counterdrag from the housing market— and— and its
complete bust. But, it would have been worse with— without this. The problem is, they know very
well how to stimulate the market. But, for whatever reason, they step away as the market gathers
steam, and— and resign any responsibility for moderating— a bull market that may get out of
control as we saw in '98 and '99 with Alan Greenspan, as we saw in the housing market.
And— I fear that the market will continue to rise. It will be continuously speculative. After all,
when you can borrow at a rate that is negative after adjustment for inflation, it's not surprising that
you would borrow a lot.
BARTIROMO: So, what are the implications of— of this constant easing and stimulation? You
know, it— it seems the numbers are so mind boggling: $600 billion here.
GRANTHAM: They— they (CHUCKLE) are mind-boggling.
BARTIROMO: You know? (CHUCKLE) But, give us the—
GRANTHAM: The consequences are you get boom and bust. You— stimulate in '91. You let it
get out of control. You have this colossal tech bubble in '99. Sixty-five times earnings for the— for
the growth stocks. Then you have an epic bust. Then, of course, they're panic struck. They race
back into battle with immense stimulus with negative real rates for three years.
"You can drive a market higher and eventually — of its sheer overpricing, it will eventually pop.
And, typically, it seems to pop at the most inconvenient time."
And you get another— rise of risk taking and everything risky— prospered in '03, '04, '05, '06, '07
until we had what I called the first truly global bubble. It was pretty well everywhere in everything.
It was in real estate. Almost everywhere. It was in stocks absolutely everywhere. And— and it was
in the bond market to some considerable degree.
And that, of course, broke. They all break. That's the one thing they can't control. You can drive a
market higher and eventually — of its sheer overpricing, it will eventually pop. And, typically, it
seems to pop at the most inconvenient time. So, we're going to drive this one up, and this time there
isn't much ammunition. In 2000, the Fed had a good balance sheet. The government had a good
balance sheet.
In '08, it was still semi respectable, and— and now it's not. It's not very respectable at all. So, what
are they going to use as ammunition if they cause another bubble and it breaks, let's say, in a couple
of years? Then we might have some real Japanese-type experiences.
BARTIROMO: Where are the solutions then, if not this? What do you think ought to be done?

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GRANTHAM: I think the Fed is not designed— to have effective tools to deal with the economy.
It should settle for just controlling the money supply. And— if it insists, it can worry about
inflation. The way you address a weak economy, particularly very substantial excess
unemployment is through fiscal policy. You must either bribe man— manufacturers, corporations
to hire people who have been unemployed, which they did in Germany. A lot of economists think
that's perfectly effective.
Or you must go in there and hire people yourself as a government. Now, I— I believe in crowding
out. So, I— I would never do it unless there was clearly quite a few million extra unemployed. I
wouldn't go after too many skilled labor because there's never— enough of them to go around. And
that does cause crowding out. I would go after the— what I called lightly-skilled workers.
The kind of people who were building the extra million-dollar— sorry— extra million houses in—
in '05, '06 and '07. And find— and find jobs for them. We have an infrastructure that is decades
behind schedule.
We could insulate every house in the Northeast. These are high-return projects, great— for society
in general. And to— to allow people to sit there unemployed. Their skills are deteriorating. Their
family morale goes to hell. And— it's a deadweight on society. And you have to remember when—
when the government hires someone, he doesn't pay the full price like a corporation does.
He pays about half price because he pays a lot. He, the government— it, the government, pays a lot
for someone sitting down unemployed. All the— all the many ways— that unemployed get— get
helped plus— the government carries the atrophying of the skills. Society loses that, the longer
they're unemployed.
BARTIROMO: So, what should the federal government be doing then? I mean, the housing
industry, for example, missing in action. What is it going to take to get housing moving again?
What is it gonna take to get businesses hiring again? If it's not the job of the Federal Reserve, what
policy should we be seeing coming out of the government?
GRANTHAM: I think the Federal Reserve has— is in a very strong position to move against
bubbles. Bubbles are the most dangerous thing— asset-class bubbles that come along. They're the
most dangerous to investors. They're also the most dangerous to the economies of— as we have
seen in Japan and in 1929 and now here. You've got to stop them.
The Fed has enormous power to move markets. And it— not necessarily immediately, but give
them a year and they could bury a bull market. They could have headed off the great tech bubble.
They could have headed off the housing bubble. They have other responsibilities— powers.
They— they could have interfered with the quantity and quality of the sub-prime event. They chose
not to.

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In fact, Greenspan led the charge to deregulate this, deregulate that, deregulate everything, which
was most— ill advised, and for which we have paid an enormous price. So, they can— they can
stop bubbles, and— and they should. It's easy. It's a huge service. What you do now is— is— I like
to say it's a bit like the Irish problem.
I wouldn't start the journey from here if I were you when you ask— the way. You— you really
shouldn't allow the— situation to get into this shape. You should not have allowed the bubbles to
form and to break. Digging out from a great bubble that has broken is so much harder than
preventing it in the first place.
"Greenspan led the charge to deregulate this, deregulate that, deregulate everything, which was
most— ill advised, and for which we have paid an enormous price."
Japan has paid 20 years for the price of the greatest land— bubble and the greatest stock bubble in
history. Far worse, in my opinion, than the South Sea bubble or the tulip bubble in many ways. The
land under the Emperor's Palace really was worth the whole state of California, which is quite
remarkable. But, we spent quite a few hours checking it, and it seemed to be true. And the price
they paid— to dig out of that has, of course, been legendary.
And we better hope that we don't pay anything like that price. But, that is a risk. It's not— it's not
certain that we will escape— without several years of— sub-average growth and— and stress to the
system.
BARTIROMO: So, are there policies that the administration could be implementing?
GRANTHAM: It's really Congress. If Congress is bound and determined to— interfere with any
proposed stimulus, then— we’re going to have a nice experiment and that is to see how the natural,
recuperative powers of the economy stand up to this stress. I think it will probably muddle through.
But, it won't be pretty. I— I don't think it will necessarily go backwards. But, it will go forward at a
very sub-average rate. And I think that's the course that— would have to be recommended now
is— it would be much better if Congress would shape up and— and do some sensible— stimulus
program from here.
And it would be sensible if the Fed recognized it doesn't have that— that power, and— and get out
of the way. Cranking out the printing press irritates all the foreign countries. Why wouldn't it?
It's manipulating the dollar downwards. It's causing inflationary fears.
It's causing— commodities to go through the roof. Not led by gold by the way. Gold has gone up
almost exactly the same in the last year as all the other metals. Everything is up. The commodity
index in a year is up 35 percent. A weighted average of everything. And that isn't oil because oil is
slightly less than that.

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But, it is— a very dangerous situation. And it risks currency wars. If we're seen to be pushing
down the dollar, when on technical terms— and fundamental terms, I should say, the dollar looks
already pretty cheap, and we're clearly driving it down by aiming to increase inflation and— and
swamping the system with money, why wouldn't— emerging countries take defensive action? And
all of them are.
So, we're already in— in a— in a currency war in a way. It's a mild one, and I hope it stays that
way. But, a currency manipulation is exactly the same as tariffs. It's a bit easier to change, a bit
easier to back off. But, it has the same effect on global economy if we get into a currency war as if
we got into a tariff war, which characterized the period after 1930 when the Smoot-Hawley Tariff
Bill was passed. And— and— and they're talking about that even as we speak in— in— in
Congress.
"So, we're already in— in a— in a currency war in a way. It's a mild one, and I hope it stays that
way."
BARTIROMO: So, while so many people are talking about the Chinese as far as manipulating
their currency, you say the Fed is manipulating these markets?
GRANTHAM: They are. And— and— and China is, of course, manipulating its currency. And it
would make life easier for everybody if they would allow the currency to rise a— a little faster.
But, it— it certainly weakens our hand enormously to go there and— and shout at them angrily
when we're clearly doing the same thing. And this is what the— the German Finance Minister—
the point he made two days ago.
BARTIROMO: Yeah. Let me ask you about emerging markets. You recommended an overweight
position in emerging markets back in 2000 when not many people were talking about it. And,
obviously, it was dead on, the right call as we've seen a huge move in the emerging markets. Do
you think there's still room to run in the emerging markets? Or is that becoming a bubble?
GRANTHAM: Incidentally, the emerging market since— 2000 is 3.3 times the S&P. So, every
$100 you have in the S&P, you would have had $330 starting from the same point in emerging.
And after that incredible discrepancy, which by the way says the main event in investing should be
getting the big picture right. It's nice to pick stocks. But, how many good stocks do you have to
pick in a whole portfolio to equal that incredible move between the biggest asset class in the world,
U.S. equities, and the third or fourth biggest asset class emerging markets?
It— it's these movements between the great asset classes that make you money. And I'm happy to
say that that's the group that, GMO, I work with— asset allocation where we are students of
bubbles. And— and— and, basically, financial history. It's a very entertaining job, I might say,
which has made me forget the question.

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BARTIROMO: The question is do you think that is now becoming overvalued? Is there still room
to make money in emerging markets?
GRANTHAM: I'm pleased to say two and a half years ago, I did a quarterly letter called the
Emerging Emerging Bubble, and I argued that in the following five years, the case for emerging
would be seen as so crystal clear— that it could not possibly help but outperform and go to a
premium PE. Now, up until then, they had always sold at a discount. Sometimes a substantial
discount.
But, I — the case is this, they are growing at about six percent real. Six percent plus inflation. We
are growing in the developed world at about two. Before '95, there was no difference. Before 1995.
And now it's three to one. My argument two and a half years ago is what a simple bull case? You
want to grow? Buy emerging.
You want to be conservative? Buy utility companies or the blue chips of— of— of the developed
world. If you're going to grow at six, you're— you're— it is very appealing that you would
outperform a world growing at two percent. And the developed world is slowing down. I— I say it
has an incurable case of middle-aged spread.
It's just been there, done that. It's a little old. It's a little pastured. Doesn't have the population
profile. Emerging does. And they have the attitude, and they have good finances. And— and they're
really showing— a— a clean pair of heels to the developed world.
Now, it turns out that you— it's a bit more complicated. You don't actually find a strong correlation
between— top-line GDP growth and making money in the market. It— it seems like you should.
The fastest-growing countries should give you the highest return. They simply don't. But, there's
only four of us— that— that believe that story. Everyone else in the world believes that if you grow
fast like China, you'll outperform in the stock market.
And so, I'm reasoning two and a half years ago, everybody will think this way pretty soon. And
surely— emerging countries will go to a big premium on— every dollar of earnings that they make.
And they're beginning to. But, I think they've got at least a few years left. The bad news for us,
because we're fairly purest value managers for mainly institutional clients, is we don't like to play
games with overpriced assets.
And that's the world that we're in now. The Fed is driving the S&P, which is overpriced— the
Standard & Poor's 500— a broad measure of the U.S. market, is driving it from already
substantially overpriced into what I would call dangerously overpriced.
This is about the boundary line. We expect on a seven-year horizon one percent only plus inflation
from the U.S. market. And now, as you push it up another 20 percent perhaps in the next year, it

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becomes dangerously overpriced. A bubble territory and ready to inflate to considerable pain.
That's what we have to worry about.
So, you're caught between, if you want to become conservative, you've got to start taking—
counteraction now. If— if you want to go with the flow, don't fight the Fed as they say— you
should be prepared to speculate on very nimble feet. It's not our style as a firm. But, I think it's—
probably a game that you could play with a pretty good chance of winning for— for a few more
quarters.
BARTIROMO: A few more quarters. But, at some point— or is it today— would you be
recommending selling into the rally?
GRANTHAM: Our institutional clients— sell very gracefully into this rally. We've already
started to sell. We're not even— averagely weighted. We're modestly underweighted. And you
must remember bonds are even worse than stocks on a seven-year forecast. So, you get caught in
this paradox. It's very tempting— and this is what the Fed wants by the way.
It wants us to go out there and buy stocks, which are overpriced because bonds they have
manipulated into being even less attractive. So, we’re being forced to choose between two
overpriced assets. That is not always a terrific choice to make because there is a third choice, and
that is don't play the game and hold money in cash.
And cash has a— a virtue that people don't appreciate fully. And that is its— its optionality. In
other words, if anything crashes and burns in value— say the U.S. stock market, if you have no
resources, it doesn't help you. If the bond market crashes, and you have no resources, it doesn't help
you. And what cash is is an available resource. It buys you the right to buy the U.S. market if the
S&P drops from 1,220 today to 900, which is what we think is fair value.
You then have some resources if you have some cash. There's another complexity and that is that
we believe that the old-fashioned, super blue-chip franchise companies like Coca-Cola [KO 63.77
1.25 (+2%) are also much cheaper than the rest of the market. So, if someone put a gun to my head
and s— said, "I've got to buy stocks. What should I buy?" I'd say, "Buy two units of the Coca-
Colas. They're the cheapest group in— in the equity world. Buttress it with a fairly large dose of
emerging markets. They're a little overpriced. But, they've got potential. And— a lot more cash
than normal for opportunities should the bubble blow up."
"I have an eccentric view on commodities not necessarily shared by my colleagues or by— almost
anybody."
BARTIROMO: What about commodities? I mean, clearly, the story of China and the demand
coming out of China has boosted all sorts of commodities. Is that bull run still in place?

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GRANTHAM: I have an eccentric view on commodities not necessarily shared by my colleagues
or by— almost anybody. And that is we're running out of everything. I think it will become
devastatingly clear to everybody. I— I think we went through a great paradigm shift about five
years ago and— we'd spent a 100 years with almost all commodities declining. Perhaps oil was
about flat in real terms, adjusted for inflation.
But, everything else was declining: copper, corn, and so on. And, now, you look back five years
later, you can't see that clearly at all. A lot of them seem like they've been going up for 50 years, a
100 years: copper— iron ore— tin. But— and— and— and oil. Oil has clearly broken out. It
spent a 100 years at $16 in— in our currency until 1974. And then it doubled when OPEC started
and it's been 20 years trading around 35, plus or minus a lot.
And then I think it doubled it again, and I think the trend line is probably about 75. So, the world
has changed. We're entering a period where we're running out of everything. The growth rate of
China and India is simply— can't be borne by declining quality of— of resources. And— and I
think we're in a period that I call a chain-linked— crisis in commodities.
So, it'll be a crisis in rice. It will triple and it'll come down. But, then— then it'll be followed by one
in corn and— and barley and so on. And— and copper will go up a lot, and then that will come
down. But, oil will be in crisis mode. From now on, we just better get used to it. So, if you're afraid
of inflation, I think— and if you can bring yourself to have a long horizon— and when I say long, I
mean ten to 20 years, not the usual ten to 20 weeks— that locking up resources in the ground is a
terrific idea.
Or locking up— timber, agricultural land will do just fine. A great inflation hedge. You will win, in
my opinion. Very high probability over a long horizon. Now, have these things gotten ahead of
themselves in the short term? Quite possibly yes. And that— that's what makes investing so tricky.
If they were to break for whatever reason at all in the next year, I— I would suggest that is a great
buying opportunity.
BARTIROMO: And—
GRANTHAM: To— to buy here is to trade off the long-term high prospects of winning with quite
a reasonable chance of— of— of buying at a— a— a short-term peak.
BARTIROMO: So, is there value in some of the commodities producers? The equities
GRANTHAM: If they have stuff in the ground. If they're just processors, forget them. Shoot them,
in fact. Because they're the people who will pay the price of constantly having to raise their prices
paying more for their raw materials. But— if they've got stuff in the ground. The oil industry since
2000 has doubled against the stock market. They didn't double because they got brilliant.

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They doubled because oil in the ground became worth four times what it was. And that is a
wonderful thing for an oil company with good reserves. But, the same if you had mineral reserve.
That— that's the play, I think, on commodities.
BARTIROMO: It's extraordinary that people are putting so much money into such low-yielding,
fixed income— products. And— ignoring dividend payers, which of course in equities are— are
even more competitive than— than the yields that you're seeing. You're seeing no yield in— in
fixed income. Is that a bubble?
GRANTHAM: I— I don't call it a bubble because it's not— it's not driven by huge animal stir—
spirits. They're not doing it to sell it at a huge profit. They're doing it because they were severely
frightened— in the great crunch. It was a devastating event. And it could have c— turned out much
worse than it did. It— it should have frightened people. It did frighten people and they'll still
frightened for quite a while.
And what the Fed is trying to do is to make cash so ugly that it will force you to take it out and
basically speculate. And in that, it's very successful, of course, with the hedge funds. They're out
there speculating. Finally, the ordinary individuals are beginning to get so fed up with having no
return on their cash that they're beginning to do a little bit more purchasing of equities. And that's
what the Fed wants.
It wants to have the stocks go up, to make you feel a bit richer so that you'll spend a little more and
give a short-term kick to the economy. But, it— it's a pretty circular argument. For every dollar of
wealth effect you get here, as stocks go from overpriced to worse, you will give back in a year or
two. And you'll give it back like it— like it happened in— in '08 at the very worse time.
All of the kicker that Greenspan had engineered for the '02, '03, '04 recovery and so on was all
given back with interest. The market overcorrected through fair value. The housing market that was
a huge driver of economic strength and a— actually masked structural unemployment with all those
extra, unnecessary houses being built. All of that was given back similarly at the same time. It
couldn't have been worse.
BARTIROMO: What are you expecting from the economy in 2011?
GRANTHAM: (Sigh.) I'm expecting 2011, 2012 to— and— and 20 as far as I can see to be less
handsome than it used to be. I think we— we're on a trend lying growth of about two percent.
And— I think we'll muddle through— quite well. The problem is in the not too distant future,
stocks will be too expensive and they'll crack again. Risky, fixed-income will be too expensive and
that will crack again.

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And unless we're lucky, we will have yet another crisis without being able to lower the rates 'cause
they'll still be low, without being able to issue too much moral hazard promises from the Fed
because people will begin to find it pretty hollow. Cycle after cycle, the Fed is making basically—
is flagging the same intention. Don't worry, guys. Speculate. We'll help you if something goes
wrong. And each time something does go wrong and it gets more and more painful.
And, eventually, even— even— fairly unintelligent investors might get the point that this is not a
good game to play indefinitely. I am impressed, however, how eager we have been to return to the
game. We got a— a practically mortal blow, and, yet, everyone was back in there swinging last
year. It wasn't just that the S&P went up 80, which I did call by the way. I said it would race up to
1,100. And— but, it was speculative so the— the junky part of the market went up 120 percent.
This is a formidable— recognition of what the Fed can do when it wants to.
BARTIROMO: What about the dollar? Where do you see it?
GRANTHAM: The dollar is on fundamental purchasing power— it's a— a fairly cheap currency.
And— as long as there's QE three, four, five and six, you'd have to bet that it's more probable
that it will go down. Now, if it stirs up— a currency war, all bets are off. We haven't had one since
the 1930s. We— who knows how that will play out? That's one thing that can completely change
the game, and— and— very hard for me or anyone to guess what that would do.
But, if we avoid that, I think you have to count on the dollar being at least irregularly weaker until
we finish the Q game, which is ma— basically just running a printing press and using it to push
down artificially— the bond rate. And let me point out that the Fed's actions are taking money
away from retirees.
They're the guys, and near retirees, who want to part their money on something safe as they near
retirement. And they're offered minus after-inflation adjustment. There's no return at all. And where
does that money go? It goes to relate the banks so that they're well capitalized again. Even though
they were the people who exacerbated our problems.
And, hopefully, the redeeming feature in that infamous trade is that your corporations go out there,
borrow money, build factories, hire people, which they're not doing because consumption is weak
and because they were also terrified by the crunch. I— I think, therefore, under these conditions,
low rates is actually hurting the economy. It's taking more money away from people who would
have spent it —retirees — than are being spent by passing it on to financial enterprises and being
distributed as bonuses to people who are rich and, therefore, save more.
So, I think it's a— a— bad idea at any time and a particularly bad idea now.

15
BARTIROMO: So, final question here. What are you recommending to institutional clients today?
How— how should they be investing?
GRANTHAM: We recommend a very heavy overweight in— in the great franchise companies:
the Coca-Cola’s [KO 63.7664 1.2464 (+1.99%) , Johnson and Johnson's [JNJ 63.95 0.89
(+1.41%) . I'm not recommending those two names. They're just examples. We're recommending a
modest overweight in emerging, an underweight— in everything else. Extra cash reserves and—
patience. But, I think if you're willing to speculate, you might find that this is an interesting one
more year to speculate.
"The trouble with bubbles is when they go, it's very hard to know how painful it will be."
BARTIROMO: And—
GRANTHAM: But, be aware the ice is thin. It's overpriced. It's a dangerous game. Don't believe
that it's somehow justified. It is not justified by anything except the crazy behavior of the Fed.
BARTIROMO: You said, "The ice is thin." In terms of these cracks, how significant a crack
would you expect when, in fact, we do see a crack?
GRANTHAM: The trouble with bubbles is when they go, it's very hard to know how painful it
will be. But, typically, they go racing back to fair value. So, if this market goes to 1,500 in a couple
of years, by then, fair value might be at 950— 950 is painfully below 1,500. And by the time it gets
there, the mysteries of momentum in— in the market— everyone likes to go in the same direction,
and they shout, "Fire."
It— it's— usually the case that it doesn't stop at fair value— 950. So, it might go to 700. And— and
you're talking another market that halves. It halved in 2000, and we thought it would by the way.
We predicted a 50 percent decline. It halved this time in— in '08, '09. And I think it might very
well halve again if it gets back to 1500.

Ireland, PIGS, QE2, the euro and the melting pot

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