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Perspective

Immigration and Brexit
Immigration from outside Europe is a potentially explosive problem & Brexit may be the fuse

Jeremy Grantham

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 the UK and what they might mean. We in the US can see the turmoil stemming from the Brexit vote, which seems to have happened 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 of the remarkable experiment of the European Union are unknowable but potentially profound.

The US political scene, to me,  seems 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. Our financial establishments are driving interest rates towards zero and beyond in a never seen before move. How will this end? I think of these political, social, and financial experiments as Black Hole Experiments where 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. While the twin forces of the Fed’s policy and corporate buybacks are trying to push stock prices higher, there is an impressive array that includes everything else trying to pull them down: disappointing productivity, growth, and profit margins together with all our domestic and international political uncertainties, and now Brexit! It is a testimony of the strength of those two bullish forces, that they can steady the US market near its high, apparently, regardless of what is thrown at it. I therefore remain at where I have been for the last two years for at least one more quarter on the basis of those two remarkable pillars of support. Despite brutal and widespread asset overpricing, there are still no signs of an equity bubble break eventhough cash reserves and other signs of bearishness are indeed, 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 that went down by at least 50%– 1972, 2000, and 2007, 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. Now, things could change if we just have a breakout rally to over 2300 on the S&P 500 and a bit of towel throwing by the bears. (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 on 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 the broadest range of advantages with it: 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 and the simplest input to social cohesion turns out to be income equality, which is correlated highly with every individual measure of social cohesion listed above. Conversely, income inequality leaves the impression, probably correctly, that the political voice of the poor has been lost or weakened….

…I wrote two years ago that this immigration pressure would stress Europe and that the first victim would be Western Europe’s liberal traditions. Well, this is happening in real time and far faster than I expected. It will only get worse as the number of refugees touch millions.

The EU and Europe may support increasing numbers of these failing state refugees for a few years, but that is all. Fairly quickly, they will have to refuse to take even legitimately distressed refugees. The alternative – to take all comers – would likely lead to not just a failed EU, but a failing Europe. The key question now is what are the social and political problems that will be caused by the stress of getting from here to there: from today’s chaos to a time when European borders will have uniform and controlled immigration.

Brexit is an early warning of how sensitive this issue will be. A serious country, or at least a formerly serious country, the UK is risking a lot at a small whiff of the immigration problem that is coming. (Immigration problems in the US are trivial in comparison to what Europe faces, yet they have already become a serious political issue.)

The EU (with or without the UK), and indeed the whole of Europe, must get a uniform policy on immigration as soon as possible. Yet, based on what they say, they seem to have not yet realised the long-term seriousness of their predicament. They are behaving like headless chickens faced with the problems they already have. Problems that will, when viewed from the future, appear to have been just moderate in scale.

By far the biggest downside of Brexit is that it serves to weaken the EU at exactly the wrong time – as external immigration begins to seriously stress governance and political cohesion.

In the larger context of immigration, because I believe I have no serious career risk on this issue (touch wood!), I should say that I believe that the UK and many other European countries have not had a net benefit from immigration. In 1945 they were, in most cases, culturally and ethnically homogeneous. This was absolutely not the melting pot situation of North America where steady immigration was supported by the elite-intellectual, political and economic. In Europe, it occurred largely against the will of the people— more were nervous about increased immigration than enthusiastic. It seems likely that in most cases immigration has made social cohesion more difficult.

Any offsetting economic advantage for the UK has to be on a productivity basis, for driving GDP forward with population increases alone is no bargain in a small, overcrowded island that feeds barely half its own population (although business support for growth of any kind is often forthcoming). Possible productivity gains from immigration seem at best to be insufficient to offset increased social stresses. There, I said it…

This is an excerpt from Jeremy Grantham's July 2016 GMO Commentary, you can read the full version here

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