Code Red By John Mauldin: A Mixed Bag


Book Review: Code Red By David Merkel, CFA of Aleph Blog

This is a tough book to review.  It is correct in analysis of what went wrong, but overpromises in what its main goal is — protecting assets before the next financial crisis.

Let me take a step back, and describe the structure of the book.  A major goal of neoclassical macroeconomics is to try to eliminate the business cycle, and end up with smooth growth that minimizes unemployment.

As a result, central bankers, since they have a freer hand than politicians, as they are appointed, not elected, act to try to stimulate demand by lower interest rates.  They did that from 1982 to 2008, until they came to the bottom rung of their ladder, and realized they could go no further.

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Thus “Code Red” — a situation that is an emergency.  Many central banks felt they needed to act in an emergency to create liquidity to pump up economies with significant financial bankruptcies.

Would it work?  When the central bankers started, all they had was theory, and  Japan.  Japan had tried out their theory, and it did them no good.

The academics argued that Japan did not do it right, and sadly, one was the Chairman of the Fed.  Would that Bernanke had done his Ph.D. dissertation on another unrelated topic.  Some historical accidents are real killers, and this was one.  (As an aside: always be wary of academic researchers that have a lot invested in an idea.  They cease to be neutral, and cause contrary data to be ignored, because you can always find a method to twist the data.)

Anyway, that is the first and longer part of the book explaining how bankrupt. untested theories led us to a situation where debt levels are high with governments, and central banks are ultra-loose.  In such a situation, nations will try to weaken their currencies to gain a nominal advantage over other nations, so that they can export more.  Eventually, it could lead to a currency war of competitive devaluations, or worse, a trade war of competing tariffs.

If central banks cooperate with their governments, they can repress people financially, making the rate that they can invest in with safety to be lower than the inflation rate.  The authors believe that governments will try to do that and eventually fail, because credit creation will eventually lead to significant inflation.

One virtue of the book is that it shows that economists with influence over policy don’t know what they are doing, but make a bold show of it.  Particularly telling is Bernanke on page 135 saying the Fed can mop up excess liquidity at the right time, and he is 100% confident of that.  The Fed has never succeeded at that before, so who is he kidding?

The second half of the book deals with how to protect your assets — half is generous here, because it is 25% of the book.  It goes over the permanent portfolio idea of Harry Browne, and then a series of non-solutions in Chapter 10, essentially arguing that diversification is called for.

Chapter 11 argues for inflation protection through buying shares of companies that have moats, such as:

  • Valuable Intellectual Property
  • Benefit from strong network effects
  • Are low cost producers
  • Have lock-in, and customers can’t switch easily
  • Natural monopolies and monopolies of market niches

These are good ideas, in my opinion, but difficult to continually implement.  The book gives companies that presently fit the ideas of the authors, but updating it, and knowing how to trade it is tough.  We’ve been through eras like the early ’70s, where companies like this have cratered, so this strategy does not come without the possibility where it becomes too popular, and gets abandoned.

Chapter 12 goes through commodities and gold, and is bearish on them, arguing that the commodities supercycle is dead, and that gold is tied to real interest rates.

In short, the second half of the book is thin.  If you are looking for protection, maybe the book should have said, there aren’t a lot of great ways to seek protection against the monstrous economic policies of the developed world and China, but that wouldn’t have sold many books.


I disagree with the first chapter that we had to have bailouts.  The government could have protected regulated subsidiaries of the banks, and derivative counterparties, and let the holding companies fail.  I also disagree that we had to have abnormal monetary policy to stem the crisis — so long as there is a positive yield curve, there is stimulus, but once you get down near zero, perverse effects kick in.

The rest of my disagreements are already expressed.  To summarize: the first half of the book is good, but the second half is thin gruel if you want to protect your assets.

Who would benefit from this book: If you want to understand the causes of the crisis this is a great book to buy.  For protection of your assets, it will give you a few ideas, but no solution.  If you want to, you can buy it here: Code Red: How to Protect Your Savings From the Coming Crisis.

Full disclosure: I asked the publisher for a copy of the book, and he sent one.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.