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.

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.)

 Code Red By John Mauldin: A Mixed Bag

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.

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