The 10th Man: Why Quantitative Easing Was The Worst Thing In The World By Jared Dillian, Mauldin Economics
Long before I started writing for Mauldin Economics, I was a gold bull.
A mega-gold bull.
Seth Klarman: Investors Can No Longer Rely On Mean Reversion
"For most of the last century," Seth Klarman noted in his second-quarter letter to Baupost's investors, "a reasonable approach to assessing a company's future prospects was to expect mean reversion." He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
This started in 2005. I was making markets in ETFs at the time, and as head of the ETF desk at Lehman Brothers, I signed the firm up to be one of the early authorized participants in the SPDR Gold Shares fund (GLD). I was pretty excited.
It may seem quaint now, but at the time, there really wasn’t an easy way to invest in gold outside of coins or bars (high transaction costs, cumbersome) or futures (high barriers to entry). Physical gold, of course, is preferable, but you can’t really trade it, per se.
So I bought some GLD in 2005, bought more, bought more, bought more in 2008 with veins popping out of my neck, and was caught massively long in 2011.
I figured, oh well, it’s just a correction, I’ll ride it out. Except I didn’t know that it was going to be a 40+% drawdown and last five years. If I’d had that knowledge, I probably would have sold.
But my investment thesis on gold hadn’t changed.
Let me explain.
When the financial system was melting down in 2008, I predicted (possibly before anyone else) that Ben Bernanke would conduct unconventional monetary policy: quantitative easing. In retrospect, it wasn’t a hard call. He basically said he was going to do it in a 2002 speech.
I remember the day. The long bond rallied nine handles.
Anyway, that’s when the veins popped out of my neck, because I said all this printed money was going to slosh around the financial system and cause hyperinflation. Of course, I wasn’t the only one saying this, but I was saying it pretty loudly.
Never happened. All that money never ended up sloshing around—it ended up deposited as excess reserves back at the Fed. Years later, people theorized that quantitative easing actually caused the opposite to happen: deflation.
Anyhow, in finance, it is okay to be right for the wrong reasons. Gold went up for three more years, the best-performing asset class, even though the underlying thesis was totally wrong. There was no inflation whatsoever. Eventually, gold got the joke as sentiment turned, and you know what the last five years have been like.
The Weimar Experience
When the gold bugs start talking about hyperinflation, they usually start talking about Weimar Germany, probably the best-documented example of a situation where inflationary psychology took hold.
I don’t want to rehash the whole story here, but basically, post WWI, the League of Nations saddled Germany with a bunch of war reparations it could not possibly ever repay. In the end, though, Germany did repay—with printed money.
The funny thing about inflation is that it is always fun at first. Weimar Germany boomed for a couple of years, before the inflation began to get out of control. Ultimately, the deutsche mark collapsed, replaced by the rentenmark, which was actually backed by something of tangible value: land.
The ensuing financial collapse brought about political instability, which led to the rise of Hitler, and you know the story from there.
Now, clearly that hasn’t happened in the US, and it isn’t likely to happen. We did not get inflation… of goods and services. Interestingly, though, we got inflation of financial asset prices. Stocks and bonds went up, as well as real estate—even art. Great, but as you know, not everybody owns stocks, usually only people with some money to invest.
So as all the research shows, the rich have gotten richer, and the poor have gotten poorer. Inequality has increased massively, which has brought about political instability, which will lead to… who, as president, exactly?
Perish the thought.
Anyway, whether gold goes up or down, I continue to assert that printing money is absolutely the worst thing a central bank can do. Even under the best of circumstances, the unintended consequences are colossally bad. Even now, the Fed is just getting around to acknowledging the fact that quantitative easing might have actually caused wealth inequality.
There are those who will always say, “What, was the Fed supposed to do nothing? What do you think would have happened?”
An unimaginably bad depression. Then, the best recovery ever. And nobody would be mad at each other.
Gold Is Bouncing
You can’t deny the price action. Over the last few weeks, it is positively buoyant. If I were short, my butt cheeks would be tightening up.
I’m starting to develop a theory, which is crazy, but then again… it might not be entirely crazy. You can help me decide.
Maybe gold is starting to price in some of this political instability. Maybe it is starting to price in a Sanders or Trump presidency.
After all, if Bernie Sanders were to become president, he would double the debt overnight. If it were Trump, probably the same thing—we are talking about a guy who has spent his entire career screwing creditors.
This increases the possibility, however remote, of debt monetization. Also, populists are great for gold prices.
Like I said, maybe not so crazy. Regardless of whether gold goes up or down, or if you think gold bugs are total idiots, it makes sense (for a lot of portfolio theory reasons) to have it as part of your portfolio.
Sometimes a bigger part than others.
By the way, if your portfolio needs a boost this year, Mauldin currently has a low-price bundle offer out that includes Street Freak, Yield Shark, and Over My Shoulder. It expires in a few days, though, so check out the details here.