Why QE Was the Worst Thing in the
World
Jared Dillian
Editor, The 10th Man
Editor, The 10th Man
Long before I started writing for
Mauldin Economics, I was a gold bull.
A mega-gold bull.
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.
Why Gold
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 QE 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.
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