Reading Roundup: October 2022
This month we read:
Keeping At It: The Quest for Sound Money and Good Government by Paul Volker
The Wealth of Nations (Books IV and V) by Adam Smith
Freezing Order: A True Story of Money Laundering, Murder, and Surviving Vladimir Putin's Wrath by Bill Browder
American Buffalo: In Search of a Lost Icon by Steven Rinella
Keeping At It: The Quest for Sound Money and Good Government by Paul Volker
![Keeping At It: The Quest for Sound Money and Good Government by [Paul A. Volcker]](https://substackcdn.com/image/fetch/$s_!PeXa!,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2Fe1af46b5-3e5a-47e6-8db1-a3e1402177fd_323x500.jpeg "Keeping At It: The Quest for Sound Money and Good Government by [Paul A. Volcker]")
In August, speaking in Jackson Hole, Jay Powell said the Fed “must keep at it until the job is done.” The phrase “keep at it” struck me as a subtle nod to Paul Volcker and his memoir Keeping At It.
Keeping At It reinforced two themes I see every time I read history. First, there is nothing new under the sun. Kelly Hayeys said it best: “Everything feels unprecedented when you haven’t engaged with history.” Studying the past can often reveal clues about the future.
Second, history is “just one damn thing after another.” The solution to one crisis inevitably sows the seeds of the next. Central banking is like a never-ending game of Whac-A-Mole.
Volker was Under Secretary of the Treasury for International Monetary Affairs between 1969 and 1974 and played a key role in ending the gold standard and collapse of Bretton Woods.
The problem with the gold standard was that the world couldn’t produce gold fast enough to keep up with a growing world economy’s demand for international reserves. As a substitute, foreign central banks held dollars instead of gold. This required the US to print money and run balance of payments deficits, which produced inflation and undermined the fixed $35 gold price.
The US dollar was relatively overvalued, which encouraged imports and slowed exports. The US balance of payments had turned negative and European countries with large dollar surpluses began to request to convert them into gold.
The US did everything it could to avert the inevitable. In 1961 the Treasury and the Fed worked together on Operation Twist to increase short-term interest rates without increasing long-term rates. Operation Twist made a comeback in 2011 when Chairman Bernanke implemented his own version. History doesn’t repeat, but it does rhyme.
Later, lawmakers in Washington levied tariffs to slow imports, demanded foreign markets open themselves to more US trade, and asked that NATO expenditures be more evenly distributed. The Trump administration pursued policies that rhymed with these. Politics is just as cyclical as fashion.
Eventually economic forces compelled Nixon to suspend the dollar’s convertibility into gold. It was announced as a temporary measure, and that “temporary” measure remains in force today.
Volker said his work on the gold standard and the Bretton Woods agreement was the most important of his career. He concluded that sovereign nations could pick two of three priorities:
Full control over their monetary and fiscal policies;
The benefit of a free flow of capital across national boundaries; or
Stable, predictable foreign exchange rates.
The US, UK, Japan, and Canada, and others achieve 1 and 2 by sacrificing 3. The Eurozone achieves 2 and 3 by sacrificing 1. China achieves 1 and 3 by sacrificing 2.
In 1979 Volker became Chairman of the Fed. Due to a quirk he was paid just $57,500 as chairman, much lower than the $110,000 he had received while president of the New York Fed. So when Volcker moved to Washington he rented an apartment in a building full of George Washington University students. Imagine being an undergrad and discovering your neighbor isn’t a student but the Chairman of the Fed!
In 1979 interest rates were historically high but inflation was still higher at 15%. Volker thought that the Fed was loosing credibility. Its habit of making small, incremental changes to the discount rate was always too little, too late. He decided to directly target the money supply. Inflation is too many dollars chasing too few goods, so fewer dollars would mean less inflation.
Volker debuted his new policies on October 6, 1979 in what’s now known as the Saturday Night Massacre. The Fed increased the discount rate 100bps to 12% and increased deposit reserve requirements. He kept at it until 3-month T-Bills hit 17%, the prime rate hit 21.5%, and mortgages 18%.
Volker used the yield curve to understand market expectations. He wanted short-term rates to rise but for long term rates to stay put. Low long-term rates would signal that the market was confident the Fed could control inflation. Today the yield curve is inverted, suggesting confidence in Powell.
Volker’s policies didn’t produce an immediate recession, though they did anger some. Farmers surrounded the Fed with tractors and home builders, forced to shut down, sent sawed-off two-by-fours with messages to the Fed’s board. Today we’re seeing growth managers like Cathie Wood write open letters to the Fed asking for lower rates.
By the summer of 1982 Volker inflation was clearly falling and he began to ease. The markets, which had been flat since 1968, took off. Watch for that to repeat this time.
Despite his success, Volker still had to manage a conflict of interest with President Reagan.
In the summer of 1984 I was summoned to a meeting with President Reagan at the White House. Strangely, it didn’t take place in the Oval Office, but in the more informal library. As I arrived, the president, sitting there with Chief of Staff Jim Baker, seemed a bit uncomfortable. He didn’t say a word. Instead, Baker delivered a message: “The president is ordering you not to raise interest rates before the election.”
I was stunned. Not only was the president clearly overstepping his authority by giving an order to the Fed, but also it was disconcerting because I wasn’t planning tighter monetary policy at the time. In the aftermath of Continental Illinois’s collapse (described in the next chapter), market interest rates had risen and I thought the FOMC might need to calm the market by easing a bit. What to say? What to do? I walked out without saying a word.
This isn’t any different than what Trump did to Powell, except that Trump did it on Twitter.
No sooner had Volker tamed inflation than the Latin American debt crisis began. US banks, flush with cheap deposits from the newly oil-rich Middle East, had been lending aggressively to Latin America. Between 1979 and 1982 Latin American debt doubled. The influx of petrodollars and Latin American lending turned out to be one reason Volker struggled to tame the money supply. When oil prices collapsed in 1981, Mexico defaulted. US banks refused to roll over other Latin American countries’ short-term loans, and the world was plunged into a debt crisis.
Finance is a complex, interrelated system, and even Volker didn’t see this coming. The Fed can’t just change one thing. As soon as one thing is fixed, another breaks. When talking to an economist, Warren Buffett advises always asking “and then what?”
Keeping At It is a great read for anyone looking for insights into how the Fed behaves and into what might lie in our future.
Matt
The Wealth of Nations by Adam Smith
The final two books in the Wealth of Nations follow the same pattern as the first three; concepts that Smith writes about are as true today as they were 250 years ago. The first several books focused on laying out the foundations of supply and demand and free markets, and books four and five focus on how governments can aid and interfere with these immutable laws of economics.
I can save you 500 pages of reading and a lot of time with a brief summary; when at all possible do not interfere with free markets. Smith shows example after example of how increased tariffs, trade exclusions, and any stifling of free markets leaves countries on all sides of the deal worse off. There are examples of when Britain, Spain, Portugal, France, and others imposed huge tariffs on imported items that were low-cost compared to what could be produced domestically and the effect was simply to raise prices for the goods in their own country and lower the standard of living for everyone. It seems governments around the world would do well to read Smith’s advice today.
Smith summarizes by saying that anything, however well intentioned, that stifles capitalism with false demand (subsidized by the government) or suppresses free trade never works for the benefit of all:
extraordinary encouragements to draw towards a particular species of industry a greater share of the capital of the society than what would naturally go to it, or, by extraordinary restraints, to force from a particular species of industry some share of the capital which would otherwise be employed in it, is, in reality, subversive of the great purpose which it means to promote. It retards, instead of accelerating the progress of the society…and diminishes, instead of increasing, the real value of the annual produce of its land and labour.
I found another interesting parallel to successful businesses today; decentralization. Britain discovered by accident the benefits of decentralization that unleashes entrepreneurial spirits.
Because the American colonies were so far away Britain simply couldn’t keep tabs on everything happening in America. This allowed the colonists to pursue rapid expansion and progress with very little shackles from the mother country. When combined with the vast amount of uncultivated land in America what resulted was the flywheel that is American society today. Other newly established colonies from European nations (like by Spain or ancient Greece) were much more closely monitored, taxed, and stifled in general, compared to America.
the European colonies established in America and the West Indies resemble, and even greatly surpass, those of ancient Greece…their great distance from Europe has in all of them alleviated more or less the effects of this dependency. Their situation has placed them less in the view, and less in the power of their mother country. In pursuing their interest their own way, their conduct has upon many occasions been overlooked, either because not known or not understood in Europe…The progress of all the European colonies in wealth, population, and improvement, has accordingly been very great.
Basically the American colonies were allowed to be very entrepreneurial compared to other colonies of the day, which laid the foundation for the greatest capitalist system the world has ever seen. Berkshire, Constellation Software, Alimentation Couche-Tard, and so many other great businesses we’ve written about are simply applying this same principle to business as the early colonists did to establishing America. This is one of dozens of parallels Smith writes about between economic principles and businesses that still apply today.
Dan
Freezing Order: A True Story of Money Laundering, Murder, and Surviving Vladimir Putin's Wrath by Bill Browder
![Freezing Order: A True Story of Money Laundering, Murder, and Surviving Vladimir Putin's Wrath by [Bill Browder]](https://substackcdn.com/image/fetch/$s_!G08E!,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2Fc6eaf1fb-f59c-40cf-a69f-403db737250d_329x500.jpeg "Freezing Order: A True Story of Money Laundering, Murder, and Surviving Vladimir Putin's Wrath by [Bill Browder]")
Freezing Order continues the story author Bill Browder began telling in Red Notice. Both read like a Tom Clancy thriller, but unlike Clancy’s fiction, these are true stories. The book is filled with jaw dropping accounts of Russian corruption and aggression. It turns out a lot of people in Russia “accidentally” fall off tall buildings shortly after criticizing Putin.
In Freezing Order Browder follows a trail of stolen Russian money and discovers that the path leads all the way to Putin.
I drew a line from the $230 million fraud to Putin’s proxy, the cellist Sergei Roldugin. I explained that this wasn’t a one-off, but one of thousands of crimes Putin had benefitted from, allowing him to accumulate an estimated $200 billion fortune. I pointed out that nearly all of this wealth was held at financial institutions in the West and at risk of being frozen under the Magnitsky Act. For these reasons, the law was an existential threat to him and his senior officials.
Once Browder discovered how much money was at stake — hundred of billions, not millions — he began to understand why Putin was acting so aggressively.
For the first time, it all made sense: one of the main reasons Putin had interfered in the US election was because of the Magnitsky Act.
The book helped connect several recent events in a cohesive narrative — from the Magnitsky Act to the Danske Bank money laundering scandal to the 2016 US Presidential election.
On the surface, it appeared that Trump was acting irrationally, but what I’ve learned over the years as an investor is that almost everyone behaves rationally. If someone does something that appears irrational, it just means you don’t have all the information.
Like Red Notice, Freezing Order is riveting and worth a read for entertainment value alone. Though it also provides a lot of context investors will find useful in understanding Russia and current world events.
Matt
American Buffalo: In Search of a Lost Icon by Steven Rinella
![American Buffalo: In Search of a Lost Icon by [Steven Rinella]](https://substackcdn.com/image/fetch/$s_!rUPx!,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2Fbd73f2e9-7dde-42a9-a11e-781c632c4eaa_324x500.jpeg "American Buffalo: In Search of a Lost Icon by [Steven Rinella]")
American Buffalo is an adventure story. Rinella wins a rare permit to hunt a wild buffalo in Alaska’a remote Wrangell-St. Elias wilderness. But the best parts are Rinella’s humorous anecdotes, tangents, and side bars. Rinella weaves together trivia from biology, ecology, and anthropology to paint a portrait of the American west, from past to present.
It turns out that buffalo make a wonderful lens to view the history of the American frontier.
At once [the buffalo] is a symbol of the tenacity of wilderness and the destruction of wilderness; it's a symbol of Native American culture and the death of Native American culture; it's a symbol of the strength and vitality of America and the pettiness and greed of America; it represents a frontier both forgotten and remembered; it stands for freedom and captivity, extinction and salvation.
The book’s recurring theme is the relationship between buffalo and man. The book forces you to consider how your food ends up on your table. The modern world is so seamless it is easy to take food for granted.
I used to be endlessly troubled by meat-eating people who were uneasy with hunters and hunting. ... How can someone suggest that paying for the slaughter of animals is more justifiable than taking the responsibility for one's food into one's own hands? ... Civilization is a mechanism that allows us to avoid the necessary but ugly aspects of life; most of us do not euthanize our own pets, we don't unplug the life support on our own ailing grandparents, we don't repair our own cars, and we don't process our own raw sewage. Instead, the delegations of our less-pleasant responsibilities is so widespread that taking these things on is almost like trying to swim upriver. It's easier not to do them, and those who insist on doing so are bound to look a little odd.
Matt
The Best of the Rest
TikTok saw operating losses swell to $7B in 2021. ByteDance’s revenue continues to expand, up nearly 80% to $61.7 billion in 2021, but so too are the company’s expenses as it focuses on growth. The Chinese company’s cost of sales came in at $27.4 billion for 2021, up 79% from the previous year.
Bloomberg — Will Jerome Powell’s Inflation Crusade Get as Ugly as Paul Volcker’s? “Did I realize at the time how high interest rates might go before we could claim success? No,” Volcker wrote in his memoir. “From today’s vantage point, was there a better path? Not to my knowledge—not then or now.”
Frederik Gieschen —Inside the Mind of Young Seth Klarman. “We want to stay small because it is more fun. The last thing I want to be is manager of a staff of a dozen analysts and portfolio managers.”
Morgan Housel — Little Rules About Big Things. “You should obsess over risks that do permanent damage and care little about risks that do temporary harm, but the opposite is more common.”
Novel Investor — Notes From The Book Capital Account by Edward Chancellor. “Profitability is determined primarily by the competitive environment or the supply side, rather than by revenue growth trends. It is better to invest in a mature industry where competition is declining than in a growing industry where competition is expanding.”
A Rare Interview with Phil Fisher Following the 1987 Crash. “The only way that I’ve suggested is get them to give you a transcript of what they actually have done. And if they take losses, and small losses, quickly and let their profits run, give them a gold star. If they take their profits quickly and let their losses run, don’t go near them.”
BRK Daily: What's the first question Buffett asks when evaluating a new investment? “We tend to judge by the past record. By and large, if the thing has a lousy past record and a bright future, we’re going to miss the opportunity.”
“Meta, née Facebook, is now, incredibly enough, worth 42% less than it was when I wrote Facebook Lenses, hitting levels not seen since January 2016. It seems the company’s many critics are finally right: Facebook is dying, for real this time.
The problem is that the evidence just doesn’t support this point of view. Forget five lenses: there are five myths about Meta’s business that I suspect are driving this extreme reaction; all of them have a grain of truth, so they feel correct, but the truth is, if not 100% good news, much better than most of those dancing on the company’s apparent grave seem to realize.”
It’s worth pointing out, though, that the Metaverse’s costs, which will exceed $10 billion this year and be even more next year, are, relative to Meta’s overall business and overall spending, fairly small. It’s definitely legitimate to decrease your valuation of Meta’s business if you think this investment will never contribute to the bottom line — that’s a lot of foregone profit — but this idea that Meta’s business is doomed and that the Metaverse is a Hail Mary flail to build something out of the ashes simply isn’t borne out by the numbers… Meta the metaverse company may be a speculative boondoggle, but that doesn’t change the fact that the old Facebook is still a massive business with far more of its indicators pointing up-and-to-the-right than its Myspace-analogizers want to admit.
The madness of crowds — A group CrossFitters passed by a restaurant in Brazil. Everyone eating thought they were running away from something, so they jumped up and ran with them.
Case study of Buffet’s investment in the Ambassador Bridge in Detroit between the US and Canada.
Andrew Kuhn: How Buffett Turned $10k into $100k before he started his partnership.
If you would like to invest with Eagle Point Capital or connect with us, please email info@eaglepointcap.com. You can also find more information on our website. We recommend starting with our Fundamentals. Thank you for reading!
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These are great. I have a lot of reading to do now. Thank you so much again. :)