Book Club - Arguing With Zombies #2
Chapters 5-9
Welcome back to the Rolling Thunder book club. With January having five weeks, I took last week off, but this week we’re getting back into it. This post is also a few days late, but I have a good reason! My son was born early and then my daughter caught the flu. Things have been crazy! Anyway, like last time, I’ll summarize each section and share any investing insights I find relevant. The five chapters covered were: Crisis Management, The Crisis in Economics, Austerity, The Euro, and Fiscal Phonies.
Chapter 5: Crisis Management
This was by far the most interesting chapter of the book for me—I wrote nearly three pages in my journal after reading it. This book was published in January 2020 and primarily written in 2019 (though it’s a collection of articles dating back to 2004). Paul Krugman discusses the aftermath of the Great Recession and how poorly we, as a country, handled the recovery.
Once interest rates are cut to zero, there’s only one thing left to do to keep the economy afloat and boost demand: stimulus. In 2008, the planned stimulus packages were calculated to only do about a third of what was needed. The fear was that a large price tag would fail to satisfy critics and, worse, make them seem correct if the recovery didn’t succeed—when in reality, the package would fail because it wasn’t big enough, not because it was too costly. The beauty of “doing too much” is that the only downside is inflation, and the Fed can always raise rates to rein it in.
I’m oversimplifying here, but the basics of fighting a severe recession boil down to:
Cut rates to zero.
If rates are at zero and there’s still a problem, it’s time for depression economics—government spending.
If that spending overshoots and causes inflation, no problem: the Fed can raise rates to address it.
Run deficits when the economy is weak; pay for them once the economy recovers.
What I found fascinating is how closely this mirrors what happened during COVID-19 under both Trump and Biden. The economy faced a unique shock, rates were cut, and stimulus checks were sent (CARES Act). Our government did an excellent job absorbing the pandemic’s impact and keeping the economy humming along. When the economy recovered, inflation kicked in. Some of this was global, and the U.S. performed better than most countries. Even if you believe we inflicted it on ourselves, the outcome was still positive: the economy stayed decent, then improved. Inflation rose, the Fed raised rates, and now it’s coming down. By most measures, things look fantastic. So why is everyone upset?
That’s the big question: Why is everyone upset? I think Krugman missed one crucial factor in his roadmap for managing depression economics—just how much people hate inflation and the political cost of high prices. People hate paying more, and it’s difficult to explain that inflation, while painful, is better than a prolonged recession or depression. The disaster that was avoided is something most people never realized was possible. The pain of inflation is tangible, and when people feel economic pain, incumbents typically pay the price—even if the alternative was worse.
Investing Takeaways:
This chapter didn’t offer as many direct investing insights, but it reminded me of an anecdote. During the COVID-19 crash, one of the hardest-hit sectors was mREITs (mortgage real estate investment trusts). These are REITs that finance income-producing real estate by purchasing or originating mortgages and mortgage-backed securities. Essentially, they’re tied to the kind of investments that caused the 2008 crash. They suffered enormous losses simply because they were the culprits of the previous recession.
That’s an important lesson: during the next major shock, the biggest initial winners and losers will likely be those tied to the successes and failures of the prior crisis—regardless of the current crisis’s cause. If you can, consider using LEAPs or underlying stocks to capitalize on this tendency.
Chapter 6: The Crisis in Economics
I found this section interesting, but not particularly relevant to Rolling Thunder. It focused on the disagreements among economists about how to model the world. It reminded me of how people who’ve never experienced severe illness sometimes skip vaccines. Similarly, those who didn’t live through the Great Depression often have very different—and often worse—ideas about solving similar problems.
Investing Takeaways:
When you find someone smarter than you who can unpack complex problems and explain them simply, keep them close. Krugman has a deep understanding of how the world works. His New York Times columns have been my north star for years, and now his Substack is even better. While there aren’t specific stocks to consider here, if he identifies areas where consensus diverges from reality, that’s where the opportunities lie.
Chapter 7: Austerity
This shorter chapter discusses how governments that pursued austerity—cutting budget deficits during a recession—experienced longer and harsher recessions. In the U.S., austerity measures were pushed but never fully implemented. However, they did prevent the country from deploying more stimulus when it was needed most.
The pain caused by austerity in other countries was clear, but in the U.S., its impact was harder to see at first. The 2008 recovery could have been better and faster, but most people couldn’t envision that better world. They did see a large amount of money spent, yet the economy remained weak. Once again, good economics don’t always make for good politics.
Investing Takeaways:
In the next recession, pay attention to rate cuts and government actions like stimulus. If we reach the point of “depression economics” and there’s inaction, brace for a longer downturn. If the government steps in as it did during COVID-19, it’s a strong signal to start buying LEAPs as the market will recover—even if inflation follows.
Chapter 8: The Euro
This chapter explores the challenges of sharing a currency without a shared government. Spain and Greece, for example, faced issues during the Great Recession that they couldn’t solve traditionally because of the euro. Even now, while EU inflation is back down to 2.4%, some Eastern European countries are still at 4–5%. Managing economic challenges is much harder without a unified approach.
Investing Takeaways:
Avoid investing in the EU during downturns. Recoveries are more complicated there, and performance varies significantly by country. In contrast, the U.S. tends to see more uniform outcomes.
Chapter 9: Phonies
This chapter delves into the recovery plans proposed by figures like Paul Ryan after 2008. These plans promised to cut taxes, reduce deficits, and maintain benefits—but relied heavily on dubious assumptions. Trump’s tax cuts were designed to create huge deficits, which wasn’t a major issue when interest rates were lower than the economy’s growth rate. However, if similar cuts are implemented now, with higher rates, the consequences will escalate quickly.
Investing Takeaways:
If Trump 2.0 pushes tax cuts for corporations and the wealthy, expect the market to rise in the short to mid-term, even if long-term issues arise. Big tech companies like Apple, Amazon, Google, and Meta seem poised to benefit most.
Summary
This section was fascinating to read in the aftermath of COVID-19 and on the eve of Trump 2.0. The actions taken during COVID-19 were effective economically compared to the Great Recession, but inflation’s political cost was enormous. We now face a similar situation to Trump’s first term: a strong economy and a Republican trifecta prepared to cut taxes. Unlike before, higher interest rates could make this much more costly long-term. In the short to mid-term, though, these actions will likely fuel market growth. Big tech, in particular, appears to have the most to gain. This is what I will be looking at next for ideas - Tech and what benefitted most last time around.
Thanks for Reading,
S. Andrew