John Law by most accounts was the Elon Musk of the early 18th Century: young, vain, good-looking, rich, and quite uncontrollable. He was Scottish by birth, but found himself in France at a time when France was on the brink of bankruptcy. As the leading financier of the day, he concocted a scheme for France to repay its debts.
He incorporated a company called the Mississippi Company in 1717 that would have the exclusive rights to all the precious metals in the province of Louisiana, which France controlled at the time. Law would sell stock in the new company and use the proceeds to repay France’s debts.
Law’s plan worked beautifully, for a time. The initial offering was oversubscribed. Its price eventually increased 100-fold as the people of France scrambled to be a part of the fantastic new company. Millionaires were created in a few short years. Law did a second offering of the company and a third. The more stock Law sold, the higher its price went. The people of France became wealthy beyond their wildest dreams.
The problem, of course, was no gold or silver existed in Louisiana. Law, in fact, had zero evidence of any occurrence of precious metals in Louisiana. By 1720, that sad reality started to dawn on the people of France. People that were once worth millions suddenly found themselves paupers as the smoke-and-mirrors of the Mississippi Company became evident. The price of the stock crashed to zero. The whole episode lasted about 3 years.
The people that bought into Law’s scheme at the wrong time got crushed.
John Law, it is important to note, was part of the intellectual elite of the day. His reputation as a preeminent financier gave him a platform to perpetuate a faulty theory without the burden of cross-examination or question. People believed what he said.
That is what makes the intellectual elite so dangerous. People take what they say without question. “Stocks have reached what looks like a permanently high plateau” proclaimed the Yale economist Irving Fisher in October of 1929. The Dow Jones Industrial Average went on to lose 89% of its value over the subsequent 30 months.
Ben Bernanke told us the problems in the subprime real estate market were contained. Ken Lay and Jeff Skilling at Enron pushed their asset-light energy strategy. Alan Greenspan told us derivatives actually decreased risk and increased the resiliency of our largest financial institutions because they allowed for the more efficient sharing of risk.
People believed what these people said because of their status. They went to the right schools. They worked for the right institutions. They were quoted by the right publications. We trusted what they said not because of what they said, but because of who they were. They were the intellectual elite. They were people of stature; their theories were dangerous and wrong.
Investors who followed their lead got their heads handed to them.
So, please forgive us for being skeptical when Janet Yellen, Jerome Powell, and their respective institutions claim that inflation is transitory. They have a very different agenda, in our view, one that doesn’t include making sure their theory is correct.
What we see is a balance sheet at the U.S. Federal Reserve that has mushroomed ten-fold since the start of the global financial crisis, nearly without interruption, with the last doubling coming in the most recent twenty-four months alone. The Fed’s balance sheet is what is left over after the Fed buys assets in the markets. The Fed pays for those assets with new money, essentially injecting liquidity into the market with each additional purchase. Calling the effects of such a wild expansion of the Fed’s balance sheet transitory is shortsighted, dangerous, and completely reckless.
