1. THE AMPHORA REPORT
John Butler jbutler@jb-cap.com Jon Boylan jboylan@jb-cap.com FEBRUARY 2010
IN THIS EDITION
INTRODUCING THE AMPHORA REPORT
FROM “DARTH” TO “CZAR” VOLCKER?
INTRODUCING THE AMPHORA REPORT
The idea behind this newsletter originated in early 2009, following the spectacular financial market
developments of the previous year. Although by end Q1 risky assets had begun to bounce back—a trend
that would continue more or less uninterrupted through the year—it was clear that this had been made
possible by a number of unprecedented monetary and fiscal policy actions around the globe. Perhaps most
significant in this regard was the Fed’s massive expansion and substantial qualitative deterioration of its
balance sheet.
As fiat currencies are only as strong and stable as the financial systems and central banks that back them,
the Fed’s unprecedented (and, some argue, illegal and even unconstitutional) actions naturally have led to
speculation that the dollar is no longer a safe, stable store of value and will, at some point in the not-too-
distant future, lose its pre-eminent reserve currency status. To paraphrase R.E.M: It’s the end of the dollar
as we know it (but do we feel fine?).
The obvious problem, however, is that there is no obvious currency to replace it. The euro-area, Japan,
China and most other major economies all have serious issues with their own financial systems and their
respective central banks have followed the Fed’s lead to at least some extent. Even legendary “hard”
currencies, such as the Swiss franc, have been to varying extent undermined by central bank rhetoric and
action resisting currency appreciation amidst the dramatic weakening of economic activity worldwide. Is
there no place left to hide?
Well, perhaps not in fiat currencies. But the historical safe-havens and once universal currencies, gold and
silver, have risen steadily in value and, since the financial crisis broke in summer 2007, have dramatically
outperformed all major currencies and most other assets. We consider this a clear indication that the world
is beginning to consider alternative stores of value to the various major fiat currencies that have provided
the benchmark, “risk-free” rates of return1 ever since the US went off the gold standard in 1971. It therefore
seems appropriate to consider what currencies or commodities are most likely to emerge as the preferred,
alternative stores of value as the dollar either gradually, or perhaps suddenly, loses its pre-eminent position.
Stepping back and surveying the potential universe of stores of value, it has become apparent to us that
there is no obvious, single, best answer for what, if anything, can replace the dollar. Therefore, broad,
efficient diversification has now become the most appropriate way to construct an effective store of value,
one that can protect real wealth in a wide variety of circumstances, including those associated with
financial crises and so-called extreme events, now generally referred to as “black swans”, which could lead
to either significant inflation or deflation across the globe. This is the key insight behind the Amphora
concept, which can be summarised in three simple assumptions:
The dollar is no longer a safe or reliable store of value
There is no obvious alternative to replace it, dramatically increasing regime uncertainty
Diversification, the only “free-lunch” in economics, is the best protection against the unknown
In this newsletter, we intend to provide practical advice on how best to protect wealth during the potentially
disorderly transition away from a dollar-centric global financial system in the coming years.
FROM “DARTH” TO “CZAR” VOLCKER?
1979 was not an easy year to be President of the United States. On the domestic front, although economic
growth had been relatively weak on average for years, inflation seemed to trend steadily upwards
nonetheless. OPEC member nations had, for the second time in a decade, demanded higher prices,
contributing to that unfortunate (and, to Keynesians, perplexing) set of conditions now termed
“stagflation”. New economic indicators were invented to help measure the malaise, most notably the
1
The reference here to “risk-free” is in the nominal, credit-risk-free sense only. An issuer of currency can always print additional
currency to service debts, public and private, so long as they are denominated in that currency. In this sense only are such returns to be
considered “risk-free”. Printing fresh currency to service bad debts has, historically, carried great risks indeed.
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2. “Misery Index” which simply added up the headline unemployment rate and the inflation rate. Having risen
into mid-double digits by the mid-1970s, it was now rapidly approaching the 20s.2
The “Misery Index”: Then, and now
25
20
15
10
5
0
1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Source: Federal Reserve
On the foreign front, 53 Americans were taken hostage at the former US Embassy in Tehran in November
1979, following the successful revolution of Ayatollah Khomeni and his clerical associates against the
Shah, Reza Pahlavi (and the foreign powers thought to be behind him) in February. In Asia, there were
occasional reports of sightings of American prisoners of war (POWs) in Vietnam, yet there seemed little
the US could do about it. Tail between its legs following its withdrawal some years earlier, the US army
had returned home, demoralised and, in the view of some, disgraced.
It must have seemed so unfair. Jimmy Carter, the 39th President, had inherited an economic mess. Exactly
who was to blame was unclear, and perhaps still is to the present day, but the US spent and borrowed its
way into an economic crisis in the late 1960s and early 1970s and, taking the easy way out, President Nixon
famously “closed the gold window” at the Federal Reserve in August 1971. Without the protection of the
Bretton-Woods system of fixed exchange rates, the dollar was now in full free float, and occasionally free
fall, versus other major currencies. And not only currencies: Oil producers, previously selling oil at fixed
prices in dollars, revolted against this devaluation in the denominator of the oil price by organising supply
and pricing convention and forcing the price dramatically higher in the process. Almost overnight, OPEC
became nearly as big a villain in American’s eyes as the Soviet Union.
In was mooted in certain circles how the US military, home from Vietnam, might be re-deployed to deal
with “those Arabs”—in so doing displaying traditional American geographical ignorance: Among major
OPEC members, Iran is a Persian and Libya a North African country; both are Muslim but neither is Arab.
And Venezuela and Indonesia are not even in the Middle East, as those few Americans who did bother to
look at a map might have noticed.
It all added up to the harshest set of economic conditions the US had faced since the 1930s. Sure, the US
was now an immensely wealthier country, with interstate highways fencing in the landscape from coast to
coast and (to paraphrase Henry Ford) not just one, but two or more automobiles in every garage. Indeed,
America was now so wealthy that a majority of Americans were not merely graduating high school but
receiving some form of further education. Americans celebrated their wealth by consuming all sorts of
goods and gadgets that had not even existed in any form but a generation earlier, such as televisions and all
manner of home appliances. Leisure activities once reserved for the upper classes were now thoroughly
middle-class pastimes, such as golf, tennis, sailing and skiing. And, although the dollar was weakening, it
was still strong in purchasing power terms versus the rest of the world. Combined with the arrival of long-
range, relatively cost-efficient jet travel, middle class families could now contemplate foreign vacations and
2
Economist Arthur Okun created the Misery Index—originally using wage growth rather than consumer price inflation—as a simple
means to measure overall economic performance from the perspective of the average worker. It peaked at just under 22% in mid-1980,
as Carter was running for re-election.
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3. those that did were amazed that they could eat fine French cuisine for the cost of an ordinary meal out at
home, or stay in a grand hotel in many old-world cities for the cost of the local Holiday Inn.
The problem, however, as psychologists have learned, is that it is not the level but rather the change in our
standard of living that matters when people consider whether they are satisfied or not with the economic
state of affairs. We are wired to expect either stability or improvement: Any sense of outright economic
decline, even from a lofty level, can raise dissatisfaction quickly, with obvious consequences for
politicians.
Boldly optimistic on assuming office in 1977, Carter believed that he could use his salt of the earth
charm—he had been a successful peanut farmer before entering politics—to reach out to ordinary (read:
voting) Americans and not just palliate their concerns but reinvigorate their spirit and shake America out of
its national funk. In the epitome of this style, he began broadcasting regular “fireside chats”, in which he
would wear his trademark cardigan sweater in front of a modest, slow-burning fire, implicit signals to
Americans that there were simple, commonsense ways to deal with higher energy prices. Once seated
comfortably, he would inform his audience of what was going well, what could be improved and how lucky
they were to be citizens of such a fine country.
But perhaps like all peoples, Americans might enjoy listening to promises and platitudes, but what they
really want are results. They were promised victory in Vietnam. They got defeat. They were promised a
“Great Society”. They got civil strife and deficits. They were promised wage and price controls. They got a
weaker dollar and inflation. They were promised the American dream. And they felt they were slipping into
a nightmare. It might not have been Carter’s fault. But the consequences were showing up on his watch.
As the economy continued to get worse, Carter found that he had an unusually short “honeymoon” period
with the electorate. But optimism gave way not to pessimism but to determination. He seized the
opportunity to mediate peace talks between Egypt and Israel, eventually presiding over the Camp David
accords, which would contribute to the decision to award him the Nobel Peace Prize in 2002. He embraced
efforts to deregulate certain industries, such as railroads, airlines and communications. He even made a
push to provide comprehensive health care for all Americans but failed to convince Congress to go along.
Perhaps most important of all, Carter faced down the financial markets and set about repairing the damage
unleashed in the aftermath of the breakdown of the Bretton-Woods system.
***
In the summer of 1979, as he approached the end of his first term and began campaigning for his second,
Carter had a choice to make, certainly one of if not the most difficult decisions he would ever make.
Inflation was rising. The dollar was falling. Unemployment was high and it looked like the economy was
beginning to weaken. The choice in question was who Carter was going to appoint to be the new Chairman
of the Federal Reserve when the seat was abruptly vacated by Bill Miller, who had left to head up the
Treasury. The candidates were several, including David Rockefeller, arguably the most powerful banker on
Wall Street. But he declined, citing his prominent position and the public image problems it might create
for the President. In his place, he recommended his onetime colleague and friend, Paul Volcker.
The problem with Volcker, according to some of Carter’s senior advisers, was that he was perhaps “too
independent”, in other words, he was a noted hard money advocate who would not cave to pressure from
the President or anyone else for that matter. He might not be enough of a “team player”. But Carter
overrode his advisers, sensing that the best way to deal with an economic crisis was to bring in a tough guy
with market credibility that, hopefully, would shore up White House economic credentials generally.
Carter could have done like some presidents before him and deliberately given the economy a jolt of
stimulus, boosting job prospects and carrying him through to a second term; but instead he did what he
thought was right, which was to tackle the problems before him right there and then although he knew it
could cost him the election. He appointed Volcker. And he lost to Reagan in a landslide. 3
3
It has been claimed, based on Carter’s initial press conference following Volcker’s appointment, that the President was not
particularly aware of what Volcker planned to do at the Fed and appointed him in the expectation that he would provide continuity
rather than an abrupt charge in policy. While possible, it seems not plausible that a president clearly in the midst of an economic crisis,
who has just announced a major cabinet reshuffle, would prefer continuity over change, rhetoric notwithstanding. In Volcker’s own
account, he stressed the need for tighter policy and strict Fed independence in his meetings with Carter prior to his appointment. For a
thorough account of how Carter came to appoint Volcker to the Chairmanship, see Paul Volcker, the Making of a Financial Legend,
by Joseph B. Treaster, Wiley and Sons, 2004.
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4. Paul Volcker was not just known as perhaps the tallest man on Wall Street. He had a solid reputation both
as a banker and as a public servant. Notwithstanding a stellar career at the Chase Manhattan Bank, at the
Treasury and at the NY Fed, he was not particularly wealthy by Wall Street standards. He eschewed luxury.
As one example, he commuted on foot, briefcase in hand, from a relatively modest apartment to his NY
Fed office in Maiden Lane. Yet his legendary support for tight monetary policy would soon earn him the
nickname “Darth” Volcker.
Following his appointment, “Darth” Volcker didn’t waste any time. At his first Federal Reserve Board
meeting as Chairman in August 1979, Volcker asked around the room for comments on the current state of
the economy, what the Fed should be watching and whether a change in policy was appropriate.
His Board of Governor colleagues and a handful of senior staff subsequently chimed in with a great deal of
comment on the state of industrial production, inventories, employment, exports and imports and all
manner of economic activity. The general message was that the economy appeared to have entered a
recession, although to what extent and for what duration was, naturally, unclear. But in keeping with the
conundrum of those times, there was also reference to inflation being stubbornly high notwithstanding
economic weakness.
Once the discussion had completed an initial circuit around the room in this fashion, Volcker weighed in,
invoking a dramatic change in subject and tone. Rather than talk about economic activity in any detail or
anything remotely quantifiable, he focused on the more basic, qualitative issues of confidence, credibility,
psychology and symbolism. This is worth quoting at length:
...this is a meeting that is perhaps of more than usual symbolic importance if nothing else. And
sometimes symbols are important...
In general, I don't think I have to go into all the dilemmas and difficulties we face for economic
policy. It looks as though we're in a recession; I suppose we have to consider that the recession could be
worse than the staff's projections suggest at this time...
When I look at the past year or two I am impressed myself by an intangible: the degree to which
inflationary psychology has really changed. It's not that we didn't have it before, but I think people are
acting on that expectation [of continued high inflation] much more firmly than they used to. That's
important to us because it does produce, potentially and actually, paradoxical reactions to policy.
Put those two things together and I think we are in something of a box--a box that says that the
ordinary response one expects to easing actions may not work, although there would be differences of
judgment on that. They won't work if they're interpreted as inflationary; and much of the stimulus will
come out in prices rather than activity...
I think there is some evidence, for instance--if a tightening action is interpreted as a responsible action
and if one thinks long-term interest rates are important--that long-term rates tend to move favorably. The
dollar externally obviously adds to the dilemma and makes it kind of a "trilemma". Nobody knows what
is going to happen to the dollar but I do think it's fair to say that the psychology is extremely tender...
I'm not terrified over the idea of some decline in the average weighted exchange rate of the dollar or
some similar measure. The danger is, however, that once the market begins moving, it tends to move in
a cumulative way and feeds back on psychology and we will get a kind of cascading decline, which I
don't think is helpful. In fact, it's decidedly unhelpful to both our inflation prospects and business
prospects...
In terms of our own policy and our approach, I do have the feeling--I don't know whether other people
share it or not—that economic policy in general has a kind of crisis of credibility, and we're not entirely
exempt from that. There is a similar question or a feeling of uncertainty about our own credentials. So
when I think of strategy, I do believe that we have to give some attention to whether we have the
capability, within the narrow limits perhaps in which we can operate, of turning expectations and
sentiment. I am thinking particularly on the inflationary side...
Specifically, that suggests that we may have to be particularly sensitive to some of the things that are
looked at in the short run, such as the [monetary] aggregates and the external value of the dollar. When
we're sensitive to those things, there's certainly a perceived risk of aggravating the recession... it would
be very nice if in some sense we could restore our own credentials and [the credibility] of economic
policy in general on the inflation issue.
To the extent we can achieve that, I do think we will buy some flexibility in the future... If we're
going to be in a recession, by all traditional standards the money supply does tend to be a little weak and
interest rates go down. I suspect that's a pretty manageable proposition for us if long-term expectations
are not upset at the time by any decline in interest rates--an action we might actually have to take to or
want to take to support the money supply. But I don't think that approach will be a very happy one
unless people are pretty confident about our long-term intentions. That's the credibility problem...
I don't know what the chances are of changing these perceptions in a limited period of time. But as I
look at it, I don't know that we have any alternative other than to try...
In saying all that, I don't think that monetary policy is the only instrument we have either. I might say
that my own bias is, while I certainly think in the particular situation we find ourselves it's premature to
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5. be arguing for a big fiscal policy move, that such a move might be necessary. If it is necessary, it ought
to be through the tax side and it ought to be through a tax program that not only deals with the short-run
situation but fits into the long-term objectives... Ordinarily I tend to think that we ought to keep our
ammunition reserved as much as possible for more of a crisis situation where we have a rather clear
public backing for whatever drastic action we take. But I'm also fairly persuaded at the moment that
some gesture, in a framework in which we don't have a lot of room, might be a very useful prophylactic-
-if I can put it that way--and would save us a lot of grief later. If we can achieve a little credibility both
in the exchange markets and with respect to the [monetary] aggregates now, we can buy the flexibility
later.
So, in a tactical sense, that leads me to the feeling that some small move now--I'm not talking about
anything big--together with a relatively restrained [monetary] aggregate specification might be
desirable...
I might only say that I'm somewhat allergic to the use of the discount [rate] as pure symbol--in other
words move the discount rate and do nothing else because I think there's already some flavor of that in
market thinking. We do that about once and that means the symbol is pretty much destroyed for the
4
future.
This meeting represents a turning point US monetary policy. In subsequent meetings, Volcker worked
toward building a consensus around the idea, initially laid out in his remarks above, that the Fed needed to
communicate in a fundamentally different way with the financial markets. Given that the 1970s had
seriously undermined the Keynesian concept of the “Phillips Curve”5 in which there was a quantifiable and
manageable trade off between unemployment and inflation, Volcker aimed for a clean break, and in short
order he got it. To anchor inflation expectations, Fed policy itself needed an anchor. In October 1979, the
Fed announced that, going forward, it would target growth rates in monetary aggregates which were
consistent with low and stable inflation. The Phillips Curve was out. Unemployment had been relegated de
facto to a second-order priority. But the financial markets were not convinced. They would first have to test
the Fed’s new regime.
Their opportunity was not long in coming. In early 1980, notwithstanding a weakening economy, money
growth remained surprisingly strong. The Fed, in line with its new policy, pushed interest rates higher and
higher. The economy now began to weaken dramatically. But Volcker was relentless. His priority, to
restore credibility in the Fed and the dollar specifically and, by implication, in the US economy generally,
remained unchanged. Recession be damned, the Fed kept on tightening. At the peak, rates reached 20%.
US money growth and Fed funds 1976-83: The high cost of restoring confidence
14 20
18
12
16
10
14
8 12
10
6
8
4
6
2 4
1976 1977 1978 1979 1980 1981 1982 1983
M1 % y/y Fed Funds (effective, rhs)
Source: Federal Reserve
4
FOMC meeting transcript, August 1979, p. 20-23, available online at
http://www.federalreserve.gov/monetarypolicy/files/FOMC19790814meeting.pdf
5
Although associated with Keynesian theory, Economist William Phillips did not publish his paper claiming that there was a
quantifiable trade off between wages (inflation) and unemployment until 1958. Although discredited during the 1970s, several
modified, neo-Keynesian versions of the concept live on today, including the NAIRU, or Non-Accelerating-Inflation-Rate of
Unemployment, and Gordon’s Triangle Model.
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6. The reaction on Capitol Hill was predictable. In one instance in the summer of 1981, when Volcker was
answering questions before a Congressional committee, he explained that, notwithstanding the recession,
rates were going to remain high as long as money growth failed to slow. Vitriol followed:
The Congressmen literally shrieked. Frank Annunzio, a Democrat from Illinois, shouted and pounded his
desk. “Your course of action is wrong,” he yelled, his voice breaking with emotion. “It must be wrong. There isn't
anybody who says you're right.” Volcker's high interest rates were “destroying the small businessman,” decried
George Hansen, a Republican from Idaho. “We're destroying Middle America,” Representative Hansen said.
“We're destroying the American Dream.” Representative Henry B. Gonzalez, a Democrat from Texas, called for
Volcker's impeachment, saying he had permitted big banks to be “predatory dinosaurs that suck up billions of
dollars in resources” to support mergers while doing little to help neighborhood stores and workshops and
6
the average American consumer.
Although Volcker’s policies no doubt contributed directly to the most severe recession since WWII, he
achieved his goals. Inflation plummeted from double-digits to less than 3% by the mid-1980s. The dollar
not only stabilised but by 1984 had recovered its 1970s decline. The US re-emerged as a productive,
dynamic economy. President Reagan basked in this success and was re-elected in a landslide. Yet when the
going got tough again in the late 1980s and the dollar was once again in sharp decline, Volcker had left the
stage, replaced by Alan Greenspan. The rest is history. A history of bubbles, one might add.
***
Now Volcker has re-emerged, not merely on stage, but front and centre. What should we expect? On the
one hand, it could be that his presence is merely being invoked as a tool by a new president desperate to
generate some economic credibility of his own in the face of another harsh set of conditions. But in the
other extreme, what if President Obama is prepared to appoint Volcker the economic “Czar”, with a broad
mandate for economic policy generally, including monetary policy? If so, what would Czar Volcker do?
And how might financial markets react?
Notwithstanding certain parallels, most obviously the general sense of crisis that currently hangs over the
US economy, in other key respects, the US economy of today looks far different than that of a generation
ago. Back then, US exports and imports were roughly in balance and the current account was in surplus, if
only slightly. More significant, the US was by far the world’s largest net creditor, to the tune of 13% of
GDP, despite massive spending on domestic, “Great Society” programmes and also foreign spending on
Vietnam and other engagements abroad. US debt and securities were still overwhelmingly domestically
held and the US household savings rate was close to long-term historical averages.
US total debt and GDP: What a difference a generation makes
60 3.5
50
3.0
40
2.5
30
2.0
20
1.5
10
0 1.0
1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006
Debt (tn) GDP (tn) Debt/GDP (rhs)
Source: Federal Reserve
6
Paul Volcker, the Making of a Financial Legend, by Joseph B. Treaster, Wiley and Sons, 2004, p. 5.
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7. Fast forward to 2009 and things look far different. The US has run chronic trade and current account
deficits since the early 1980s and, although these have declined in size since the recession began, the US is
now by far the world’s largest net foreign debtor nation, with a cumulative external debt of nearly 1/3 of
GDP. Foreigners now hold a majority of the federal debt and also hold large amounts of other securities.
The household savings rate, while slightly higher than before the 2008-09 recession began, remains far
below the average of the post-WWII period.
Most important, economic leverage is much, much higher. Total economy debt/GDP was about 160% in
1979. It has grown to a colossal 350% today. That’s right: A generation-long consumption boom has been
debt-financed, with foreigners providing much of the credit. This means that, for each incremental rise in
US interest rates, economic growth will be depressed by that much more. But who is to decide what US
interest rates will be? What if they just remain near zero, as has been the case in Japan for some 20 years?
Does the size of the debt burden really matter?
If up to the Fed, as long as the inflation outlook was benign, rates would stay low, perhaps close to zero.
But what of those foreigners holding the debt? Some of these countries, most notably China, have
currencies that are still effectively pegged to the dollar. What if their inflation rates should begin to rise as
the dollar declines? Would they allow a dramatic currency appreciation? What would that do to the dollar
and, more importantly, to the US inflation outlook? How would Volcker respond to that? The same way he
responded to a similar set of conditions in 1979?
Possibly. But given the vastly greater economic leverage, it would not take much of a rise in interest rates
to send the US economy spiralling right back into a recession worse than that of either 2008-09 or 1981-82.
Indeed, with US unemployment currently at around 10%, it is already nearly as high as the 1982 peak of
11%.7 A further rise from here would place labour market conditions on a par with the 1930s.
In practice, with Ben Bernanke now confirmed as Fed Chairman for another four-year term, it is unlikely
that Volcker, even if he becomes Obama’s economic “Czar”, is going to have much direct influence, if any,
over US monetary policy decisions. Under Bernanke, the Fed’s overriding priority has been to safeguard
the financial system. This has been done in various ways, although essentially all of them boil down to
some combination of Fed balance sheet expansion—quantitative easing or “QE” as it is known—and asset
quality deterioration. Indeed, Treasury securities now comprise only a small portion of the Fed’s balance
sheet. Various forms of mortgage-backed securities, including highly illiquid CDOs, now make up the bulk
of Federal Reserve assets. Given the lack of transparency around these assets, it is impossible to know to
what extent they have already been effectively monetised, carried at artificially high values on the balance
sheet. Until there is a proper audit of the Fed, it is impossible to know.8
If the economy enters a double-dip and the financial system is once again threatened, Bernanke might feel
it is necessary to take even more aggressive action to shore up the banks. But what more might he do?
Plenty, if you take at face value the content of one of his first major speeches after becoming a Federal
Reserve Board Governor in 2002, Deflation: Making sure “it” doesn’t happen here. In this speech, he
gives various examples of how a central bank can prevent deflation, including currency devaluation:
...it's worth noting that there have been times when exchange rate policy has been an effective weapon against
deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against
gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the
9
rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly.
Near the end of the speech, he also makes the rather straightforward but possibly disturbing point that a
central bank can always successfully fight deflation, and create inflation if desirable, by printing ever more
money without limit.10 Yes, this is probably true, but one wonders to what practical economic effect. Where
would such printed money go? Into asset bubbles that will further distort prices, misallocate resources and
7
Those who follow US economic statistics closely are aware that the BLS changed the definition of the so-called “headline”
unemployment figure in 1994, from what is known today as “U5”, to “U3”., removing so-called “discouraged workers” from the
calculation. On either measure, unemployment today is comparable in magnitude to the peak reached in 1982.
8
To elaborate on this point, the Fed’s balance sheet has assets on one side and forms of “money” on the other, principally cash in
circulation and bank reserves, which collectively make up the monetary base, or M0. If the assets are carried at artificially high values,
this implies that money (M0) has been created in excess of the value of assets held, which is monetisation. The Fed might argue that,
at some point in future, these assets will be returned to the market rather than held to maturity and that they will fetch values in line
with current estimates. Until that day, however, given the plunge in real estate and other securitised asset values, it seems much safer
to assume that there has been a de facto monetisation of much risky debt, rather than to take the unaudited Fed’s word at face value.
9
http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm
10
Bernanke gives several examples of how the Fed could quickly create inflation, including explicit reference to Milton Friedman’s
famous image of a “helicopter drop of money”.
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8. depress real economic growth? Into the hoarding of commodities that could be used as money substitutes?
Into inflated salaries and pensions for public-sector workers? We doubt into anything resembling sensible,
sustainable economic activity.
Regardless of what sort of shenanigans the Bernanke Fed gets up to during his second term, we are struck
with a growing sense that US economic policy in general—monetary, fiscal and regulatory—lacks any
coherent set of assumptions, goals or even basic coordination. What, exactly, do policy makers in aggregate
hope to achieve by, on the one hand, forcing banks to shrink proprietary, risk-taking activities and, on the
other, to increase lending to already highly leveraged homeowners and businesses? If it is an important goal
to ensure that no financial institution is too big to fail, then why are the regulators allowing the biggest
banks to become even bigger? And if the banks need to be recapitalised, why are they now going to face
new taxes, and why is Obama now recommending that depositors move their money out of big banks and
into their local community financial institutions instead? If the administration is getting serious about
deficit reduction but still wants to provide some stimulus to the economy, why is it proposing to freeze a
substantial portion of discretionary domestic spending, rather than foreign, military spending? Such
contradictions do nothing to rebuild confidence in the US economy, the financial system or the dollar.
Perhaps the explanation is just that there is no longer anyone in charge. Perhaps the players in DC are out to
seize a windfall opportunity to expand their own power and influence, if necessary at someone else’s
expense. After all, the only consistency in the myriad policy initiatives floating around Washington is that
they all assume, in varying degrees, a greater role for one or more government agencies or the Fed. Is that
what this is about, giving yet more power to the panopoly of government agencies which collectively failed
to prevent the crisis in the first place, and quite possibly contributed to it? Is this what our foreign creditors
are asking for, before they agree to finance an ever larger portion of our national debt? Hardly.
Of course it is possible that, if US economic policy continues to lurch from one direction to another without
a clear sense of purpose, Obama might eventually give Volcker a broad mandate as “Czar” to administer
the tough medicine necessary to get the sick economy on the mend. But this is unlikely to happen unless
there is a renewed sense of crisis, quite possibly brought on by foreign creditors losing patience, reducing
their holdings of Treasuries and sending interest rates higher and the dollar lower. As a first step, Volcker
might pressure Bernanke to follow a tight money policy to support the dollar, hold down inflation
expectations and restore international confidence. But if so, Volcker would most likely find that his hands
were tied by an economy which has transformed itself over the past generation. Not only is the total debt
burden far higher; various other factors are going to make it much harder to bring it back down to a more
manageable level. First, the public sector has grown dramatically relative to the private, implying a lower
level of productivity growth for the economy as a whole. Second, entitlements are rising far out of line with
economic growth, implying the need for higher tax rates on productive workers and capital. A third and
related factor is that demographics are generally less supportive of growth as the Boomers enter their
retirement years. Sure, some of them will choose to retire later, perhaps working part time. But it is not
realistic to conclude that they will be as productive as they were in their full-time, prime earning years.
While these problems are serious, they are shared by a number of other countries, including Japan and
much of Europe. A key difference, however, is that neither Japan nor the euro-area has run up a massive
net foreign debt position. Nor are these countries’ currencies in danger of losing the pre-eminent reserve
currency status enjoyed by the United States. No, they are “normal” countries in these respects. The US is
not. Not yet. But it is perhaps only one more crisis away from becoming so.
We wish Volcker luck. His views on financial sector reform are at least a start in trying to come to grips
with some obvious conflict of interest and moral hazard issues. His preference for sustainability over quick-
fixes in both fiscal and monetary matters is welcome. It would certainly be far, far better in our eyes for
Volcker to be anointed “Czar” than either Treasury Secretary Geithner, Council of Economic Advisors
Chairman Christina Romer, special adviser Larry Summers, or anyone else in Obama’s inner circle. But do
we think that, given the economic mess the US is in, that “Czar” Volcker would be able to make a material
difference?
Sadly, no. It is too late to turn the ship around. The dollar is going to lose its pre-eminent reserve currency
status. It is only a question of time and of what, if anything, might replace it. As we see it, there aren’t any
good, realistic alternatives to choose from, leading us to conclude that, absent a single, clear standard, one
could do worse that to hold a broad, well-diversified basket of liquid assets that, separately and together,
have a good track record of maintaining their real purchasing power in a wide variety of circumstances,
including episodes of both inflation and deflation. In subsequent issues of this newsletter, we will explore
the potential candidates in detail.
JB CAPITAL PARTNERS LLP www.jb-cap.com
PROTECTING WEALTH | ENSURING LIQUIDITY
9. The Amphora Liquid Value Index (through Jan 2010)
AMPHORA: A tall, lateral-handled, ceramic vase used for the storage and intermodal transport of
various liquid and dry commodities in the ancient Mediterranean.
JB CAPITAL PARTNERS is dedicated to helping clients preserve wealth in a highly uncertain
global environment by developing products protecting against both inflation and deflation
John Butler jbutler@jb-cap.com
John Butler has over 16 years experience in the global financial industry, having worked for European and US investment banks
in London, New York and Germany. Most recently he was Managing Director and Head of the Index Strategies Group at
Deutsche Bank in London, where he was responsible for the development and marketing of proprietary, index-based quantitative
strategies. Prior to joining DB in 2007, John was Managing Director and Head of European Interest Rate Strategy at Lehman
Brothers in London, where he and his team were voted #1 in the Institutional Investor research survey.
Jon Boylan jboylan@jb-cap.com
Jon Boylan is a global capital markets professional with a 16-year record of trading and selling fixed income securities and
interest rate derivatives for US and European investment banks. He specialises in all facets of the G-10 interest rate markets.
Most recently he was a Director in the Macro Sales group for Dresdner Kleinwort based in London. Prior to that he spent 10
years in charge of USD trading and risk management for Dresdner Kleinwort and Societe Generale in London. Jon began his
career working as a market-maker on the US Treasury desk for Credit Suisse First Boston in New York.
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JB CAPITAL PARTNERS LLP www.jb-cap.com
PROTECTING WEALTH | ENSURING LIQUIDITY