The Amphora Report's 2010 Topics in Review (4 of 4)

[Introduction below, and then continuing from Part 3.]

In 14 editions of the Amphora Report this year we have covered nearly 30 topics, many of which overlap in some way. What binds them all into a coherent set is our view that the economic policies being implemented in nearly all major countries are not just unsustainable but in some cases outright reckless. These countries include the US, the issuer of the world’s reserve currency. By implication, the dollar is likely to lose its pre-eminent reserve currency status in the coming years. The result is bound to be a period of global economic and financial market turmoil and, for most if not all traditional financial assets, underperformance in real, purchasing-power adjusted terms. What follows below is a list of all topics, including both a brief summary and an update of our thinking for 2011.


When a young child is caught in a lie, they deny it. As they grow, they find ever more elaborate ways of deceiving their parents, only to be caught out time and again. Finally, as a teenager, they give up trying to deceive and begin simply to blame their parents for their transgressions, rather than take responsibility. Recent statements by Federal Reserve officials suggest that, following a long childhood, the Fed has now entered its teenage years.

It is highly unusual for the Fed to offer opinions about US government economic policy, much less criticize it, but Chairman Bernanke did just that earlier this year, when he said that the Congress should focus on getting the deficit under control and leave the economy to the Fed. Yet the Congress has now extended tax cuts and unemployment benefits, actions which will increase the deficit. The Fed may not be pleased with this development. It might result in a scaling back of planned Treasury bond purchases. But regardless, relations between the government and the Fed are more strained today than at any time since the early 1980s, when Paul Volcker came under fire for raising interest rates in the middle of a major recession. With Ron Paul, a noted Fed critic, assuming the Chairmanship of the House Monetary Affairs Subcommittee next year, the acrimony is all but certain to continue in 2011.


The surge in global food prices will soon arrive on the dinner table. However, to focus on the direct inflationary impact of higher food prices alone is to miss the bigger, far more inflationary picture implied by rising wage demands in developing countries. Beginning next year, consumers in most developed economies will discover to their surprise that “food” price inflation is creeping into an astonishingly wide variety of consumer goods.

Food price inflation is a dangerous animal. As a product which must be purchased and consumed on a daily basis, consumers are acutely aware of it and, for those on low incomes, it can threaten their basic health and that of their family. This is why the recent surge in global food prices is so significant. And so far, food prices are holding these gains, with corn, wheat and soya bean prices all near recent highs. In 2011, as food price inflation feeds into wage pressures in emerging markets, it will gradually transform into a more general manufactured goods price inflation the world over.


US CPI has been trending lower amidst a stagnating US economy. However, a look behind the headline economic data and across some financial market developments reveals a disturbing picture, that in fact the US economy may already have entered a “stagflationary” situation not unlike the late 1970s. This spells danger for financial asset prices.

Many economic commentators have speculated that the US might find itself in a stagflationary situation as a result of a weaker dollar, higher oil and import prices generally, yet with a weak jobs market and high unemployment. We argue that, if you look behind the headline economic data, we may already be there. While the Fed claims that inflation is undesirably low, they are referring to the current rate of core price inflation, which excludes food and energy. Also, the CPI calculation methodology has changed dramatically through the years. Indeed, if CPI is measured in the same way in which it was in the 1970s, for example, the last time the US economy was mired in stagflation, then you find that the current rate of overall CPI is over 8% y/y and rising, notwithstanding broad unemployment in the double-digits. As pipeline price inflation is still on the way, this situation is likely to worsen in 2011.


This past week provided an excellent example of this old French saying, which translates somewhat inelegantly into English as: “The more things change, the more they stay the same”. The US mid-term elections may have resulted, as expected, in a large victory for the Republicans, who now control the House of Representatives. But notwithstanding some grand headlines in the press, this is highly unlikely to change current US or global economic and financial market trends.

Our assessment of the US political outlook following the recent mid-term elections was not entirely correct. We expected complete gridlock, yet there has already been agreement to extend both tax cuts and unemployment benefits. We doubt we are the only ones surprised by this. However, while these actions may not qualify as gridlock, they do nevertheless reinforce our ultimate conclusion in this topic, which is that the US government is not going to be able to address its deficit during the coming two years. Indeed, the deficit is now going to be commensurately larger in 2011 and 2012, and perhaps beyond.


In this edition, we take a brief pause from our normal economic and financial market commentary with this tale of common sense economic calculation and action. And no, we do not believe that the world is any more complex than we present it here. If you want to understand economics, you need first understand two things: That the human condition of one of scarcity and uncertainty; and that absent rational economic calculation and a certain degree of passionate risk-taking, nothing good can ever come of it.

As this topic was a parable, rather than an economic or investment analysis, there is really nothing to update other than to say that we still don’t believe that the US is as attractive a place to do business as it used to be, with obvious consequences for future economic growth. We would like to draw readers’ attention to the protagonist’s name, however. Did anyone make the connection between his name and the themes in the story? Hint: Adopt a gentle French accent and speak the name softly as one long word.


The US Fed recently celebrated the centennial of its founding at a historic hotel on Jekyll Island, off the cost of Georgia, where a secret meeting took place to lay the political foundations for what would become the Federal Reserve System. But what, exactly, does the Fed have to celebrate, as it was created, ostensibly, to promote financial stability?

What can we say? More and more observers are coming to the inevitable conclusion that the Fed has not done a particularly good job at promoting financial stability, nor at protecting the purchasing power of the dollar through the years. But why? Is the Fed incompetent? Is it poorly designed? Does it have the wrong mandate? We are pleased to learn that Ron Paul will be Chairing the US House Monetary Affairs Subcommittee next year as he is likely to ask these questions. 2011 may be the year that we begin to get some answers.


As yet another wave of crisis rolls across the global financial markets, it is instructive to step back and look at the entire sea of debt. As is postulated by global warming theory, rising temperatures result in rising sea levels. Well, as the global debt crisis heats up and the sea of debt rises, it eventually yet suddenly swamps those living close to the shore. Whether a home is lost to foreclosure, a factory to corporate bankruptcy, or both are lost to the sea, makes little difference to the holders of the debt that is defaulted on. From an investor’s point of view, there is simply too much credit risk in the sea and they want it reduced. At first, politicians presumed this could be summarily accomplished with sovereign bailouts. But now the sovereigns themselves, one by one like dominoes, are toppling over. The credit risk, sovereign and all, must be reduced. This can occur either through default or currency devaluation. With few exceptions, policymakers appear to prefer the latter.

We attempted to pull many previous threads into this topic, which looks at the debt crisis from the investor’s perspective. They want less credit risk and they are going to find a way to reduce it, one way or the other. 2011 will be yet another year in which policymakers struggle to prevent such an implied deleveraging. What forms of fiscal and monetary stimulus are we yet to see? How will investors react?  We don’t presume to know the specifics but what we do know is that increasingly arbitrary attempts to prevent financial markets doing what they know they must do are going to fail. That credit risk will be reduced in the end, through some combination of default and currency devaluation. The only question is how much additional economic damage will be unnecessarily caused along the way. Judging by the experience of 2008-10, there could be much additional damage indeed.

We wish all of our readers a pleasant and festive holiday season, free from the relentless doom and gloom of the Amphora Report. Best Wishes to all for a happy and prosperous 2011.


John Butler,
for The Daily Reckoning

[Editor’s Note: The above essay is excerpted from The Amphora Report, which is dedicated to providing the defensive investor with practical ideas for protecting wealth and maintaining liquidity in a world in which currencies are no longer reliable stores of value.]