Introducing the Amphora Report

Thu, Feb 11, 2010 - 3:00pm

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.


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 “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

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 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

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 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 future.4

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

Source: Federal Reserve

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 the average American consumer.6

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

Source: Federal Reserve

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:'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 rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly.9

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 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.

The Amphora Liquid Value Index (through Jan 2010)


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.

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.

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.

4 FOMC meeting transcript, August 1979, p. 20-23, available online at

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.

6 Paul Volcker, the Making of a Financial Legend, by Joseph B. Treaster, Wiley and Sons, 2004, p. 5.

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.


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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About the Authors

Vice President, Head of Wealth Services