John Butler's Blog

In the prior 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.

What, exactly, is economic capital? It is the productive potential of the economy, the ability to make things that people need and want to consume. But unlike paper, capital does not grow on trees. Capital itself must first be produced, in the form of capital goods.

On precisely the same weekend in November as the Republican victory parties in and around Washington, the Fed celebrated its centennial far away from its DC home at Jekyll Island, Georgia. One-hundred years ago, seven US Congressmen and bankers gathered together in secret at this highly remote location to lay the political foundations for what would become, in 1913, the Federal Reserve Act. The ostensible purpose of creating the Federal Reserve was to provide for greater financial stability in the wake of the US banking panic of 1907. So how has the Fed fared in this role?

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.

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.

In recent months, commodity prices have risen dramatically. From a low point reached in June, various broad commodity indices are up from 15-20%. Few components have not participated in this rally to at least some extent.

For years, the US has been pressuring China to allow its currency to appreciate. But Japan’s unilateral intervention in the foreign exchange market in September represents the opening of a new front in an escalating global currency war. Indeed, this event may be the trigger which sets off a series of similar actions elsewhere. Past episodes of global currency devaluation, such as in the 1970s and 1930s, have always led to increases in global commodity prices, even amidst relatively weak economic growth.

Earlier this month, in a previous report, we discussed how European monetary union (EMU) did not eliminate intra-EMU currency risk but rather transformed it into credit risk. In recent weeks, this credit risk has surged again, with spreads for Greek, Portuguese and Irish bonds soaring relative to benchmark German government bonds, known as Bunds. Why now?

By the late-1990s it became clear to informed observers that the substantial portion of EU countries that had signed the Maastricht Treaty in 1992 were going to proceed with a European monetary union (EMU) as codified in the Treaty, most probably on schedule, in 1999. Previously dismissed as a Franco-German political pipe-dream, there was a growing air of excitement in financial markets as the political winds blew ever stronger in the direction of making EMU a reality.

Back in 2006, while working for a major US investment bank, I was asked by the Chief Global Economist to participate in a small survey to estimate the probability of the US economy facing a currency crisis—that is, one that forces interest rates higher—during the coming two years. Concerned that an eventual bursting of the US credit/housing bubble could lead to the dollar losing its pre-eminent reserve currency status, I placed the probability at some 60%, which was the highest response in the survey.