In this Edition
Since 1981, every August the great and the good from US and international monetary circles travel to the small but well-known Rocky Mountain resort of Jackson Hole to enlighten one another as to how best to manage or micromanage their respective economies. Traditionally hosted by the Federal Reserve Bank of Kansas City—Jackson Hole lies within its district—attendees normally include other Federal Reserve Bank presidents and members of the Board of Governors in Washington, including the chairman. This year, however, curiously few senior Fed officials will be in attendance, including Chairman Bernanke. Now why is that? Perhaps they have alternative plans…
First Off, Some Important Business
Prior to launching into my take on this year’s Kansas City Fed Conference in Jackson Hole, a few words about the coming transition of the Amphora Report to a paid subscription service:
First off, thanks to all who have expressed interest in subscribing; you now number nearly 300, which is most welcome. I take this opportunity to remind all that I don’t plan to charge anything like what the established newsletters do. So if you’re interested and haven’t yet let me know, please do so.
Second, please note that a paid subscription will also include access to the entire Amphora Report archive (currently available at www.amphora-alpha.com) including a search engine, and a suite of proprietary analytical tools that already exist in semi-automated spreadsheet form for my own use in commodities trading, but which will be placed online in due course for subscribers’ use, with all due explanatory notes and instructions.
Third, going forward I also plan to include a brief introductory podcast with each Amphora Report highlighting the key themes. There will also be occasional presentations on special topics not necessarily covered in the reports.
Finally, I am also in process of launching a loosely-associated blog, which will be available free of charge and which will allow me to present my thoughts and musings on various matters, absent the more rigorous analysis and investment and trade ideas appearing in the Amphora Report. If you’re interested this will be located at johnkbutler.com and I hope to find some of my initial and future subscribers following along in the comment strings.
While on the topic of blogging, please also note, if you haven’t already, that I am a semi-active ‘tweeter’, focused nearly exclusively on international economics and monetary theory and policy. I take care to restrict my tweeting activities so as not to clog up followers’ feeds, although at times I am drawn into an active debate with a neo-Keynesian, ‘paperbug’ or other foe of sound money and common-sense, ‘no free-lunch’ economics and finance. If you’d like to follow me, you can find my twitter feed here: https://twitter.com/ButlerGoldRevo.
For those followers in the northern hemisphere, enjoy your summer holidays. I’m already back from my two weeks surfing and hiking in Portugal. This year I had the delight of seeing my oldest child, now 12, successfully ride his first few waves. Next summer I hope that my second, now 10, takes the plunge. So, now to our featured commentary…
A Savage Journey to the Heart of Modern Central Banking…
Those familiar with the Amphora Report are aware that I make occasional use of literary anologies to illuminate what I consider to be important points about the world of economics and finance.[1] Literature is replete with observation, commentary and judgement of human action and reaction. Notwithstanding the imposing, inhuman edifices of the Mariner Eccles and Liberty Street Fed buildings, or the Bank of England, or the modern skyscrapers housing the European Central Bank and most large commercial and investment banks of our age, for better or worse, nothing happens in the world of economics and finance that is not the direct result of human action.
In this edition, I ponder the curious situation with the Kansas City Fed’s annual Jackson Hole conference, beginning this week. Unusually few senior Fed officials will be in attendance, not even Chairman Bernanke, who explained his absence as being due to an unspecified ‘scheduling conflict’. The same goes for senior foreign central bankers, who mostly seem to have other plans this year.[2]
Well imagine perhaps that, under growing criticism from many circles that their policies are not delivering the promised or desired results, central bankers have decided to do a bit of soul-searching this year, out of the limelight…
“Every now and then when your life gets complicated and the weasels start closing in, the only cure is to load up on heinous chemicals and then drive like a bastard from Hollywood to Las Vegas ... with the music at top volume and at least a pint of ether.” —Hunter S Thompson, Fear and Loathing in Las Vegas
“Take the left fork!” barked the passenger in the back of the Cadillac Escalade.
“It would be easier if you just let me know your destination,” replied the driver, as he suddenly swerved as required by his passenger’s instruction.
“I told you my destination is secret. Perhaps it would be easier if we just pretend that I have no idea where I’m going.” This confused the driver somewhat, but as it was his job to mind the road, not his passenger’s odd behavior, he just went quiet and kept on driving ever deeper into the mountains of central Vermont.
The trip had already lasted several hours. The guest in the back was a mystery to the driver, who only knew that he was a VIP requiring urgent transport to an unknown destination near the resort town of Stowe. The money was good, to be paid in cash on arrival. Some who traveled in this way were unsavory or even dangerous characters, but this man, apparently nearing his sixties, balding and with a trim, grey beard, didn’t fit the dangerous type.
“There!” shouted the passenger. “Over there! Pull over!”
“Here?” Replied the driver. “Do you have any idea where you are? The town is miles from here.”
“It’s none of your business whether I know where I am or not. Just pull over.”
“Huh?” thought the driver to himself as he pulled over to the left. This guy is nuts, on drugs or both. Whatever, it’s a job and it appears to be nearly over now. “Well I hope you know what you are doing because there ain’t nothin’ out here. And you don’t have any hiking or camping kit to hand. Hey, are you meeting someone perhaps?”
“That too is none of your business. Look, here’s your money. Take it, stop asking questions and get out of here. I have important work to do.”
“Whatever. OK. Enjoy the scenery.” And with that the driver departed back down the windy mountain road whence he’d come, shaking his head and shrugging his shoulders repeatedly as he slowly put his strange passenger out of his mind and thought instead of how he would spend his windfall fare.
By the roadside, the passenger so focused and determined while giving directions in the back of the large SUV, suddenly appeared uncertain and frightened once left alone. “What if the driver figured out who I was?” he thought to himself. “Perhaps I should have traveled in disguise.”
His thoughts then changed tack. “I can’t believe it has come to this. All the secrecy and deception. Back when I took this thankless job, I promised to make things more transparent!”
Just then a small car approached and pulled over. Two men jumped out in hiking gear, including packs. The car quickly turned around and sped away.
“Nice day for a hike,” said one of the two men.
“Yes,” he replied. “But I’ve forgotten my pack.”
“Don’t worry, we’ve got one extra.”
That was the exact response he had been told to expect, confirming the identities of the two men. “Good morning gentlemen. Nice to meet you. I’m Ben. Ben Bernanke.”
“We’re you’re guides,” said one of the men. “We’ve got about four miles to go on what should be empty trails. At a leisurely pace we’ll need about two hours. We’ve got a change of socks and shoes should you need it and plenty of snacks and water. Oh, and we’ve got this.” They handed him what appeared to be a brand new smartphone.
“Thanks,” said Ben. Now let’s get going.” One of the two guides started off, indicating the way. The other followed behind. Ben fired up the smartphone, clicked on an icon of an eagle with wings spread, and a man’s face appeared on the screen.
“So you’ve made contact,” said the face.
“Yes. The guides estimate we need two hours. And the trails should be empty.”
“If you do encounter anyone you follow the procedure,” said the face. “The guides know to distract anyone while you hide and wait. If anyone does see you hiding in the trees, pretend you are taking a leak. But whatever you do, don’t say a word as they might recognize your voice.”
“Understood,” Ben confirmed, as he thought to himself again how ridiculous this whole charade was. His pretending to take a leak was now somehow in the US national economic interest. But secrecy was now absolutely paramount. No one must learn of his plans or financial and economic chaos could quickly ensue. And he would be to blame for it all.
“Everything OK?” asked the lead guide.
“Yes, fine,” replied Ben, who switched off the smartphone and continued up the narrow path, now deep in the forest and, were his guides absent, hopelessly disoriented and lost.
Meanwhile, In Jackson Hole…
“In a closed society where everybody's guilty, the only crime is getting caught.”
“Welcome!” said President Esther George. “Welcome all to the Kansas City Fed’s Annual Monetary Conference. We are pleased to have an outstanding program lined up for this year. Topics include how to determine the market rate of interest when rates are arbitrarily set at zero; unconventional techniques for pushing on a string; a panel discussing what to do if none of those work; observations of where global capital is flowing, even if we have no idea why; and there will be a very brief presentation to discuss what we have learned in the five years since the 2008 financial crisis.[3] Don’t forget, that in addition to this stimulating program, we are here to celebrate the incalculable achievements of the Federal Reserve System on its 100th anniversary!”
“Hear Hear!” said a handful of voices in the large crowd, amid tumultuous applause. Just as the applause began to fade, President George continued, “This conference is going to silence our critics once and for all! Now let the festivities begin!” Prolonged, tumultuous applause followed, accompanied by the ubiquitous popping sound of a volley of champagne corks. It was going to be a conference to remember.
On Arrival at the Lodge
“Good people drink good beer.”
“There it is,” said the lead guide, pointing down into the valley as they reached the ridge-line. “The Trapp Family Lodge. The original was built in the 1940s but burned down in the 1980s. The style remains the same, however, Tyrolian Alpine.”
Ben knew some of the backstory, as dramatized in the 1970s film The Sound of Music. The Austrian von Trapp family slipped out of Austria into Switzerland in the late 1930s to escape potential persecution by the new regime, which had thrown in its lot with Hitler. Georg von Trapp was known to have anti-Nazi sympathies, something which had become increasingly dangerous.
Ben was less familiar with the von Trapp family’s history following their immigration to the US. They sought out a location from which to run a summer camp and music academy, famous as they had become for their musical performances in the preceding years. They settled on Stowe, Vermont, the alpine setting of which reminded them of their former homeland.
Ben found it both amusing and disturbing that this quaint, although certainly comfortable and beautifully situated lodge, was about to hold a secret meeting of the most powerful US monetary officials. With all media eyes and public attention focused on the annual Jackson Hole conference, some 1,500 miles away in a plush resort in the Grand Tetons, the real action would be taking place in utmost secrecy in a comparatively humble venue associated with a former Austrian nun and her adopted children who found fame as a singing group.
As Ben entered the lodge, he was greeted by staff wearing traditional Tyrolian dress and offering up large glasses of beer, light and dark in colour.
“Gruss Gott! Herzlich Wilkommen!” said what appeared to be the manager on duty.
“Danke,” replied Ben, who’s German was essentially non-existent, but he could manage that much. He reached for one of the light beers but then, on a whim, grabbed one of the dark ones instead.
“Aha, ein Dunkles!” said the young lady holding the tray. “Haben Sie es schon mal probiert?” Now Ben was clueless, having no idea what was just said. So he replied a faint “Danke” again and sauntered across the lounge to where there was a small sitting area next to a huge open fireplace. There was a fire stacked and ready to light, presumably for the long evening ahead. He sat down, drank long and deep of the dark beer, and a few seconds later, for the first time in longer than he could remember, he felt relieved and relaxed.
“Ben!” came a voice from the lobby entrance. “You made it!” His colleague swiftly grabbed a beer—a dark one too—and quickly crossed the room to join him. “Nice place huh? What do you think?”
“Relaxing. Remote. Just what we need I suppose. Thanks for your assistance with all the arrangements. How are the others doing?”
“Some are already here, no doubt resting in their rooms. But word that you’ve arrived will draw them out pronto. I’ll send word.”
“No, no, not yet,” declined Ben. “Let me just relax for a few more minutes. I’d love to have time for another one of these beers first.” He drank long and deep again. “Fantastic.”
“We were somewhere around Barstow, on the edge of the desert, when the drugs began to take hold.”
The Real, Top-Secret Fed Agenda
It was late afternoon when Ben awoke from his nap, perhaps due to the birds singing outside his window. He was unfamiliar with the birdsong, but then he’d spent precious little time in this part of the country.
He walked over to the window and took in the view. Spectacular. The sun was getting low in the sky now and the colors rolling across the many ridges and valleys of trees were brilliant.
His room was small and spartan but comfortable enough. The furniture was rustic but everything was clean, tidy and uncomplicated. On the desk by the window was a sealed manila envelope he hadn’t noticed earlier when he entered the room, exhausted by his journey and relaxed by the fine dark beer. It was labelled ‘FOR FOMC EYES ONLY’. He opened the envelope and removed the folder inside. It was labelled ‘AGENDA’.
As Ben opened the folder his eyes widened. “Oh my God,” he thought to himself. “I can’t believe we are really going to do this.” His heart raced as he perused the agenda for the top-secret conference:
Morning Session
- Daedelus crashed: How Fed policy undermined the global financial system though micromanagement and moral hazard
- Why interest-rate manipulation doesn’t work: Heisenberg’s uncertainty principle and spontaneous economic order
- The mystery of money demand: Why quantitative easing is pushing on a string
- The precarious dollar: The grave dangers of deleveraging through devaluation
Afternoon Session
- Sound money, sound economy: How stable weights and measures facilitate commerce
- From nowhere to somewhere: Strategies for an orderly transition to sound money
- The Pretense of Knowledge and the Fatal Conceit: Why the Austrian economists have been right all along about everything
“The possibility of physical and mental collapse is now very real. No sympathy for the Devil, keep that in mind. Buy the ticket, take the ride.”
As his eyes as wide as could be, he couldn’t believe what he was reading and what it implied. Finally, his eyes came to the final part of the agenda, a half-day seminar titled: “Life after the Fed: Twelve steps to monetary sobriety.”
His mind shuddered but his body somehow resisted. Perhaps it was the lingering effect of the toxic dark beer. Perhaps it was the setting at the Austrian-style lodge in the mountains, or just the sense of being well-rested after a nap. In any case, it was time to get ready for the evening. As he opened the bathroom door to wash his face he was suddenly blinded by sunlight, reflected by the mirror.
“And that, I think, was the handle—that sense of inevitable victory over the forces of Old and Evil. Not in any mean or military sense; we didn’t need that. Our energy would simply prevail. There was no point in fighting—on our side or theirs. We had all the momentum; we were riding the crest of a high and beautiful wave…”
Back to Business…
Of course I have no idea what Bernanke’s actual plans are, or those of his colleagues or foreign counterparts who are giving Jackson Hole a pass this year. Perhaps they are indeed doing some soul-searching, separately or together. They certainly need to. The high drama regarding Bernanke’s replacement; the arrival of ‘rock star’ Mark Carney at the Bank of England; the hope that the unprecedented politicization of the Bank of Japan would work an economic miracle; the ‘whatever it takes’ commitment of Mario Draghi and the European Central Bank—the past year has been one of the public repeatedly expecting or even demanding the impossible from various monetary politburo members who are, at the end of the day, human beings, not gods, their PhDs and other academic and official credentials notwithstanding.
We are now five years into the most prolonged financial crisis since the world abandoned any pretense of gold-backed money in 1973.[4] Notwithstanding the protracted crisis, it is still a strong belief among the mainstream that a restoration of sound money is not a necessary condition for a resumption of sustainable, healthy economic growth. I strongly disagree.
Last month, I presented to a group of graduate students of finance in London. The final topic of my talk began with a question: “Is debt deleveraging possible without a qualitative shift in money preferences?” I don’t believe that it is. Central banks cannot commit to ‘whatever it takes’ balance sheet expansion on the one hand and to maintaining the purchasing power of their currencies of issue on the other. Common sense informs us that contradictory policy can’t possibly work. But if your economic model simply ignores the possibility of qualitative shifts in money preferences—as neo-Keynesian models effectively do—well then you can fool yourself and, to the extent you still have some public credibility, you can fool some others too.
Listen: John Butler: Currency Wars - Is the US Covertly Intervening to Support the Dollar?
The problem now is that central bankers are running out of people to fool, domestic and foreign. The latter is of particular importance to the US Fed, as the dollar remains the dominant global reserve currency and the US remains the world’s biggest net importer by a huge margin. As I have written before, this imbalance, as measured by the cumulative US current account deficit, is the single most important economic statistic in the entire world. As it grows and grows it implies a larger and larger drag on future economic growth in the US and elsewhere.
Foreign investors including central banks are increasingly aware that their accumulated dollars—held largely in the form of US Treasury bonds—are not going to retain their purchasing power. Those who think longer term have already taken action to slow their accumulation of dollars. Foreigners have been large net sellers of US Treasuries in recent months. To some extent they are diversifying into other currencies. But the real story here is the solid underlying demand for gold. Speculative investors may have reduced gold holdings this year as the Fed’s ‘taper talk’ began[5] but central banks and sovereign wealth funds have continued to accumulate gold at an historically elevated pace. The drain on physical gold inventories on the COMEX (New York) has been dramatic and there are also reports of a surge in UK (London) gold exports to Switzerland and elsewhere, as global investors lose faith in the opaque custodial and cumbersome delivery arrangements prevailing in those locations.[6]
Of particular note is that the correlation between the gold price and US Treasury yields has broken down. Earlier this year, rising US Treasury yields were associated with a falling gold price. More recently, although the rise in yields has continued, the gold price has recovered strongly. Alongside the physical demand indications above, this is powerful evidence that the gold price has now put in a floor and, absent a large wave of producer hedging—always a possibility—or a decision by a western central bank to release some gold into the market, the long-term secular bull market has resumed.[7]
Listen: John Doody: I'm Sticking to My Guns - $2,000 Gold by Year End
Another factor worth considering is the relationship between the gold price and the equity risk premium, which compressed dramatically from late 2012 into this summer. As it did so, the decline in the gold price accelerated to the downside. This was evidence of a shift in risk preferences. More recently, it appears that risk preferences are shifting back again or, at a minimum, are stabilizing. The equity markets have lost much momentum and, for those interested in this sort of thing, a so-called ‘Hindenburg Omen’ price pattern has been observed repeatedly in recent weeks. Some believe that this is a reliable indicator of a market top. A shift in risk preferences away from equities and back toward safe haven assets would be supportive of gold.
Finally, there is always the possibility that the BRIC countries will move forward with theoretical plans to pro-actively reduce their reliance on the dollar for multilateral trade and begin using some new currency backed by their vast and growing gold reserves. Sure this would be vastly disruptive for the global economy, including their own part of it, but you never know at what point they will determine that the costs of inaction outweigh the costs of action. In the event they do so, the price of gold is going to soar, and not only in dollar terms.[8] The September G-20 summit in St Petersburg may provide some color on the current state of play in global monetary relations, and one or more headlines around the event could push the gold price sharply higher.
Don’t Forget to Diversify!
As the Amphora Report is dedicated to providing investors with helpful observations and recommendations for wealth preservation generally, with a particular focus on commodities and other real assets, I always try to offer my readers some thoughts regarding the broader commodity spectrum and the opportunities this can provide for greater diversification. Here there are a few things to note.
First, commodities in general have performed somewhat better of late, in particular metals, both precious and industrial. This may be an indication that the prolonged under-performance of commodities versus equities that began back in 2011 is coming to an end. At a minimum, it can be said that commodities offer good relative value when placed alongside clearly stretched equity market valuations. The latter may correct lower, or commodities may catch up. I suspect that equities will suffer a setback first, but then I’ve been predicting a major correction for months, so readers will have to consider for themselves how much weight to place in that view.[9]
Second, a sharp selloff in grains over the summer left them looking very cheap and the recent bounce might have some room to run. Corn prices have fallen the most, although for good fundamental reasons, but in my opinion it should be able to recover further along with grains generally.
Third, tropical commodities continue to be mixed, with cotton remaining expensive but sugar and coffee both depressed. My most recent new position was coffee and I also added to my sugar holdings on a dip earlier this week. It is impossible to know at what point either coffee or sugar prices are going to recover materially, but indications of investor positioning, implied carry and my proprietary measure of ‘risk-adjusted margin’ (RAM) all indicate that when prices do begin to rise again, they are likely to do so abruptly and asymmetrically. Cotton, on the other hand, appears increasingly likely to correct sharply to the downside.
Longer term, there is no good reason to believe that a general out-performance of real vs paper assets will not resume. You can print the latter, but not the former, as central banks demonstrate day to day. Paper can also be defaulted on or restructured in some way. Even bank deposits are at risk, as the ‘bail-in’ in Cyprus demonstrated.[10] Unencumbered real assets, including of course precious metals, don’t default. But do take care in your custodial arrangements, which may be subject to force majure or other, unforeseen ‘encumbrance’ in a crisis.
John Butler
john[dot]butler[at]amphora-alpha[dot]com
Follow me on twitter! @butlergoldrevo
Resources:
[1] For example, see The Rime of the Central Banker, Amphora Report vol. 3 (February 2012). The link is here.
[2] Apparently the Bank of Japan’s Kuroda will be attending but this is the exception that appears to prove the rule this year.
[3] For a more official take on this year’s conference agenda, please see the Wall Street Journal article linked here.
[4] President Nixon abruptly suspended dollar gold convertibility in August 1971 but this was not generally understood to be a permanent arrangement until the Smithsonian agreement was negotiated in 1973.
[5] As it happens, I don’t take the Fed’s ‘taper talk’ very seriously. They may perform some window dressing on their policy to make it more palatable to some of their critics, including those Fed presidents who have expressed concern, but I expect little effective change in Fed policy in the near-term. This view is expressed in somewhat more detail in my previous Amphora Report Is the Fed Going to Re-Arm the Bond Market Vigilantes? The link is here.
[6] The Financial Times recently reported on these flows here.
[7] I previously discussed several of these supportive factors for gold and the strong possibility that the floor had been reached in my July report, Is the Fed Going to Re-Arm the Bond Market Vigilantes? The link is here.
[8] Global monetary regime change is a central topic in my book, The Golden Revolution (John Wiley and Sons, 2012). In Part II I specifically address how the BRICs may represent the tipping point away from the dollar reserve standard and back to gold. The Golden Revolution can be found on Amazon here.
[9] My most recent discussion of why I’m anticipating a major equity market correction can be found in my report Monetization on Steroids, Amphora Report vol. 4 (May 2013). Link here.
[10] Cyprus is unlikely to have been an isolated event but rather an example for what may follow elsewhere. Please see Someone Has to Pay - Will it Be You? Amphora Report vol. 4 (April 2013). The link is here.
Find The Golden Revolution on Amazon here. And on Facebook here.
Follow John Butler on twitter! @ButlerGoldRevo
"John Butler provides much illuminating detail on how the world’s monetary system got into its present mess. And if you’re wondering what comes next, this is the book to read."
—Bill Bonner, author of the New York Times bestsellers Empire of Debt, Financial Reckoning Day, and Mobs, Messiahs and Markets
More Praise for The Golden Revolution:
"John Butler has written an indispensable reference on the subject of gold as money. His book is a combination of history, analysis, and economics that the reader will find useful in understanding the use and misuse of gold standards over the past century. He breaks the book into a long series of essays on particular aspects of gold that the reader can take as a whole or in small bites. It is technical yet accessible at the same time. The Golden Revolution is a useful and timely contribution to the growing literature on gold and gold standards in monetary systems. I highly recommend it."
—James Rickards, author of the New York Times bestseller Currency Wars: The Making of the Next Global Crisis
"In The Golden Revolution, John Butler makes a powerful case for a return to the gold standard and offers a plausible path for our nation to get there. Enlightened investors who blaze the trail will likely reap the greatest reward. For those still wandering in the dark, this book provides necessary light to keep you headed in the right direction."
—Peter Schiff, CEO, Euro Pacific Precious Metals; host of The Peter Schiff Show; and author of The Real Crash: America’s Coming Bankruptcy—How to Save Yourself and Your Country
"John Butler’s historical treasure trove empowers the reader to understand, prepare, and act. To have a chance to emerge unscathed from financial turmoil, join the Golden Revolution. I have."
—Axel Merk, Merk Funds; author of Sustainable Wealth
"The Golden Revolution is another indispensable step on the road map back to sound money. John Butler’s experience of the modern’ fiat’ banking world, combined with his understanding of the virtues of a disciplined monetary system, allow for genuine insight into the practical steps that could, and surely will, be taken to reestablish gold as money."
—Ned Naylor–Leyland, Investment Director MCSI, Cheviot Asset Management
"Ex scientia pecuniae libertas (out of knowledge of money comes freedom).John has used his exemplary knowledge of money to lay out a cogent framework for the transition of society based on fiat money to a more honest society forged by gold. He has taken complexity and given us simplicity. Monetary economics and its interrelationship with geopolitics, finance and society is extraordinarily complex, but he has managed to assimilate a vast array of information and distill it in a simple and thoughtful framework. That is an art many academic writers never achieve."
—Ben Davies, cofounder and CEO, Hinde Capital
Source: Amphora Report
