Moneyization: The global financial
phenomenon of individuals and businesses moving their
funds to monies in which they have the highest confidence,
or money in which they have a higher store of faith.
Or, The Chairman Almost Confessed
In the past week, the outgoing, hopefully, Chairman
of the Federal Reserve spoke at Jackson Hole, Wyoming
for a meeting of the dreaded central bankers. His
words were widely quoted and readily available on
the Fed's website. That the meeting is held annually
in that location has always seemed appropriate. Bandits
and other undesirables often traveled through there
during the 19th century. The desperadoes of that era,
though, had a certain integrity when compared to central
bankers. Since they wore masks and carried their guns
at the ready, little doubt existed that you were about
to be robbed. Central bankers are more subtle.
While the cable news shows can still find some that
do not understand the danger in the impending U.S.
housing market crash, at least the Chairman is starting
to recognize the obvious. He noted, "Nearer term,
the housing boom will inevitably simmer down"(Greenspan,2005,
3) Is "simmer down" the NASDAQ plummeting
from 5000 to the first bottom? Was that near fatal
collapse in the NASDAQ stocks nothing more than a
"simmer down?" What will be the value of
your home when prices "simmer down?"
Next the Chairman commented, " . . . home price
increases will slow and prices could even decrease"
(Greenspan,2005, 3) . That's the phrase that bothered
everyone. That's the phrase that rattled the psyche
of so many. Commenting further he said, "As a
consequence, home equity extraction will ease and
with it some of the strength in personal consumption
expenditures"(Greenspan,2005, 3). That statement
is as close as anyone at the Federal Reserve has come
to saying a Great Recession is likely to follow the
bust of the housing bubble. However, we note that
the good Chairman did not accept any of the blame
for the situation.
Many are still deluded into thinking that housing
prices are a local phenomenon. That condition was
true in 1955. In 2005, as will be explored in the
September issue of THE VALUE VIEW GOLD REPORT, housing
prices are a national phenomenon. The financing of
housing has taken a giant step from the days of our
parents borrowing money for their two bedroom, one
bath home at the local savings & loan. Hyman Minsky
did not write enough, but his musings on financial
fragility and instability are about to become a whole
lot more well known.
The Chairman went on to comment on the
likely ". . . rise in the personal savings rate,
a decline in imports, and the corresponding improvement
in the current account"(Greenspan,2005, 4) that
will follow the lower level of "home equity extraction."
Greenspan said, "Whether those adjustments are
wrenching will depend, as I suggested yesterday, on
the degree of economic flexibility that we and our
trading partners maintain, and I hope enhance, in
the years ahead"(2005, 4).
Those last comments are extremely important. For what
they mean is that the difference between "simmering
down" and a Great Recession in the U.S. lies
with the attitudes and expectations of U.S. trading
partners. In short, will they continue to hold
about one and a half trillion dollars of U.S. debt
while watching the U.S. collapse into an economic
abyss? As with elections, we have some early indications
from the exit polls. The early "exit polls"
suggest that the existing incumbent is losing support.
The first graph, an old favorite, is from the weekly
data released by the Federal Reserve. Included in
that data is the size of holdings of U.S. government
debt by foreign official institutions, central banks,
at the Federal Reserve. Plotted is the year-to-year
change in the size of these holdings. At this time
last year, foreign central banks were adding to their
holdings of U.S. IOUs at over a $300 billion annual
rate. That rate of acquisition tapered off till in
early 2005 they were buying at about a $200 billion
rate. Their hunger for U.S. debt continued at that
rate till the most recent release.
$200 billion had come to be almost
a "support level," using the parlance of
the trader. As is apparent in the graph, the most
recent action broke through that "support level."
The year-to-year change has
now broken below the $200 billion level. That
most recent plot is approximately $188 billion.
Any contention that foreign central banks are not
losing their appetite for U.S. IOUs would be contrary
to the picture in the graph. No they are not
yet selling, but their appetite for buying is certainly
waning, and the latest data is more than a little
The second graph is another way of viewing this data,
and reflecting on the meanings within it. Plotted
with circles is the year-to-year percentage change
in the holdings of the U.S. debt at the Federal Reserve
by those foreign official institutions. The triangles
are the year-to-year percentage change in the holding
of U.S. debt by the Federal Reserve itself. Two observations
on this picture are important.
First, the willingness of foreign central banks to
acquire U.S. debt is clearly falling. Now the rate
of increases has fallen below 15% versus over a 30%
annual rate a year ago. This line is a momentum measure.
As good technicians know, momentum declines before
a series turns down. To forecast anything other than
a declining sponsorship for U.S. debt requires the
identification of some new motivation for foreign
central banks to buy U.S. debt. Perhaps all the goodwill
the U.S. has built up in recent years?
Second, the gap between those two series
explains the source of the error in the inflation
forecasts of most of us, including this author. Those
trends also explain why the forecasts for higher inflation,
aside from that due to the collapse of the U.S. dollar's
value, are likely, as in the broken clock's time,
on track to be right. To date, the Federal Reserve
has not had to monetize government debt in an excessive
manner due to the foreign financing. That situation
is trending toward a change.
The massive purchases of U.S. debt served to recycle
dollars back into the U.S. economy. This action did
not create new dollars, which would have pushed up
U.S. inflation. These dollars were unfortunately redirected
into the U.S. housing market. The
purchasing power of those dollars, in terms of how
much housing a dollar will buy, has plummeted. That
action may not qualify under a pure definition of
inflation, but the effect is the same.
As the dollar recycling was so intense,
the Federal Reserve's purchases of U.S. debt were
not great enough to increase U.S. inflation, especially
the government's phony number. Their creation of
base money was moderated by the dollar recycling by
central banks. The gap between those two series
is a measure of monetary pressure on the U.S. inflation
rate. That gap is portrayed in the third graph. Being
somewhat naive, an assumption is made that the artificial
calculations of the U.S. CPI will not continue to
The data plotted in the third graph
is the year-to-year percentage change in Federal Reserve
holdings of U.S. debt minus the like number
for foreign central banks. When negative, foreign
central banks are acquiring U.S. debt at a far faster
rate than the Federal Reserve. This recycling of,
rather than creation of new dollars, does not have
a direct impact on the overall general level of inflation.
Yes, the focus of those dollars into housing debt
has created a price bubble in that market. When
the gap is positive, the inflationary potential will
be greater as the Federal Reserve will be financing
the U.S. government.
As this gap, portrayed by the line of squares in the
graph, moves into positive territory, the pressure
on U.S. inflation will be in an upward direction.
That development, combined with higher oil prices
and the collapsing global purchasing power of the
U.S. dollar, may make the pricing environment far
different than financial markets currently expect.
The purchasing power of the
U.S. dollars is about to enter a dramatic bear market,
and she is going to demonstrate a particularly nasty
Compounding the seriousness of this outlook is the
lack of skills at the Federal Reserve. For about the
last five years, the Federal Reserve has only used
one tool, easy money. The Fed's response to every
event has been to lower rates. Now that policy tool
has lost its effectiveness. For example, lower interest
rates will not increase oil supplies, pushing prices
down. Easy money tool has been used too often, and
is now doing nothing more than increasing the downside
of the housing bubble.
One aspect not yet touched are the implications of
this massive pile of dollars in the hands of foreign
holders. Too many dollars exist in the world, and
many in possession of those dollars do not particularly
want them. Second, they may need to spend them. Oil
is priced and traded in dollars. Surplus dollars are
being used to bid the price of oil higher in dollars.
Those dollars flowing to the oil producing regions
are not flowing back and will not flow back into the
U.S. How many copies of mortgage processing software
does an oil nation need? Anyone receiving oil dollars
is going to be buying goods that are produced by the
same nations with which the U.S. is experiencing a
trade deficit. They are not going to be buying U.S.
produced goods as their consumers are not much different.
They too would rather have a laptop, an iPod or a
What is being created is a vast,
swirling pool of dollars in the oil market with nothing
to do but buy oil. Consider that graph of the
trend in central bank holdings of U.S. debt. Oil prices
are simply the mirror image of those holdings. The
dollar is becoming useful for only two things, denominating
U.S. debt and buying oil. On what else are they likely
to be spent? What are the implications for the value
of the dollar if its only use is to buy oil? As important
as oil is to the world, consumers do not want an unlimited
amount of it. What then happens if the dollar is not
the only alternative for pricing oil?
The offense in this situation, which is the best defense,
is to invest your wealth in assets that will rise
in value relative to the dollar. Filling your basement
with oil is one choice, though perhaps not an optimal
one. Gold is another one, and makes for a far less
messy basement. Chairman Greenspan's acknowledgment
that housing prices might "simmer down"
is a signal of the slow awakening in the world. That
awakening is likely to spread, and the dollar will
suffer. Owning Gold is perhaps the best option available
in a bad situation. Silver, too, is a viable alternative
that also should be considered by investors.
Gold, like any market, moves between
attractive and unattractive price levels brought on
by changes in investor emotions. Having recently broken
out of the lateral pattern in which it has been trapped,
Gold has confirmed the longer term positive trend.
Gold, at the present, is now moving toward another
over sold condition and a buy signal. As shown
in the last graph, such conditions have been excellent
opportunities for dollar-based investors to diversify
into Gold. Your next investment choice is between
a new, improved version of mortgage software or some
Gold. Which is likely to be
worth $1,300 first?
Greenspan, A.(2005,August 27). Closing remarks. Jackson
Hole, Wyoming symposium on central banking sponsored
by Federal Reserve Bank of Kansas City. Retrieved
August 28, 2005 from http://www.federalreserve.gov/boarddocs/speeches/2005/200508272.html.