Moneyization: The global
financial phenomenon of individuals and businesses moving
their funds to monies in which they have the highest
confidence, or money which has a higher store of faith.
In money, only the fittest will survive.
The Federal Open Market Committee(FOMC),
the monetary policy setting arm of the Federal Reserve
System, recently raised interest rates by twenty-five
basis points. This policy decision is consistent with
their previously stated policy of raising rates in a
measured fashion, or similar such meaningless words.
While Wall Street has been happy with such a decision,
a feeling of dismay would seem more appropriate. Speculators
in paper equities seem joyed that another rate increase
will not occur till February, while ignoring the implications
of such policy. Gold and Silver investors have, by the
continuation of this policy, had the wisdom of their
investment decisions reconfirmed.
Two major problems exist with FOMC policy.
Both inadequacies can be interpreted as positive for
Gold and Silver investments. The recent announcement
by the German bank of "measured" sales of
German Gold is acknowledgment of the inherent dangers
in U.S. monetary policy. Would the Germans be retaining
their Gold if they thought the value of that Gold was
going to fall? No, they too understand that the Federal
Reserve will only make Gold more valuable. Holding Gold
is certainly more appropriate than frivolously spending
the sale proceeds on social programs in that country
or investing in U.S. debt.
U.S. monetary policy continues to be
set in global isolation. The Federal Reserve will not
acknowledge that the U.S., as a participant in the global
economic and financial systems, does not truly control
domestic monetary policy. In the age of an electronic
global world, operating as the Federal Reserve has means
that either interest rates are going to rise or the
national money, the dollar, is going to fall. Other
possibilities are not within the set of consequences
to this monetary policy.
In a world where capital is highly mobile,
meaning money can move freely between most nations,
central banks, including the Federal Reserve, lose their
independence when it comes to monetary policy. When
capital can move freely and exchange rates are set by
the markets, the world dictates the level of interest
rates for a nation. Now, a country can attempt to thwart
this reality. A nation can make an effort to control
interest rates within its domestic economy. However,
the reality of such an effort is that the national money
will eventually face devaluation.
Gold investors wishing to explore this
"Unholy Trinity," as Cohen refers to this
situation, may refer to either of his books listed at
the end of this article. This situation is not unique
in monetary history. Any experienced trader of foreign
exchange recognizes the symptoms of the dangerous game
being played by the Federal Reserve. The most recent
period of weakness for the U.S. dollar is probably due
to these informed market participants moving to avoid
the U.S. dollar devaluation.
Devaluation, by the global foreign exchange
markets, is a near inevitability given current Federal
Reserve policy. The only policy choice left available
to prevent such an event is to raise interest rates
by a material amount. To thwart a dollar devaluation,
the U.S. prime rate would ultimately have to be in double
digits. Such a move is beyond the scope of reality for
the Federal Reserve. So, the policy of "Intentional
Neglect" for the U.S. dollar will continue.
The dangerous game being currency played
by the Federal Reserve could also be referred to as
"Equilibrium Management," and has a long history
of repeated failure. Perhaps it could be also called
"Managed Depreciation." Most banana republics
have demonstrated that such policies are doomed. Apparently
the U.S., now the world's biggest banana republic, is
going to again validate again the widely recognized
idea that competitive devaluations no longer work. This
Federal Reserve has had its head buried in doomed policy
sand for two decades. Why should they change now?
What is "Managed Depreciation?"
The answer is that it is part of what we have already
referred to as "Equilibrium Management." Remember
that the Federal Reserve, and unfortunately most economic
policy making entities, are dominated by economists
trained in equilibrium determination and indoctrinated
in discretionary economic policy. These descriptions
are really not difficult to understand. What is scary
are their implications for the economy and financial
If you remember back to an economics
class you might have taken, much time was spent on the
intersection of lines in those graphs. Those points
of intersection were considered equilibrium, where the
markets were in harmony. Supply and demand, for example,
were equal in some. Economics education focuses on those
single moments of market happiness. Forgotten is that
those ideal points only exist in the graphs, never in
the real world. The real world is an ever changing,
dynamic system. Each and every trade in a stock or a
currency or Gold is an equilibrium price in the market.
How long does that equilibrium price persist?
Students in economics have been taught
that they can control the world through the wonders
of monetary and fiscal policy. They can manipulate and
control with such precision that markets can be held
in equilibrium, and that the point of equilibrium can
be manipulated. No longer is it believed by many that
the markets have free will. Rather, the markets are
subject to the decisions and desires of economic policy
makers. Of course, all that is nonsense. Markets are
more powerful than any group of policy makers. That,
however, does not stop the Federal Reserve from attempting
the economically impossible.
This monetary policy of a measured movement
of interest rates is an attempt to move the U.S. economy
into a state of managed equilibrium. The Fed is trying
to raise rates enough to prevent the dollar from collapsing
but yet keeping the U.S. economy expanding. The goal
is to keep both the foreign exchange market and the
U.S. economy at some mythical points of equilibrium.
Only on the chalkboards in school and the muddled minds
of managing economists can this be accomplished.
In the foreign exchange markets the value
of the dollar is being allowed to fall. Higher interest
rates are an experiment to see if the Fed can find that
ideal mix of monetary policy where the dollar's slide
is stable and prosperous economic growth are in sync.
In short, the Federal Reserve is attempting to accomplish
what no other central bank has ever been able to do.
Hey, they have Alan Greenspan, a zillion computers,
a great number of highly educated economists and the
internet. What could possibly go wrong?
One of the many problems with this "fairytale
monetary policy,"where everyone lives happily ever
after, is reality. No matter how many computers they
have, putting Humpty Dumpty back together again is not
going to happen. The structural damage inflicted on
the U.S. economy over the past two decades is probably
irreversible. The structure of the U.S. economy has
been seriously harmed by the diversion of capital funds
to frivolous expenditures on housing and faster ways
to apply for mortgages. The Fed has decided the U.S.
would rather have DSL than jobs.
The Fed's "measured response"
means no throttle will intentionally be applied to the
U.S. economy. Consumers will continue to spend. Wal-Mart
will continue as a giant vacuum for goods made in China.
As long as the spending continues unimpeded by existing
level of U.S. interest rates, the pressure on the dollar
will be persistent. This Federal Reserve policy is an
attempt to maintain indefinitely the current situation,
massive spending on imports of foreign goods. All of
that is good for dollar Gold, as it is bad for the dollar's
In Chart One we can see how the dollar
price of Gold has been following the trend of the volume
of goods being imported for U.S. consumers. The bars
in the chart are the monthly level of U.S. imports,
in billions, minus the energy related component, like
oil. From each month's total imports is subtracted the
amount spent on energy imports. Triangles, which use
the right axis, are of the monthly average of U.S. dollar
Gold. That the two seem to be moving together is fairly
As long as the Federal Reserve continues
this "measured" policy, U.S. interest rates
will remain below the level necessary to reduce U.S.
imports. That situation means that an excess flow of
dollars to foreign producers will continue unabated.
The U.S. dollar will remain under "covert"
selling and on a depreciating trend. Gold price of U.S.
dollar will continue under pressure, and dollar price
of Gold will rise further. In terms of the graph, the
bars will continue to rise as well as will the triangles.
Moneyization of U.S. dollar holdings
around the world continues in process. Individuals and
businesses have developed an unwillingness to hold the
dollar. They have been moving to national monies possessing
a higher store of faith. Reluctance to hold dollars
is high, and going to increase. That said, widespread
selling of the U.S. dollar has yet to be evident in
the data. Given the extent of the dollar's decline in
a period characterized by reluctance to hold rather
than a willingness to sell, the size of the ultimate
devaluation of the dollar when selling does appear is
certainly beyond any of the modest estimates being put
Central banks continue to hold their
U.S. dollar denominated investments. They do appear
to be moderating their buying, as suggested by many
reports. Chart Two shows the year-to-year change of
holdings by official institutions of U.S. government
debt on deposit at the Federal Reserve. While the year-to-year
change has moderated, the recent level of holdings is
still 270+ billion dollars more than a year ago. Also
in included in that graph is the linear trend of the
weekly change in those holdings plotted using the right
axis. That trend is also negative, but does not yet
indicate liquidation. In short, official institutions
have moderated their buying of U.S. debt but are not
yet selling.(How would you like to be one of those economists
that wrote grand epistles about the wisdom of selling
Gold and buying dollar assets?)
Two reasons exist for the lack of selling.
First, the central banks, including the Federal Reserve,
operate under the delusion, inspired by their staff
economists, that the dollar's depreciation will be only
moderate. Quite frankly they, central bankers, believe
their own analytical nonsense. The dollar, in their
view, will depreciate modestly, magically correcting
the massive U.S. current account deficit. Other core
beliefs include the Easter Bunny and their ability to
put Humpty Dumpty back together again with their magical
analytical super glue.
Forgotten in their analysis is that a
large component of the U.S. current account deficit
is structural in nature. In large part that unfortunate
economic reality was brought on by the abnormal bull
market for the dollar created by the Federal Reserve.
If a U.S. consumer wants furniture for a new, but unnecessary,
home that purchase will likely come from a foreign producer.
That goes for many of the goods the U.S. consumer purchases.
Due to the structural nature of the trade deficit, only
a massive recession that seriously depresses consumer
demand in the U.S. will effectively reduce the current
account deficit. Which central bank will vote first
for that option? Dollar devaluation is the only true
The second reason selling has not developed
is that central banks do not want to increase the size
of their losses on U.S. debt. Additionally, realized
losses are always more painful to a central banker,
or anyone it seems, that unrealized losses. What that
means is that as painful as holding a depreciating asset
might be, selling it and booking the loss is perceived
as more painful. Additionally, they own so much U.S.
government debt they do not want to make their losses
larger. As we all have experienced some time in our
trading life, panic selling will develop and likely
after the price has dropped materially. Ever sell a
stock out near the bottom? Same thing.
All these trends suggest that the U.S.
dollar is not out of its bear market, but only that
it has been in a rally from a short-term over sold condition.
The U.S. dollar's bear market is real, and is still
in puberty. When the selling of the dollar actually
begins, time will be too late to buy Gold. The dollar
price of Gold will be already up. One can not buy fire
insurance with smoke coming out your front door.
Many words, most of them unsupported
by real facts, are expended on what the central banks
have been doing or will do with their Gold holdings.
Thus far these commentaries and central bank actions
have been a great set of contrary indicators. You can
comfortably sit on your Gold until central banks start
buying. As long as so many analysts are still worrying
about central bank selling, your holdings of Gold are
secure investments. They have been a consistent source
of nonmaterial information.
Individual investors, however, must deal
with their individual situation. In which currency an
investor lives does have implications for whether or
not to buy Gold at any one time. The world has only
begun the process of repudiating fiat money. Your national
money may or may not be in a position that makes Gold
a wise purchase. On a regular basis our work now publishes
recommendations for individual investors.
In the following table is listed a selection
of the major national monies. This work focuses on the
Gold price of a national money, not the price of the
money in dollars. Remember, your national money could
be appreciating against the dollar but depreciating
in terms of Gold. The middle column in the table gives
the trend for the Gold price of the money along with
the ranking of that money against the others. In the
final column is a recommendation on whether investors
denominated in a particular national money should be
With the wide spread introduction of
Gold ETFs as well as the traditional forms of purchasing
physical Gold, investors have little reason to accept
the demise of their wealth by holding fiat monies. U.S.
dollar-based investors are certainly the most vulnerable,
but many others are at risk. Remember the important
question. Will my national money exist ten years from
now? Does anyone use the fiat money of the Russian Tsar?
As is apparent in the last chart, our
intermediate indicator is working toward a buy signal.
The short-term indicator, published weekly in our TRADING
THOUGHTS, recently gave a buy signal. It is now working
towards a modest over bought condition. That action
likely will set the stage for a move to an over sold
condition, and most importantly to a buy signal on the
intermediate indicator. Such a set of conditions would
suggest that U.S.$ Gold is preparing to begin another
rally that will carry to a new cycle high in early 2005.
Silver, high beta Gold, should also prove profitable
during this period. Be prepared for the next leg in
the Gold Super Cycle to US$1,300. Periodic comments,
never as full as these articles or our publications,
are now available at www.valueviewgoldreport.blogspot.com
Cohen, B. J.(1998). The Geography of
Money. Ithaca: Cornell University Press.
Cohen, B. J.(2004). The Future of Money. Princeton:
Princeton University Press.
Ned W. Schmidt,CFA,CEBS
is publisher of THE VALUE VIEW GOLD REPORT. That report
now includes a weekly message, TRADING THOUGHTS, to
help investors identify timely points for buying Gold
and Silver. You can join him for the Gold Super Cycle
His monumental report, "$1,265 GOLD", which
has now been read in 12 countries, has 255 pages and
98 graphs, is available at www.amazon.com
or from the author. Ned welcomes your comments and questions.
His mission in life is to rescue investors from the
abyss of financial assets and the coming collapse of
the U.S. dollar. He can be contacted at firstname.lastname@example.org.