VALUE VIEW GOLD REPORT
HEADLINE from 2008:
"PATRIOTIC MONETARY ACT"
Washington, D.C.: The President elect
today called for passage of the Patriotic Monetary Act
of 2008. She said that economic conditions have deteriorated
faster than previously forecast. Further, "We can
no longer tolerate U.S. citizens controlling their wealth."
The Act would prohibit any U.S. citizen from moving
more than $10,000 outside the country without a government
permit. Any U.S. citizen having money on deposit outside
the U.S. would have six months to return the funds,
or face confiscation of U.S.-based assets. No U.S. citizen
would be allowed to have more than $10,000 of currency
in their possession. The U.S. Self Defense Tax would
also rise to 3% of all wealth in excess of $30,000.
United Nations officials said the higher tax was essential
to fund their observers monitoring U.S. economic and
In a recent issue of THE VALUE VIEW GOLD
REPORT we considered a graph of various measures of
the rate of change of the U.S. consumer price index.
As most others agree, a change in inflationary conditions
seems evident. Even the Federal Reserve may be adjusting
its thinking somewhat. That conclusion acknowledges
all the criticisms and discussions of the problems with
The real issue though may be the question
of whether or not the recent tendency toward higher
prices is being monetized. When prices rise, such as
the recent experience with oil, the central bank has
two fundamental choices. First, the central bank could
let market forces dictate the response. In this case
the rate of interest would rise to reflect the higher
prices. In the short-term, this action might result
in a lower level of economic activity.
That lower level of economic activity
should lead to a correction in the sources of rising
prices. Demand for goods would fall. The higher prices
for goods, oil included, would ultimately fall back
down. In this case the natural workings of the markets
adjust, and the higher prices are not built into the
system. Market can naturally adjust to such forces if
allowed to do so.
However, the Federal Reserve does not
like to let market forces work naturally. Having made
the assumption that the collective wisdom at the Federal
Reserve is greater than that of the market, it will
not allow markets to react naturally. The Federal Reserve's
wisdom is substituted for market wisdom. This mistake
of arrogance is commonly made by central banks.
The Federal Reserve's wisdom sets the
level of interest rates. Rather than let market interest
rates react naturally to supply and demand pressures,
it fixes those rates. That action requires the Federal
Reserve to supply reserves whenever the market has a
tendency to raise rates. This move keeps rates fixed
at the prescribed level, but monetizes any price increases.
That means it provides enough money to cause the markets
to accommodate and accept the higher prices.
Sufficient "money" is provided
the system to keep interest rates fixed. Since more
money is now in the system, the inflationary tendency
of the economy is higher. Such is the simplified view
of how the Federal Reserve actions monetized recent
price increases, such as those of oil. Little criticism
can be leveled at the central bank of China for its
policy decisions, when similar such actions are being
taken by the U.S. central bank.
Before going further with this look at
monetization of higher prices let us take a quick look
at the results of Federal Reserve policy. In our first
chart is the year-to-year change in U.S. M-1, the narrowest
measure of money. Some obvious observations stand out,
and are worthy of mention.
First, stability is apparently not an
important consideration in the development of Federal
Reserve policy. Little evidence of a stable policy,
however defined, can be found in that graph. Monetary
instability leads to economic instability. Such is the
reason the U.S. economy has experienced a stock market
bubble, a housing & mortgage bubble and the likelihood
of currency depreciation of a significant magnitude.
Second, the U.S. economy has been supplied
with monetary "juice" at an accelerating rate.
Monetary policy has been set without consideration of
possible adverse consequences, or more dangerously the
cumulative negative impact on the U.S. economic system.
The impact of higher and higher rates of monetary expansion
on stability, both economic and price, has not been
Generally accepted is that the money
supply should not grow faster than the growth rate of
the economy's ability to produce goods. Let us accept
that. If the money supply grows faster than the growth
rate of the economy's ability to produce goods that
action is deemed to be inflationary. The reverse is
generally also accepted.
What we have done in the second graph
is plot this tendency of monetary policy to be either
inflationary or deflationary. To do this each month
the year-to-year change in the narrow money supply,
M-1, is calculated. From that value 3% is subtracted.
Three percent is probably a reasonable estimate of the
growth of the long-term potential of the economy. If
the year-to-year change exceeds 3%, then monetary policy
is conducive to higher prices developing.
A ten-month moving average is then calculated,
and that is what appears in the graph. If that value
is positive, monetary policy is conducive to higher
prices. If the plot is negative, the impact of monetary
pressure is negative on prices.
Three distinct periods of monetary pressure
are evident in the graph. In the early 1990s the impact
of Japanese banking fading from the scene had not yet
appeared. Then a long period of monetary conditions
depressing prices developed. This is shown by the measure
being in negative territory. Previously we have written
how this era was largely due to the withdrawing inward
of the Japanese banking system.
More recently we see that the monetary
influence is positive. This condition has manifested
itself in exploding housing prices and much higher rates
of increases of other prices. An era of monetary
policy encouraging higher prices has been evident for
some time. That effort to boost prices has now been
seen in many sectors, and has encouraged the depreciation
of the U.S. dollar.
Naturally our curiosity took hold. To
that plot we added the monthly average price of Gold,
the solid line. That appears in the third graph. Here
we now have an interesting picture. Also, included are
two triangles. The triangle pointing down is when this
monetary measure last turned negative. A second triangle,
pointing up, is when the measure turned positive.
In short, when monetary policy is exerting
a depressing force on prices Gold does not do well.
When monetary policy is a positive force on prices,
Gold does well. Those results are as we would expect.
Most important though is that the measure continues
positive suggesting that Gold should continue to do
well. Since this measure is more like an oscillator
than an index, the level of the measure and the price
of Gold are not particularly comparable.
Now let us tie this graph in with whatever
a "measured" response might be. The Federal
Reserve is saying, as so many others have commented,
that taking away the punch bowl in a hurry is not likely
to happen. Waiting is more likely to be the approach
to raising rates. In the mean time, price increases
are being monetized and the cumulative danger to the
dollar continues to compound.
Potential investors on Gold need to keep
attention on the longer term impact of Federal Reserve
policy. The Fed has never got "religion" till
salvation was a necessity. That approach is not likely
to change. Central banks just do not have a tendency
to do the "right thing." Why else would Gold
have survived while fiat currencies have faded?
In the day of money moving on the click
of a mouse, volatility in the dollar and markets is
going to cause Gold to also be volatile. More important
is what will happen tomorrow to the dollar, not what
happens today based on a measure of last month's consumers'
confidence. Investors should use these opportunities
to add to their Gold positions.
As our last graph shows, these reactions
in the price of Gold create opportunities for investors.
One of the fundamental laws of finance is as the price
declines, the future return on Gold simply rises. Let
the stock junkies compound their losses on consumer
confidence estimates while you increase your future
returns. By the way the Silver chart has also flashed
a buy signal. So enjoy the ride in Gold($1,200+) and
Silver($21+), but do so by increasing your profits through
wise purchasing on price corrections.
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. His
monumental report, “$1,265 GOLD”, with 255
pages and 98 graphs, is now widely known, and available
at www.amazon.com. Previous editions of this work have
been read by hundreds, probably saving their portfolios
countless millions of losses. 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.