THE VALUE VIEW GOLD REPORT
HEADLINE from 2008:
EUROPE'S PAPER PROBLEM
Paris Airport: Europe's paper problem: dollar bills.
Today the first of weekly flights of chartered 747's
will depart Paris for Washington, D.C. The cargo? U.S.
currency being returned to the Federal Reserve. For
months banks in Europe have had a problem. Citizens
of all EU countries have been exchanging dollars for
Euros, as acceptability of the currency has plunged.
With vaults spilling over, banks are no longer able
to store all that unwanted paper. The flights will depart
weekly to carry the no longer wanted dollars for redemption.
Only Gold will be accepted in the redemption, as few
central banks will any longer invest in U.S. Treasury
securities despite yields well in excess of 12% yield.
In the last issue of THE VALUE VIEW GOLD
REPORT a graph was included about which
the author has been thinking for some time. Some of
my clients have been looking at this graph for years,
baffled at why the author was so persistent on including
it in the discussion. Sometimes one just has to look
a long time at a picture before it becomes meaningful.
That situation is surely true with something as exciting
as the amount of U.S. currency in circulation. Yes,
you have been waiting a long time for this though unaware
of this internal craving.
We are going to be fairly pedestrian in going through
some graphs. Few investors look at as many graphs as
those interested in Gold and Silver. One almost needs
a Masters in Graphing to get through some of the writings.
Far those of you with advanced degrees in number theory
please bear with us.
In the first graph we take a look at the relationship
which is the source of our interest. The subject of
our attention is U.S. currency in circulation. Those
green pieces of paper, Federal Reserve notes, that you
carry around in your wallets are about half of this.
The other half is those green pieces of paper being
carried around in the wallets of people all over the
world. The U.S. dollar circulates around the globe.
Those black triangles, using the right axis, represent
the weekly value of U.S. currency in circulation. This
number comes right off the Federal Reserve's balance
sheet each week.
The other line in the graph is the year-to-year percent
change in the outstanding amount of U.S. currency, and
uses the left axis. As is readily apparent, the year-to-year
change rose to a high level in the early part of the
graph. That line has been falling in an irregular fashion
since then. The
pile of U.S. currency around the world is now growing
at an extremely slow rate.
Reasons for the slower expansion of the U.S. currency
supply are probably numerous. Debit cards certainly
are more popular now than ever before. That development
is acknowledged. However, when we look at this series
compared to Gold the statistical evidence suggests that
a conversion to the use of e-plastic money is only part
of the development.
The high rate of expansion of the U.S. currency supply
early in the graph coincides with the introduction of
the physical Euro in the European Union. Many feared
that calamity would occur with that event. Individuals
probably converted to dollars to avoid the inevitable
catastrophe, predicted by many British fear mongers.
Others likely feared revealing their cash holdings.
Some around the world do not report all their income
to the taxing authority, a practice we abhor in public.
Cash transactions often occur to avoid the payment of
confiscatory tax rates in Europe. These individuals
certainly did not want to go into the bank with a large
bag of marks or francs or whatever to convert into Euros.
As many know, taking bags of cash into a bank has not
been acceptable for a considerable time. Some kind of
explanation of the source of all those marks and francs
might have been required. Many apparently converted
their money hoards or business activities to dollars.
In part, these transactions explain the weakness of
the Euro during this period.
At this point we are going to digress for a small graphing
lesson before going on to the heart of our discussion.
Again, an apology to those well versed in graphics.
In the next graph are two series. The top one is the
normal view of the year-to-year percentage change in
U.S. currency such as that which we looked at above.
The second line is that series flipped over. We have
done that simply by converting all values to negative.
This convention will be useful later when we look at
Remember now a couple of rules when looking at this
graph. The top line is the normal portrayal of the year-to-year
change. When the rate of increase in U.S. currency is
extremely positive, the confidence in the U.S. dollar
is high. The U.S. dollar should appreciate and dollar
Gold should be weak. When the rate of increase declines,
confidence in the dollar is declining. The dollar price
of Gold should be rising.
The reverse is true when we look at the inverted series.
When converted to a negative, the greater the negative
the greater the confidence in the U.S. dollar. In this
type of period the dollar will appreciate and Gold should
weaken. When converted to a negative, the less negative
the lower the confidence in the U.S. dollar. In this
latter case the dollar should depreciate and Gold should
appreciate. The usefulness of this inversion will be
Moving on, the foreign exchange market really functions
on two levels. At the top is the institutional level
where trades in the billions take place on a near continuous
basis somewhere in the world. Around the globe, on electronic
exchanges, these trades occur. With billions moving
at the click of a mouse, these transactions are the
ones that have the greatest influence on foreign exchange
rates. These transactions take place in electronic money.
Few of us operate in that market.
The other part of the foreign exchange market might
be called the "street" market. Here is where individuals
are making transactions. The tourist that trades currencies
outside the airport is an example. Another is the merchant
or individual in any country of the world that exchanges
dollars for local currency or vice versa. These transactions
take place in the form of paper money.
In the very first graph we looked at the divergence
between the amount of U.S. currency outstanding and
the year-to-year percent change is fairly obvious. You
probably should take a look back at that graph. Divergence
is when one series is going up and the other is going
down. In that graph the size of the pile of U.S. currency
is still rising while the momentum, year-to-year change,
is going down. Declining momentum is a certain sign
of change. This graph is a first class demonstration
of the concept of divergence.
The change being read into this situation is that individuals
around the world are desiring to hold less U.S. dollars
than before. In the parlance of the economist, the marginal
propensity to hold dollars is declining. Individuals
are apparently more willing to hold some other currency.
When we look at Gold, we will present a little evidence
to support that conclusion.
What are they holding instead of dollars? Euros could
be one example. Other currencies that have experienced
improved confidence are possibilities. Perhaps they
are holding Gold coins. Actually, we do not know what
they are holding. All we know is that the marginal propensity
to hold dollars is falling, and that their marginal
propensity to hold some other currency is rising.
In the next graph we have plotted the monthly price
of U.S. dollar Gold and the year-to-year change in U.S.
currency circulation, inverted. Note that the year-to-year
change is inverted. What we see is an extremely tight
relationship between the year-to-year change in U.S.
currency outstanding and the dollar price of Gold. The
falling tendency to hold dollars on the part of individuals,
for whatever reason, is being reflected in the rising
dollar price of Gold.
In our previous article on money and Gold we talked
about R2. That measure is the percent of
the variance of the price of Gold explained by the variance
of the year-to-year percent change in U.S. currency
outstanding. Huh? It tells us how much the wiggles in
Gold are explained by the wiggles in the percent change
in U.S. currency outstanding.
About 75% of the wiggles in dollar Gold are explained
by the tendency of world citizens to hold dollar currency.
that the falling rate of increase in the amount of U.S.
currency outstanding is a reflection of falling confidence
in the U.S. dollar on the part of citizens around the
world. This tight fit between the two suggests
that the impact of e-plastic money does exist but is
probably not the dominant reason for global individuals
wanting to hold less dollars.
Around the world, the average citizens in a bazaar
or the merchants in a city or unknown individuals in
other countries may be less willing to hold dollars
than was previously the case. The poor performance and
poor fundamentals of the U.S. dollar have apparently
reached wide and far. If these individuals, perhaps
without the blessing of CNBC on a daily basis, know
enough to not hold dollars, some of the rest of the
world might be advised to listen up.
Our next step is to see what this declining propensity
to hold U.S. currency means for investors. In a previous
graph the close correlation between this tendency and
the dollar price of Gold was noted. In the next graph
we use this concept to look at the potential for the
dollar price of Gold.
In the graph, the inverted year-to-year change in U.S.
currency is advanced five by months. What this methodology
does is show that what happens today influences tomorrow.
In other words,
today's falling marginal propensity to hold dollars
influences tomorrow's dollar price of Gold. That
series is shown by the squares. The black line is the
dollar price of Gold. Notice again the tight fit.
We have also projected out, using black hourglasses,
a possible path for the propensity to hold U.S. currency.
This forecast suggests a likely path for dollar Gold.
Again as we found in our last look at money, the argument
for buying Gold is strong. Around the world individuals
are shifting away from dollar bills to something else.
That shifting demand for dollars has extremely positive
implications for the dollar price of Gold. Kind of exciting
when we find these relationships that point to the future.
At this point you should congratulate yourself. To
your understanding of the world you have added an important,
and not easy, concept. Tell your kids or grandchildren
you studied the marginal propensity to hold dollars.
They may look at you strangely, but just smile. This
knowledge and your holdings of Gold and Silver mean
you are way ahead of the bobbing heads on CNBC.
Everywhere we look, with one exception, positive indicators
are found for the future price of dollar Gold. That
one exception? Street research still is pushing paper
assets, and those technology stocks. Why? They can create
paper assets out of thin air and sell them to the gullible
public. The Street can not create Gold. Given that truth,
Gold is assuredly destined to rise in value more than
paper assets. Stay on board for the ride to 1,200, for
Gold in dollars and no doubt for the NASDAQ Composite
Given the positive outlook for Gold, you should be
joining us and all the other "Gold bugs" as we seek
out buying opportunities on the road to wealth preservation
and financial prosperity.
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.