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,
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 ominous.
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
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 overcome reality.
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 disposition.
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
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 cell phone.
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.