Moneyization Part Three

By: Ned W. Schmidt | Wed, Nov 24, 2004
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HEADLINE, From Future:
"€10,000 Bid For Loonie"

Ottawa: Bidding was quiet, but spirited. Attendees at auctions of collectibles are not known for any outward expression of enthusiasm. That was the case, till the last Canadian dollar bill printed was auctioned. Winning bid was by phone, and believed to be a Middle Eastern buyer. After the auction, one bidder spoke to us, "Ever since the collapse of the U.S. dollar we knew this day might come. Imagine, the Euro is now legal tender in my country."

As the name implies, this article is the third in a series on moneyization. For those not familiar with the previous two articles, reading them in the archives of one of the web sites on which they appeared is recommended. Our topic, moneyization, is the global financial phenomenon of individuals and businesses moving their wealth to monies in which they have the highest confidence. Monetary complacency is no longer the norm. People will simply not hold a money, including that printed by their own government, if they do not believe it will serve as an adequate store of value. Many would give their life for their country, but are unwilling to hold the money.

Moneyization, the tendency to shift to stronger monies, has many names. Dollarization and currency substitution, for example, have been terms used for this phenomenon. Rational individuals and business will not hold weak monies, like dollars, or accept payment in weak monies, like dollars, if they understand the fundamentals. To do so is to be willing to have the value of your wealth reduced. The whole reason so many of us are interested in the Gold market is that we too understand that holding a weak currency is no longer the only option available.

Normally discussions as this focus on the wisdom of individuals shifting their wealth to include Gold. This strategy is appropriate for those individuals living in nations where the future value of the currency is in serious doubt. The United States, Canada, Australia, and others are included in this list. A study of trends in moneyization, the active avoidance of unattractive currencies, suggests that many of today's currencies will not exist tomorrow. In money, survival of the fittest will indeed be the rule. Where money is concerned, Darwin was right.

Before proceeding to the remainder of today's thoughts, a warning to businesses. Too many of you are taking the risk of invoicing in a potentially weak currency, when doing so is not necessary. If your business is invoicing in dollars, the value of your payment when received will be worth less on receipt than the day of the invoice. When you invoice in dollars, or some other weak currency, that action is costing your business money. Whenever possible, invoice in a stronger currency such as the Euro. Your business should be invoicing in value enhancing currencies. Indeed, a day will arrive when invoicing in Gold will the norm. Sorry about that digression.

Since last we talked, what has happened? Remember, that we are learning to price currencies in Gold. As the world moves to Gold as the primary money, we will buy "things" with units of Gold. The first graph portrays the recent Gold price for four monies, from the U.S., Australia, Canada, and the European Union. Remember, Gold is the price of a national money, and is the vertical axis in the graph using ounces of Gold in thousandths.

A reason for coming to understand the price of currencies in Gold is to overcome an illusion that sometimes misleads investors. The foreign exchange value of a money can go up against the dollar but yet still have a negative trend for its purchasing power. In foreign exchanges markets the dollar is a "ghost money," facilitating the statement of different monetary values with a common reference. Real money is Gold, and should be the common monetary standard.

Using Gold to price currencies removes that money illusion. In the following table, recent trends are shown for the Gold price of six currencies. Australia is the only one that has a positive movement in terms of Gold, and has the only arrows pointing up. The remainder, regardless of what they appear to do against the U.S. dollar, have fallen in terms of Gold. Australia's unique position, in terms of national resources and proximity to China, probably accounts for that money's performance.

Trends in Gold Price
Selected National Monies

National
Money
Recent
Trend
Recent
Period
Australia
Mexico
Canada
U.S.
U.K.
Euro
Source: Value View Gold Report, November 2004

 

Remember the words of Robert Mundell, "Monetary mass is important"(Mundell,2003,21). Citizens living in any money need ask themselves several questions. Does my national money have the "monetary mass" to be a survivor money 25 years from now? 10 years from now? Who else around the world wants my nation's money? Are imports invoiced in my national money or another? If you can not answer all those questions in a way that assures your mind that your national money will rise to the top of the Currency Pyramid (Cohen,1998), then switching to Gold is the only lighted tunnel.

The article may be longer than originally intended as reasons for digressing keep popping to mind. For one, why do banks in the U.S. and Canada not offer accounts denominated in other currencies and Gold? The answer is probably obvious. They are too busy levying excessive service charges for overdrafts caused by accelerated check clearings or service charges for debit/credit card usage even if money is in your account when posted. Service charges, not service, are the focus of banks. Guess we answered our own question, purging our system of some frustration. You might ask your bank why they do not offer an account denominated in Euros or Gold. Time they offered accounts for today rather than yesterday. We might even some day have viable internet methods of transacting with Gold.

Your goal is to start thinking about what the world of money will be like in the years ahead. Money and the way we use it are not constants. The technology of money changes. Checks have not always existed, and were invented to get around limitations on the ability of banks to transfer money between accounts. One of the revolutions in banking was the requirement that U.S. national banks pay checks at par, not at a discount. Do you think Lincoln bought his theater tickets with a Visa card? Today, a new global explosion in the technology of finance is again freeing consumers from the shackles of yesterday's money. And note, the Euro was the first virtual money.

Part of that new found freedom is the ability to move wealth into monies that are of greater value. According to data prepared by the International Monetary Fund, in 2001 on average 34% of bank deposits in 85 countries were denominated in a national money of a country other than that of the residence of the depositor(De Nicolo', Honhohan & Ize, 2003). Regardless of the country, the ability to move to a better money is available in some shape or form. And most important, people are willing to exercise that ability.

Where are they moving their money? Gold and the Euro are clearly benefitting from these trends. Not too long ago we wrote that a battle of monies was beginning to unfold. In one corner was the U.S. dollar, held nearly universally, and in the other corner was the newcomer, the Euro. Around the world consumers and businesses are making their bets. Which currency will they hold?

Which money "wins", rising to the top of the Currency Pyramid, is important. The "winner"money will reign for years as the top fiat money. Invoices for global trade will be written in that money. Commodities will come to be priced in that money. Bond offerings will be denominated in that money. The "winner" gets lower prices for imported goods. The "winner" money will get lower interest rates as demand for the "winner" money rises.

The Euro seems to be coming on strong as it rounds the second turn. Team Euro did not intend to be so far out in front so early in the race. Perhaps Team Dollar just does not have an effective race plan or has failed to adequately maintain their vehicle. Resting on your laurels is sure way to place rather than win. The ECB and European Commission do not seem to have intentionally planned for the Euro ascendency, but lucky is better than good any day.

Serious students of the Euro have been better prognosticators than many, certainly better than the U.K. ideologues. Robert Mundell, with a well-deserved Nobel prize, saw the potential early,

"Looking at the international monetary system as a constantly evolving oligopoly, it seems inevitable that a countervailing power would develop to challenge the dollar. Now at the close of the 'American century,' the euro has appeared as a potential rival, the countervailing power to the dollar" (Mundell,2003,p.17).

This author does not believe Europe is "better" than the Americas, but patriotism can not be allowed to sway our analysis of change in the world. Two errors dominated the forecasts that misjudged the Euro's potential. First, when a monetary union is formed, particularly one with the ECB's mandate, depreciating the money as an economic tool is no longer an option. Competitive devaluations are no longer a policy alternative for European nations. That reality has been slowly emerging in many sectors of the EU. Both management and labor realize that change is necessary if Europe is to work. The idea of a thirty-five-hour week is fading, and the Germans are going to shop on weekends. Labor's vote on boards is likely to be weakened. Change is evolutionary, but in the EU it is in the right direction.

A second misunderstanding relates to the difference between absolute advantage and comparative advantage. Many developing countries have an absolute advantage in the price of unskilled labor. T-shirts, for example, are going to be cheaper when produced in these countries. Europe, as does other countries, maintains a comparative advantage in some goods and services. The skills of their labor offset the higher costs. Wages per hour or day are only one metric. What those workers produce in a period also matters, as does how well they produce it. Mercedes Benz is made in Europe for just that set of reasons. Now, global competition is putting pressure on European productions costs in order to maintain competitive advantage.

The Euro has fundamental economic change and monetary mass going for it. Let us focus on monetary mass. In Chart Two is plotted the ratio of the Euro money supply to the U.S. dollar money supply, using M-2 for this exercise. Both are expressed in dollars for comparability. We acknowledge that the money supply definitions are not exactly the same, but close enough. For that reason, the big picture is important rather than the squiggles. Also plotted in that graph, using triangles, is the value of the Euro in dollars, using the right-hand axis.

The size of the Euro money supply appears now larger than that of the dollar money supply, and relative to the size of dollars is rising. Around the world more financial assets are still denominated in dollars rather than Euros, largely due to the humongous amount of U.S. debt that has been sold throughout the world. However, the size of the Euro, as a money, is growing faster than that of dollars. In the words of Mundell, the Euro has the monetary mass.

Yes, rising supply should push down prices. What needs to be remembered is money cannot be created without demand. A large part of any money supply is created when banks make loans. What is evident is that demand for Euros is rising faster than the supply because the price, or value, of the Euro is rising. The Euro is gaining acceptance around the world, and in particular those areas adjacent to the European Union. In previous articles, the great move of consumers and nations to using the Euro was discussed.

The size, or mass, of a money helps to determine its demand. When companies want to borrow money they do so where a pile of money is waiting to purchase their bonds. That has been happening. Borrowers around the world have been moving to Euro denominated debt. As that happens, the Euro gains credibility. The birth of the Euro was not without detractors and some rough spots. Now though, the Euro is beginning to challenge the dollar on world money markets. As this process goes on, the attractiveness of the Euro as a reserve currency and store of value will grow. Monetary history is in the making.

The third chart portrays that relative money measure along with the U.S. dollar price of Gold. As the Euro has gained in popularity and grown in stature, it has become more valuable. The Gold price of the dollar has fallen, and the dollar price of Gold has risen. This situation demonstrates the global shift away from U.S. dollars to Euros. As the value of Euros rises due to expanding reliability, acceptance, financing, and mass, the dollar price of Gold should continue to rise.

As a rising price of Gold indicates a falling value of the dollar, what this graph also shows is that money demand in the world is shifting toward the Euro and away from the dollar. A hundred years ago this happened to the British pound. A shift in global monies is rare, and one wants to be on the right side of it by owning Gold. The U.S. dollar will not be vanquished and disappear, rather it will become a second money. That process of moving to second place can be either painful or unpleasant, enjoyable not being an alternative. The work of Allegret and Sandretto's suggests instability,

"The appropriate theoretical framework for such a debate is hegemonic stability, according to which the shift from a unipolar organization of the IMS[International Monetary System] based on the dollar to a multipolar organization should lead to an unstable equilibrium"(Allegret & Sandretto,2002,106)

The term "unstable equilibrium" is economist speak for a potentially ugly situation. Their view of the unfolding process is not positive. The hegemonic battle between the dollar and the Euro will be painful. As the allotted space has been exhausted, that will have to await the next installation of Moneyization. In the meantime, you are welcome to join us on this journey of monetary and precious metal inquiry each month THE VALUE VIEW GOLD REPORT and weekly in TRADING THOUGHTS.

REFERENCES:

Allegret, J.P. & Sandretto, R.(2002). The Euro as a Stabilizing and Harmonizing Force in the International Monetary System. Eastern Economic Journal,28,105-120. Retrieved March 25, 2004 from ABI/Inform Complete.

Cohen, B. J.(1998). The Geography of Money. Ithaca: Cornell University Press.

De Nicolo', G., Honhohan, P. and Ize, H.(2003). Dollarization of the Banking System: Good or Bad?(IMF Working Paper 146). Washington, D.C.: International Monetary Fund.

Mundell, R.A.(2003). Currency Areas, Exchange Rate Systems, and International Monetary Reform. In Salvatore, D., Deon, J.W. & Willett, T.D.(Eds.), The Dollarization Debate(pp.17-45). New York: Oxford University Press.


 

Author: Ned W. Schmidt

Ned W. Schmidt,CFA,CEBS
The Value View Gold Report

Ned W. Schmidt,CFA,CEBS is publisher of THE VALUE VIEW GOLD REPORT and author of "$1,265 GOLD", published in 2003. A weekly message, TRADING THOUGHTS, is also available to electronic subscribers. You can obtain a copy of the last issue of THE VALUE VIEW GOLD REPORT at The Value View Gold Report. Ned welcomes your comments and questions, and tries to answer most all. 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 ned@valueviewgoldreport.com

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