Moneyization Part Thirteen
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.
Or, The Great Wall of America.
Finding something to read which does not include reference to the financial disaster in the making called the United States would be nice. That seems to be a near impossibility. Course a group of delusionists remain committed to rationalizing the economic mess created by the Greenspan/Bush team. Fortunately, their remaining tenure is limited. That the replacements for both might not be an improvement is the scarey part of the whole situation.
Most recently, The Exhaustion of the Dollar by H. Peter Gray and A Closer Look at Foreign Investment Behavior in the U.S. by Douglas R. Gillespie(www.gillespieresearch.com) managed to further depress any residual hope for the U.S. dollar. Both are recommended reading. And if residential real estate is still viewed as your financial savior, try The Mortgage Trap by Dean Foust in the 27 June issue of Business Week.
Course I flung that magazine against the reading room wall when another reference to Bernanke's Delusion was discovered. Bernanke is to head the Council of Economic Advisors and some have said he is on the short list to replace Greenspan. He is a major advocate of the view that the U.S. current account deficit is the fault of foreign countries. In this delusion, the U.S. has a current account deficit cause some nations have a surplus of money to invest. Or, she got a DUI cause the bar had a surplus of liquor to sell.
The coming crisis involving the U.S. current account deficit is a much documented phenomenon. Only the policy makers at the U.S. government seem to be unable to grasp the stark reality facing the country. For those that have not seen a recent chart of the current account situation consider the first graph. The bars represent the current account deficit, using the left axis, and triangles are that deficit divided by GDP, using the right axis. The negative 6% line is the much discussed danger level. Some forecasts have the deficit/GDP ratio rising to 8 or 9 percent, which the dollar would not survive. Regardless of the forecast, the situation is dire. Serious dollar devaluation wi l l be necessary to correct the situation due to the structural nature of the U.S. trade deficit.
The current account can be thought of as part of the income statement for the country. Financial statements have another important schedule, the balance sheet. Gray, in his book mentioned above, notes that the international net worth of the United States has been in deficit for some time. The international net worth of the country can be viewed as the equity in the country's balance sheet. A nation's individuals and businesses have investments in other nations. Those investments are the asset side of the balance sheet. Liabilities exist in the form of claims on U.S. assets by foreign investors. Assets minus liabilities equals net worth, or equity. What a nation owns minus what it owes is international net worth, or the nation's equity.
The second chart portrays the U.S. international net worth, and comes from data produced by the BEA, or Bureau of Economic Analysis. Black circles are the U.S. international net worth, and use the left axis. Red squares are that net worth as a percentage of GDP, and use the right axis. Note also that this data is soon to be updated and data for 2004 has not yet been released. These are not small calculations and even with computers takes them a while to do them.
Two observations can be made from this chart. First, for most of the period shown the U.S. international net wor t h has been negative, and is currently just shy of negative $3 trillion. Interestingly that period of negative net worth for the nation seems to coincide with the reign of Greenspan at the Federal Reserve. The presidency changed hands during this period so blame cannot be directed at that office. Federal Reserve policies seem to be the mos t likely influences that destroyed the equity of the U.S. By the way, how many of you would buy a stock that has a negative book value?
The second observation relates to the size of the negative equity relative to GDP. That percentage is approaching 25%. Perhaps that might be some good news. Citizens of the U.S. would only have to surrender three months of national income to eliminate the negative net worth. If the U.S. would give up everything produced by the entire nation from July 1 to October 1, the negative equity could be "eliminated." What a relief! No wonder the Federal Reserve ignores what now seems a trivial matter.
The two largest national monies available for investors are the dollar and the Euro. Both have a fundamental and political problem. The dollar's fundamental problems have been well discussed, as done above. The political problem we discussed in one of our recent articles. If one needs to borrow money f rom the world, one should make that easier rather than harder. One should not create political and legal hurdles that make it difficult for investors to lend you money.
However, the U.S. government continues to "fight the war on terrorism" by making the use of the dollar and the U.S. financial system harder for people, particular foreign ones. The USA Patriot Act, Bank Secrecy Act, court rulings and overly enthusiastic bureaucrats are serving to criminalize the use of dollars and the U.S. financial system. While the U.S. needs to borrow a couple billion dollars each day, the nation is making it harder for the world to use dollars. The fundamentals may be bad, but the drive by the U.S. government to put a wall around the U.S. financial system will be as effective protecting the nation as the Great Wall was in preserving the Chinese emperors and empresses. The Great Wall of the America is "terrorism" of investors, and the dollar will pay the price!
These policy actions will serve only to foster a parallel international financial system from which the U.S. will be excluded, and in which the dollar does not participate.
The Euro's fundamental problem is that whatever positive trends might exist, it is still fiat money. Euro is still a debt not an asset. Potential for politics to interfere with the evolution in this monetary union became clearly evident after the French and Dutch votes. However, the impact of the vote has been on the entire fiat money framework, not just the Euro. Yes the Euro went down against the dollar, but all currencies have been going down.
Consider the table below, in which all values have been rounded for simpler presentation. For each national money the value of Gold in the local money is calculated for the end of May and today. Gold went up in each of these local monies, every one of them. That means each national money went down in value. The final column refers to the Gold price of the money, simply another way of looking at the value of money. For each national money, how much Gold was required to buy a unit of the national money was calculated. That last column is how much that Gold price of the national money changed. Each and everyone of them became cheaper in terms of Gold, meaning down in value.
(Values are rounded.)
End of May
|Gold Price of Money
What this table tells us is that investors have been moving away from fiat monies, all of them. The vote on the EU constitution reminded investors around the world that fiat monies are not really secure investments. Investors around the world are shifting to the only money that is an asset rather than a debt. Is the era of debt money approaching an end? Is the era of debt as an asset about to be snuffed out by massive losses on housing loans?
The Euro offers an intermediate step for the world's monetary system in the longer term transition from the dollar to Gold. Structurally the world's financial system is probably not prepared to shift immediately from fiat money to Gold. Needed infrastructure for using Gold as money remains to be built. Technology has reached the level where the use of Gold as money is possible, but providers of financial services are not prepared.
In the monthly letter a discussion has been started on the wisdom in Gray's book. He wrote it because of his belief that the world is not prepared for a shift from one monetary hegemon, the U.S., to another, perhaps the Euro. A smooth transition may not be possible. The inability of the U.S. to adequately exercise its rights and responsibilities as the new monetary hegemon in the 1920s and 1930s contributed to the coming of the Great Depression. That immaturity as a monetary hegemon certainly exacerbated the situation.
We again face a shift from one monetary hegemon to another. The French and Dutch votes may suggest that the EU does not yet have the unity needed to exercise effectively the new monetary role for the Euro. In short and as Gray points out, no world entity stands ready to manage the situation. The world is not preparing for the problems associated with the failing of the monetary hegemon. Gray suggests that the impact on global economic activity of the U.S. financial situation may be a serious matter. Is Great Depression II just around the monetary corner?
Many investors have discovered the future role for Gold in the world's monetary system. They are using price weakness to gain early entry into the future monetary paradigm. The last graph shows that timely purchases of Gold, created periodically by rallies in paper money, can be identified. While Gold is over bought on the EU vote, another opportunity will arrive. Investors should be positioning themselves to buy Gold on the next, and any future, periods of price weakness. Think $1,300 Gold, not which piece of paper buy.
And, a final note to Silver investors. Technology will allow Gold to substitute for national monies in the future. Gold will be the most prevalent "denomination" of world money. However, that will be true only for electronic transactions and large real transactions. Silver coins were originally created so that the most typical daily transaction could be completed. Even a coin worth only a tenth of an ounce of Gold is too large to be practical for purchasing normal stuff, like a case of beer. Silver coins will again be necessary in the future. With Silver approaching an over sold condition, investors should be adding Silver to their portfolios. And do not forget, the Silver ETF is coming!