Moneyization Part Twenty

By: Ned W. Schmidt | Thu, Feb 2, 2006
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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, Structural Deficit is a Dollar Killer

A new year has changed little. That is, nothing that would alter the long-term optimism for Gold. The state of the U.S. financial system did not change suddenly and miraculously in January. Those trend we identified, now over five years ago, that were seen as sending $Gold to over US$1,200 are still in place. What was not foreseen is that our patience would be rewarded with a new, wonderful Chairman of the Federal Reserve. A leader has been appointed for the U.S. central bank that will not hesitate to destroy the value of the U.S. dollar when the Mortgage Bubble collapses. Investors in Gold and Silver could not have found a better friend if they had done the selection.

Around the world, investors in many countries have been rediscovering Gold. The global rejection of fiat money is only beginning. That shift of wealth to Gold from paper assets and fiat money is the moneyization process. Individuals across the globe are shifting from paper money to real money. Gold is rising again as the money of choice. The world is moving from less desirable national monies to that money, Gold, in which they have a higher faith.

At the heart of the thesis for investing in Gold is the mismanagement of the U.S. economy. Has anything changed? No, the massive current account deficit of the United States continues on track. That deficit will lead to a devaluation of the U.S. dollar and a rejection of dollar denominated paper assets. Rather than change for the better, the situation grows more dire as the structural nature of the trade deficit increases. Simple depreciation of U.S. dollar or appreciation of Chinese renminbi can no longer remedy the situation.

Analysts and writers tend to know which of the U.S. deficits is being discussed. Readers often do not, and try to combine them in one set of thoughts. Questions on the U.S. deficits come in on a regular basis from readers and concerned investors, and deserve some attention. The U.S. has three important deficits, the current account deficit, the deficit of the national government and the savings deficit. While they are indeed related, one relationship at a time is an easier approach. The current account deficit includes the trade deficit, and some other transactions. It is the net transfer of money from the U.S. to foreigners for essentially buying more foreign goods than the U.S. sells to foreign consumers. That process transfers wealth from the U.S. to foreign producers.

The danger in this current account deficit of the U.S. is that it is large, and growing larger. In the first graph is plotted the dollar size of the U.S. current account deficit using bars and the left axis. Again, the current account deficit is essentially the trade deficit. Also plotted is the more important metric, that annual deficit as a percentage of GDP using triangles and the right axis. As is readily apparent, the absolute size and relative size of the U.S. imbalance in trade continues to grow.

How does this deficit relate to the deficit of the U.S. government, about $600 on annual basis? While a connection exists in economic theory, the more important matter is that this governmental deficit has been financed by selling bonds to foreign investors to "soak up" those dollars being sent abroad to foreign producers. In a world without massive U.S. government bond issuance, foreign investors would have had no choice but to sell those $800 million each and every year in the foreign exchange market. That action would have sent the dollar crashing to unimaginable relative lows against other national monies.

The governmental deficit at the national level in the U.S. created the liquid debt into which those foreign owned dollars from the trade deficit could flow. Without that debt, the U.S. dollar would have already plunged to unimaginable lows against other national monies. The wisdom of the U.S. government financial deficit is in part separate from the economic impact of the reinvestment of the dollars being spewed forth by the current account deficit.

Without that liquid debt into which foreign investors have invested trillions of dollars, the U.S. dollar's value would have collapsed. That investment in debt has deferred, not eliminated, the foreign exchange and economic impact of the cumulative current account deficit. In short and for the moment, do not consider the issue of the U.S. national financial debt, but rather focus on the current account deficit.

Foreign official institutions alone own in excess of $1.5 trillion of U.S. government debt, held at the Federal Reserve. That investment has allowed the world to avoid the repercussion of the massive U.S. trade deficit.

If that debt did not exist, they simply could have opted to buy Kansas and Iowa instead. The selling of U.S. dollars by foreign investors has simply been deferred by investment in that debt.

The hope of the "good times" economists at the Federal Reserve and on Wall Street has been that the U.S. dollar will gradually and painlessly weaken. That weakening will cause more U.S. goods to be sold to foreign consumers and fewer foreign goods to be bought by U.S. consumers. In the years of the Gold standard and prior to 1971 that might have happened. Unfortunately, the U.S. economy has been radically restructured during the years Greenspan ran amuck at the Federal Reserve. For example, the U.S. owned and based automobile industry is being restructured and liquidated.

"Ford motor will axe almost a quarter of its North American workforce and close seven vehicle factories by 2012 .... The company intends to cut 25,000-30,000 jobs by 2012 and lose about one-eighth of senior managers by the end of March. The closure of the factories will cut annual capacity by 1.2 m , or just over a quarter, in the next three years.(Simon & Mackintosh,2006)"

Those factories are not being moth balled, they are to be liquidated. The machine tools and conveyor belts will not be sitting there waiting for the dollar to revalue, but rather will be loaded on trucks and hauled away. The factories will be bulldozed, and grass planted so the deer and bunnies again have a place to have sex. U.S. dollar could go to five to the Euro and the yen to below 80 to the dollar and those factories will not be reopened. The human capital base, likewise, is being liquidated. Canadians are slowly coming to recognize that their economy and employment are related to the health of U.S. economy and companies.

Depreciation of the U.S. dollar will not correct the trade deficit as it has increasingly become a structural deficit. The U.S. economy simply is no longer able to produce the goods the world wants. Autos are merely the most recent and most visible manifestation of the damage done to the U.S. economy by the Federal Reserve in the past two decades. Bernanke's Delusion may argue that the reason the U.S. has a massive trade deficit is that foreign consumers are not spending enough, but the evidence does not support that view. The auto industry is just the latest in a long list of U.S. producing industries that have been liquidated. Quite simply, the U.S. does not produce goods that consumers want to buy. Consumers prefer Toyotas to Fords and would rather have iPods than mortgage software!

Again, the sale of those dollars transferred to foreign producers has simply been deferred. The impact on the U.S. dollar's value has simply been postponed. When recession arrives in the U.S., foreign investors will begin to liquidate, either through sale or maturity, their trillions in U.S. debt. The consequences will be felt in the foreign exchange markets, and North American interest rates.

The price mechanism is the means used by foreign exchange markets to instill discipline on a rogue economy. As the value of a nation's money falls, the price of imported goods increases. Since the U.S. has failed to maintain productive capacity, U.S. consumers will have no choice but to pay those higher prices. Their standard of living will be lowered dramatically. What will be the ramifications of a U.S. recession combined with collapsing real estate prices while other prices are pushed higher by a falling value for the U.S. dollar? Bernanke "dumping money out of aircraft" will only exacerbate this situation.

As the second graph suggests, a U.S. recession of size is increasingly likely. Plotted is the U.S. savings rate, monthly. Savings is equal to disposable income minus consumption. Disposable income is after tax income, essentially equal to pay check income. U.S. consumers have been spending far more than their income. The data in this graph suggest that U.S. consumption spending should fall $400 billion, or more. That will make a nice recession, and the impact will be felt globally by those producing goods for the U.S. consumer.

For consumers in the U.S. to spend more than they earn, money must come from one of three sources. Money to fill this spending deficit can be borrowed outright, stocks can be sold, or extracted from home equity by borrowing on homes. Thus far consumption in the U.S. and production in other countries has been financed by converting home equity into debt and spending the cash acquired. Liquidation of homeowners' equity has been taking place on a massive scale in the U.S., and other countries. U.S. consumption is not financed by income, but rather by debt, primarily related to homes. Now though, around the globe we are starting to see the end of the speculative boom in real estate prices.

And despite the "blow and go" from "rosy view only" economists and analysts, the real estate bubble around the world is starting to show some serious signs of strain. First from Shanghai, the epicenter of the Chinese economic miracle and now the home of the upside-down mortgage,

"Once one of the hottest markets in the world, sales of homes have virtually halted in some areas of Shanghai, prompting developers to slash prices and real estate brokerages to shutter thousands of offices. For the first time, homeowners here are learning what it means to have an upside-down mortgage - when the value of a home falls below the amount of debt on the property... About 1 million homes in Shanghai alone - about half the number of housing starts for the entire United States in 2004 - are under construction.(Lee,2006)"

And from Texas, where housing prices collapsed in the 1980s, comes word of foreclosures,

"In a healthy local housing market, a sign of trouble has appeared. More people are losing their homes to foreclosure than at any time since the Texas real estate bust of the 1980s....[Connie Zetterlund, an agent specializing in foreclosure sales said] 'There are tons of foreclosures out there right now....I'm seeing lot of properties bought in 2004 and already going to foreclosure'.(Brown & Augustums,2006)"

And from Germany, the now former home of "fast cash" open end property funds which were till December the number three investment of choice,

"Now these brick-and-mortar investments aren't looking so solid after all. On Dec. 13, Frankfurt's Deutsche Bank shocked the German banking world by freezing the $7.2 billion fund.... Freezing the fund amounts to the equivalent of a bank closing its doors to a mob of frantic depositors, and the result has been alarm in the German banking community about the country's $105 billion property-fund industry.( Ewing,2006)"

The massive problems in the German property funds have not received adequate coverage by the North American business media. Investors are kept informed of every wiggle in the GOOG "Ponzi-like" stock scheme, but little on the crumbling world of real estate. Reality blind, real estate investors should research KanAM, for example. Euro Property, 1 August 2005, reported that KanAm quit taking cash into some funds because investors were providing too much money. And then from The Wall Street Journal Eastern Edition, 20 January 2006, we find that KanAm "freezes additional fund after asset run." One month too much money trying to get in, and now too much money trying to get out.

The global real estate market, and especially in the U.S., is a giant "musical bag" game. Someone is going to end up holding the "debt bag" on this real estate lending. The Real Estate and Mortgage Bubbles are bursting. The bell is being rung. Who will end up holding the trillions in defaulted debt? And in our, meaning Gold and Silver investors', corner is Chairman Bernanke at the Federal Reserve. Can the Fed resist "dumping money out of air craft" in an attempt to halt the collapse of U.S. real estate prices? Will Federal Reserve be able to resist destroying the value of the dollar in an effort to halt imploding real estate values. Banks will again find out the meaning of OREO on their balance sheets. Instead of encouraging your child to learn computer skills, perhaps some course work in auctioneering might be a better value.

Moneyization is about finding the right national money in which to denominate your investment life. Around the world, investors are shifting to Gold, the only global money. The U.S. dollar is the liability of an economy spending more than it earns. Canadian money is a liability backed by an economy whose biggest customer cannot pay its bills without borrowing. Gold is the money of choice in the new millennium. The Euro and the renminbi are only temporary steps, and will serve as Silver coins once did. By the way, which national money do you believe Canada will adopt?

The case for Gold's Super Cycle continues well supported by mismanagement, past and future, of U.S. economy by Federal Reserve. Short-term euphoria has developed as Gold moved to new cycle highs repeatedly in recent months, as shown in US$Gold chart above. While still expecting the US$Gold train to arrive at over $1,200, now may not be the time to jump aboard. Many of us have been anticipating the Silver ETF for some time. That filing has suddenly come as news to some investors, pushing Silver up and raising hopes for Gold. US$Gold purchasers should perhaps be sitting on their mouse rather than clicking it. Other buying opportunities will develop. CN$Gold investors, see last chart, should note that CN$Gold has recently not been as exuberant as US$Gold.

Case, B., Brown, S. & Augustums, I. Housing divide widens, (2006, January 21). The Dallas Morning News.
Ewing , J. A property market on ice. (2006, January 9). Business Week, p. 78-9.
Lee, D. A Home Boom Bursts. (2006, January 8)
Simon, D. & Mackintosh, J. Ford to axe 25,000 jobs and close seven plants. (2006, January 6). The
Financial Times, p. 1.


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

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