MONEYIZATION, PART 1
by Ned W. Schmidt, CFA, CEBS
Schmidt Management Company
October 10, 2004
"Beach Retirement Home For Sale"
Palm Beach County: Beautiful view of the beach. (as storm blew away houses across street). Motivated seller (can not afford insurance deductibles). Near shopping (as soon as rebuilt) with country style living( electricity to lift plant still out so no indoor plumbing). Vacant lot adjacent is included (gives you two addresses to vote twice). Children friendly community (as the retired people are selling). New landscaping (by 95 mph wind, twice). Available immediately (as wife already moved out). Golf course nearby (as soon as temporary government mobile homes are removed). Make offer (when phone on).
This article will hopefully be the first part of a series on the dominant global money trend, so important to Gold investors. Around the world investors have been repositioning their financial wealth in currencies that are expected to serve well as a store of value. In most countries of the world, citizens understand that money rarely retains its value. U.S. dollar based investors and businesses are some of the last coming to this understanding. While this writing may seem elementary to some, new investors are now clearly evident in the Gold information network. To them these articles are primarily dedicated.
Full appreciation of the risk in currencies will not likely come to U.S. dollar based investors and businesses, anywhere in the world, until such time as a significant devaluation of the dollar occurs. Gold investors have understood the situation for a considerable time, and many have moved to protect their wealth by investing in Gold. Others are doing the exploration and study necessary to understand the importance of Gold in a portfolio. One senses a growing body of "Gold students" out there.
At the risk of angering more than a few, a distinction is drawn between Gold, a real asset, and stocks, which are financial assets. Regardless of the outlook for Gold, stocks are still paper assets. As paper assets, they represent a residual claim on the income and equity of a company. As paper assets, their valuation is still subject to all the vagaries of all paper assets. Stocks are not an ownership interest in Gold. The stocks, may in the short-run, trade like "options" on Gold, fast and wildly, but they should not be the primary source of an investor's exposure to Gold.
Investors need to understand that the monetary dynamics in process around the world are extremely positive for Gold's dollar price. The source of this outlook is a global reshuffling of money that has been in process for decades. Investors, therefore, should go to the heart of the matter, adding Gold to one's portfolio. Why go to a secondary methodology? Why put someone or some structure between the returns on Gold and the returns earned in your portfolio? That said and with enough stock investors now upset, we can move on to understanding the situation. Once one understands the global monetary shift in process, acceptance of this view becomes more reasonable.
While many readers are seasoned Gold bugs, enough new individuals are building an interest to justify some return periodically to the basic fundamentals. The price of Gold is simply the inverse of the Gold price of a currency. While that sounds like campaign rhetoric, the statement is true. Gold at $400 per ounce is the equivalent of 0.0025 ounces of Gold per U.S. dollar. Alternatively, one U.S. dollar is equal to 0.0025 ounces of Gold. The relevant price is Gold ounces per dollar. The dollar price for Gold is simply a convenient form of stating the matter. The relationship being discussed is portrayed in the first graph, and taking some time to understand it is recommended.
Most have suffered through one class in school where supply and demand curves were portrayed graphically. We learned that an increase in supply would cause price to fall. A reduction in demand would also cause lower prices. The important matter here is that the price being discussed in those graphs would be the Gold price of a dollar, not the dollar price of Gold.
If the supply of dollars increases faster than the supply of Gold, the price of dollars will go down. Note though that the price that will go down is Gold ounces per dollar. Excessive dollar creation might push the price down to, for example, 0.0022 ounces per dollar. In the conventional statement of price, that would be equal to approximately $455. Either price can be found by taking one(1) and dividing by the other price. Thus, the declining value of the dollar, in ounces of Gold, is what pushes up the dollar price of Gold.
An alternative way of looking at the situation is from the side of the demand for U.S. dollars. Many questions come in on the bubble phobia of so many Gold investors and analysts. If a financial bubble bursts in the U.S., foreign investors may develop a reluctance to accept and hold dollars. In the words of an economist, demand for dollars would fall. If the demand for dollars declines, the price of dollars will decline. The relevant price is again Gold ounces per dollar, and that price would fall. A falling ounces per dollar price implies a rising dollar price of Gold. Hopefully, this short but meaty discussion will answer the questions which are in so many e-mails.
The second graph may be an aid in visualizing this concept. Along the horizontal axis is the Gold price of the dollar. On the vertical axis is the "demand" for dollars. Those actual numbers mean nothing as we simply needed positive and negative values on the axis to do the graph. Positive numbers indicate positive demand for dollars. Going up the vertical axis means that demand for dollars is rising. The reverse is the situation for the negative values.
As demand for dollars rises, going up the vertical axis, the Gold price of the dollar increases. If the demand for the dollar rises, the world would be willing to pay more Gold for each dollar. Each dollar buys more Gold. As shown in the previous graph, this means the dollar price of Gold falls. If the demand for dollars falls, declining on the vertical axis, the Gold price of the dollar falls. In this case, the dollar price of Gold rises. This relationship is what makes all of the Greenspan Financial Bubbles so dangerous, and why so many Gold investors and analysts are concerned with them.
If for any reason foreign investors become reluctant to hold dollars, the demand for dollars will fall. Bubbles, economic policy ineptness, or just bad luck could cause this shift. The bubbles do matter. Fannie Mae's accounting methods do matter. Monies require confidence to bolster demand. At present the economic and monetary policies of the U.S. are built on a willingness to put that confidence at risk. Ignoring bubbles is not wise.
With all the focus on bubbles we may be forgetting the global shift away from the dollar that is developing. Bubble phobia is what day trading is to a multi-year move in the market. Makes for a lot of fun discussion, but the trend is where the profits come from not the trading. That trend, which is the source of Gold profits, for the dollar is negative and investors should heed it. Not since World War One have global financial markets made a shift similar to that occurring in the monetary arena.
However, major differences exist between now and the early 1900s. One, global financial markets now exist for money, accessible by almost anyone anywhere. Individuals around the world can now shift their wealth from one money to another with the click of a mouse. Two, national monies were still rising in popularity in the early part of the 20th century. Today that popularity is fading. Three, investors around the world are consciously and actively managing the money exposure of their wealth with far faster and friendlier technologies. Cell phones and the internet are clearly an improvement over carrier pigeons.(And no, I have no idea what technology stock to buy to get a play on that.) Consumers and investors are no longer willing or required to keep their wealth in any particular money, and are exercising that right.
National monies, like either U.S. dollars or Canadian dollars, are those individual currencies produced by individual countries. National monies were created for reasons other than wealth enhancement as we understand the concept today. National monies were created for a variety of reasons. Included in the motivations were the perceived need to foster and manage national economic growth and to have national identities(Helleiner,1998;Helleiner,2003). Appropriate attention was not necessarily given to what might be the standards to which they should be managed over time. National monies were essentially assumed to be necessary to be a complete sovereign nation.
The attitude toward the sanctity of national monies has been changing. On the higher plain, Robert Mundell's(1961) exploration into optimum currency areas was the effort that started serious reflection and first elevated the matter to a higher level, both in the academic and practical worlds. His receipt of a Nobel prize certainly added respect to his work. Helleiner(1998) brought attention to the historical rational for national monies. Motivations for these creations were as often political as economic. At the time of their individual births, national monies were established for what seemed near rational national reasons. The test of time was not to be so kind.
At the ground level, attention to the subject of national monies received further impetus in the 1990s for principally two reasons First, the record of national currencies was acknowledged as poor(Shuler,2003;White,2003). A seemingly endless chain of currency crises had developed. Second, the European Union was soon to abandon individual national monies in favor of the euro. Never in financial history have so many national monies been eliminated in one peaceful moment.
The record of national currencies has been far from an exemplary one. Table I summarizes a sampling of those national currencies that have experienced severe stress and caused significant economic dislocation within the respective country and/or region. This list is not intended to include all exchange rate problems, only the major ones. Not included in this list are those countries that are minor in importance or have experienced repetitive problems through inflation, devaluation and confiscation.
Table I Significant Currency Devaluations & Crises
|Turkey1, Dominican Republic||2001|
|1Dellas & Tavlas, 2Eichengreen,et al,2003, 3Wolf,2004|
National monies have, on balance, been financial disasters for those holding them. No wonder skepticism over Federal Reserve policies is widespread. Individuals around the world are no longer willing to hold a dubious money. When the dollar comes again under this cloud of money disfavor, a significant destruction of the dollar's value will develop. That is the reason why understanding that the value of the dollar is the concern for this era, and so important for the prosperity of investors and businesses.
A general recognition has developed that money simplification through elimination of national monies should increase trade, prosperity, and interchange between peoples of different countries (Rose & Engel,2002;Mundell,2003). A record such as that in the above table is not one that might promote trade, financial prosperity, global economic progress and general harmony. The European Union's creation of the euro was in part accomplished because of the dismal record of currencies. The EU is coming to be recognized as not a panacea to all the economic changes needed but as one of many steps toward removing roadblocks to economic growth in that area (Allegret & Sandretto,2002). That tendency toward agreement on the advantages of money denationalization and/or union is evident by the way individuals and countries are "voting" with their national monies, but that is for the next article.
The length of this article has now approached that which calls for a close, and a quick summary. The 1990's was an era of an ongoing series of currency crises. For investors, the key to understanding Gold is the issue of currencies, more importantly the likely problems for the value of the U.S. dollar. In the next article this discussion will be extended to the developments with the Euro and the meaning for the dollar and Gold. Comments and questions are encouraged. Those of you early in your Gold travels and learning have been the motivation for this writing, so write us. The Gold market recently has produced some exciting gains, as shown in the last chart. A new leg on this Gold Super Cycle may well be developing. Prices for Gold under $400 per ounce or, as you now know, 0.0025 ounces of Gold per dollar, will likely not be available in 2005.
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.
Dellas, H. & Tavlas, G.S.(2003). Lessons of the Euro for Dollarization. In Salvatore, D., Deon, J.W. & Willett, T.D.(Eds.), The Dollarization Debate(pp.283-298). New York: Oxford University Press.
Eichengreen, B., Rose, A. & Wyplosz, C.(2003). Exchange Market Mayhem: The Antecedents and Aftermaths of Speculative Attacks. In Eichengreen, B.(Ed.), Capital Flows and Crises(pp.99-153). London: The MIT Press.
European Central Bank(2004a). Frequently Asked Questions: EU Enlargement and Economic and Monetary Union(EMU). Retrieved August 10, 2004 from http://www.ecb.int/ecb/enlargement/html/faqenlarge.en.html
European Central Bank(2004b). ECB: The Euro Area. Retrieved August 19, 2004 from http://www.ecb.int/bc/intro/html/map.en.html
Helleiner, E.(1998). National Currencies and National Identities. The American Behavioral Scientist,41,1409-1436. Retrieved December 20, 2003 from Proquest.
Helleiner, E.(2003). The Making of National Money. Ithaca: Cornell University Press.
Hysteresis.(1993). In Random House Unabridged Dictionary(2nd ed.). New York: Random House
International Monetary Fund(2004). Retrieved from http://www.imf.org/external/np/sec/pn/2003/pn0390.htm
Mundell, R.A.(1961). A Theory of Optimum Currency Areas. American Economic Review, 51, 509-517.
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.
Oomes, N.(2003). Network Externalities and Dollarization Hysteresis: The Case of Russia (IMF Working Paper 96). Washington, D.C.: International Monetary Fund.
Rose, A.K. & Engel, C.(2002). Currency Unions and International Integration. Journal of Money, Credit and Banking,34,1067-1089. Retrieved March 25, 2004 from ABI/Inform Complete.
Schuler, K.(2003). What Use is Monetary Sovereignty? In Salvatore, D., Deon, J.W. & Willett, T.D. (Eds.), The Dollarization Debate (pp.140-153). New York: Oxford University Press.
White, L.H.(2003). Currency Competition and Consumer-Driven Unification. Cato Journal,23,139-145. Retrieved March 25, 2004 from ABI/Inform Complete.
Wolf, M.(2004). Why Globalization Works. New Haven: Yale University Press.
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 is available at www.amazon.com or from the author by clicking HERE This work has now been read by investors in over twelve countries around the world. 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 by Email.
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© 2004 Ned W. Schmidt
Please remember that no method is perfect nor is the one
running the model.
All estimated returns are for the model portfolio and do not reflect those earned on actual portfolios.
NOTICE: This article may NOT be reproduced without the expressed, written permission of the author, Ned W. Schmidt and Financial Sense. Selective quotations are permissible as long as the author, Ned W. Schmidt, and this web site www.financialsense.com are acknowledged.