HEADLINE from 3 November:
This article is the second in a series on moneyization. We do recommend reading the previous one for background understanding, available usually in the archives of most sites. The shifting tide of global money is the focus of our attention. Just as anyone fishing needs to be aware of the tides, so does the investor. Otherwise, the "portfolio ship" may be dashed on the rocks by the rising and falling of the tidal wave of monies. In this one we also define moneyization and further expand your knowledge base.
Understanding and knowledge are the two most powerful tools of investment. A well-worn metaphor is that of providing the fish or teaching someone to fish. Anyone can scour the internet for that occasional investment idea that works, or that greater number which do not succeed. More important are the skills to recognize and perceive the meaning of shifts in the world of money. Recognition of the danger in the twin deficits of the U.S., the federal and the trade, was the first learning step.
The second learning step is knowing of the massive shift, on a global basis, of money that is beginning.
Before proceeding on to our assignment, let us reflect on the current situation. The format for the following table is intentional. One of our goals is to get more investors to think in ounces and Euros, rather than the old-fashioned custom of U.S. dollars. Several reasons exist for wanting to adapt your way of looking at the money world. This table is formatted in the way the world will come to look at relative values of monies, in Gold and Euros.Table I
|Currency||Valued In Gold(oz.)||In Euros|
|Note: For those with a math mind, we may have to quote currencies in Gold Oz. 10-3. That may be the currency measure of the future.|
For no good economic nor financial reason, around the world more than 150 different national monies exist (Cohen,2004). Since only one is really required to conduct all business done on earth, the number is certainly excessive. Agreement on quoting of money values even makes little sense. At the bottom right of page C-1 of The Wall Street Journal is a snapshot of the money values. The Euro is quoted in dollars. The yen is quoted in number of yen per dollar. British pounds are quoted in dollars. Canadian dollars are quoted in Canadian dollars per dollar. And for those with a memory, the Swiss franc no longer merits front page coverage as presumably hard currencies are no longer relevant in the financial era.
This plethora of national monies means that one may need to be exchanged for that of another if transactions for goods and services are to occur. Not content to let a system exist to simply provide for required economic transactions, the financial community felt compelled to transform it into an opportunity to trade. Some trading does serve economic purposes, providing liquidity and pricing information. Most trading simply generates fee income for brokers, and provides the opportunity to have periods of great success (manias) alternating with financial meltdowns (panics).
Trading of national monies, foreign currency trading or forex, is now a massive undertaking. A recent estimate puts the value of trading on foreign exchange markets at US$1.9 trillion per day (World,2004). Add to that another trillion dollars worth that trade over the counter, and the world is shaking the dice with almost three trillion dollars of transactions in forex each day. Equity and bond markets are side shows compared to such activity. And remember, most of this money churning adds no value to the economic well being of the world.
Little doubt exists that trading of this size is not necessary to facilitate the daily exchange of goods and services in the world. Most of this activity is done by bright, young college graduates with massive computers running questionable mathematical algorithms that have been back tested over the past twenty minutes of trading. Perhaps knowing that the financial security of the world rests each night on the success of this combination makes you sleep well. Others, though, might have a more mixed reaction. (Remember the space mission that failed cause part of the team was working in metric and the other in English measurement?)
When the meltdown in this trading frenzy occurs is no longer the question. Rather than waiting for the big meltdown, people around the world have reacted to the long series of mini meltdowns that have already occurred. In the previous article the dismal record of national monies was reviewed. On a broad basis, national monies have been a good way to destroy wealth for a lot of people. But, people learn from their mistakes. Around the world a massive shift of wealth away from weak currencies has occurred.
Investors, individuals and businesses will not hold national monies that develop weakness. Any currency, including the much worshiped U.S. dollar, will not be retained if doubt develops over the likelihood of it serving as a store of value. These groups have been burned too many times. What's the old saying about fool me once?
Around the world a move to concentrating wealth in fewer national monies is readily evident. The work of the International Monetary Fund on 85 countries suggests that a significant move on the part of consumers and businesses out of their home monies has already happened. At the end of 2001, on average 34% of bank deposits in these countries were denominated in foreign monies rather than their home money (De Nicolo, Honhohan & Ize, 2003). Roughly a third of bank deposits have been shifted to presumably more stable monies. That level of a shift is far from insignificant for not included is either foreign currency in their pockets or bank deposits in a foreign nation. Further, this situation demonstrates both a willingness and an ability to shift easily among national monies.
The early research literature on these shifts, desiring to gain an understanding of this development, is filled with attempts to empirically measure the extent to which citizens of certain countries had shifted from domestic money to foreign money. These efforts, largely due to measurement problems, were not adequate or especially successful. Early discussions referred to this phenomenon as dollarization, as much of the early identification of the phenomenon was in Latin America. Motivations for these studies were generally the money related economic problems of individual countries. Citizens in these countries had been buffeted by inflation, devaluation, depreciation, confiscation, nationalization, and politicians for decades. The barrel of a rifle could not get them to hold their home money.
Hysteresis became a common term in the literature to describe the phenomenon observed in that research. Inflation rates and past depreciation in the exchange rate were largely used as explanatory variables for dollarization. However, when inflation moderated and currencies regained relative stability, the citizens did not shift back to the domestic money (Tandon & Wang, 2003; Helleiner,2003). The term, hysteresis, was borrowed from the physical sciences as it describes a situation that continues despite the removal of the forces causing the initial reaction (Random House,1993).
From this point on though, the term "moneyization" will be used rather than "dollarization." The latter term implies that dollars are the money being substituted for the domestic money. Such is not always the case, as British pounds, Swiss francs, Japanese yen and now the Euro are acceptable foreign monies in many places as substitutes for local money. Obviously these monies are not dollars which makes the term inappropriate. In a similar vein, use of the term "currency" is not appropriate for only a portion of the world's money supply is in the form of currency. Substitution has increasingly taken place in the form of monies and financial assets, rather than currency.
Perhaps the best effort to quantify the level of moneyization has been done by and for the International Monetary Fund, and was referenced above. Concern for these financial developments stems from the impact on a country's ability to conduct monetary policy. A consequence of moneyization is that the value of a country's money is likely to be more volatile on foreign exchange markets (Berge & Borenztein,2003; Corbo,2003). This condition has serious implications for the future volatility of the U.S. dollar, but that will have to wait for a future article. Many national monies, including perhaps the U.S. dollar, are caught in a circular flow of negative forces that suggests they are more likely to become something viewed in a museum rather than in the wallet.
The move by individuals and businesses to stronger monies, or de facto moneyization, is only one aspect of the process. De juro moneyization is also occurring. Table I summarizes the move by nations to replace their national monies with others. This table is certainly not complete in present form for many of the neighboring countries to the European Union are moving either to the Euro, pegging to the Euro, or experiencing de facto Euroization. While certainly somewhere a nation created a new national money, not since the dissolution of the former Soviet Union have monies been created in any number. Please note that this effort certainly does not attempt to be the definitive source of national money creation and destruction.Table II
Countries Denationalizing Money
The money vote is not going well for the U.S. dollar!
|Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland, Slovakia, Slovenia||20041||EU€|
|Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain||2002||EU€|
|1 Date of joining EU. Euro adoption date to be determined. (European Central Bank,2004a) |
2International Monetary Fund, 2004
Of the 15 nations originally joining the European Union, the naturally stubborn United Kingdom and Sweden do not use the Euro. Denmark pegs its currency to the Euro (European Central Bank,2004b). The alignment of nations for entry into the European Union has grown in recent times. As these nations bring their internal policies into conformity with EU standards the dates for adoption of the Euro will be determined.
Decisions are being made by periphery countries on the future character of their national monies. Additionally, a de facto shift to the Euro is observed in these countries. Russia is the second largest holder of U.S. dollars in the world (Oomes,2003). A reasonable expectation would be that Russia may experience a shift to the Euro purely for trade and travel related reasons given the close proximity to the European Union and the volume of trade and travel between the EU and Russia. The impact of such a large shift in money ownership could prove interesting. An important learning step is that the citizens of all the nations in or near the European Union are already, or will be, selling dollars and buying Euros.
Thus far we have observed a string of massive currency crises over the years that have cost people hundreds of billions of dollars of wealth. People have responded by moving out of the questionable monies created by their own nation. Governments too have been busy, dumping their national monies, moving to the Euro as a better alternative. The world of tomorrow will be one of fewer national monies. The survivors will be those monies in which investors have confidence and in which they want to be invested. The next step to consider is the coming clash of two major currencies, the dollar and the Euro. Momentum, it will be argued, is on the side of the Euro. And besides, who in the world does not already own too many dollars?
Dollar denominated investors and businesses need to recognize that the era of one great currency is passing. In that transition era, financial turmoil is likely. The dollar's value will face growing risk of rapid depreciation. In terms of what we learned in the last article, the Gold price of the dollar will go down. That development pushes up the dollar price of Gold. From a strategic or longer term standpoint, a shift to Gold by dollar denominated investors and businesses is essential for financial survival.
Genius is not required to recognize that a Gold Super Cycle is unfolding, likely to carry it well over US$1,200. Once though an investor recognizes the need to own Gold, picking the day to buy is the next decision. That task is the hard one. Tactical considerations are always tougher than long-term, strategic decisions. As the graph below, from my weekly TRADING THOUGHTS, suggests, learning to buy low is possible. Just remember, do not buy when prices are up and enthusiasm is high on any given day. And finally, if one does not buy Gold one can not benefit from the Super Cycle. Trading a few stocks once or twice will not get it.
References for Your Personal Research:
• Berge, A. & Borensztenin, E.R.(2003). The Pros and Cons of Dollarization,In Salvatore, D., Deon, J.W. & Willett, T.D.(Eds.), The DollarizationDebate(pp.72-101). New York: Oxford University Press.
• Cohen, B. J.(2004). The Future of Money. Princeton: PrincetonUniversity Press.
• Corbo, V.(2003). Is It Time for a Common Currency for the Americas?.In Salvatore, D., Deon, J.W. & Willett, T.D.(Eds.), The DollarizationDebate(pp.102-110). New York: Oxford University Press.
• De Nicolo, G., Honhohan, P. and Ize, H.(2003). Dollarizationof the Banking System: Good or Bad?(IMF Working Paper 146). Washington, D.C.:International Monetary Fund.
• European Central Bank(2004a). Frequently Asked Questions: EU Enlargementand 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.(2003). The Making of National Money. Ithaca: Cornell University Press.
• Hysteresis.(1993). In Random House Unabridged Dictionary(2nded.). New York: Random House
• International Monetary Fund(2004).Retrieved from http://www.imf.org/external/np/sec/pn/2003/pn0390.htm
• Oomes, N.(2003). Network Externalities and Dollarization Hysteresis: The Case of Russia(IMF Working Paper 96). Washington, D.C.: International Monetary Fund.
• Tandon, A. & Wang, Y.(2003). Confidence in Domestic Money andCurrency Substitution. Economic Inquiry,41,407-419. Retrieved March 25,2004 from ABI/Inform Complete.
• World forex trading hits record.(2004, Sep 29). The FinancialTimes, p.1.