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Moneyization Part Seven

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, Is Love Fading?

Foreign investors have been more than willing to finance the consumption binge of U.S. consumers and the structural imbalance in trade created by Federal Reserve policies. The current "measured" rate of change in U.S. interest rates reflects the muddled, not measured, policy of the Federal Reserve. As long as the Federal Reserve fails to acknowledge that a housing bubble has been driving the U.S. economy, the U.S. trade deficit will keep inching toward the terminal phase for the U.S. dollar. With the structural nature of the U.S. trade deficit, only a recession of massive proportion will reduce the trade deficit. Muddling though is the latest strategy of the Federal Reserve, and it will likely have as little success as previous policies.

Many have wondered when, not if, foreign investors might lose their enthusiasm for buying U.S. debt. From available data, the notion that the love affair is fading seems reasonable. Few question that a limit exists to the amount of U.S. debt that foreign central banks will ultimately buy. The question remains when will the limit be hit, not if. Foreign central banks can not be relied on to continue funding an extra $700 billion per year of the consumption binge of the U.S. They might like to as it keeps their citizens working, making products to sell to U.S. consumers. But, debt does not create prosperity.

U.S. government debt, including agencies, is held by two types of foreign investors, central banks and individual investors. That latter group would include the whole list other than central banks. Central banks hold these reserves for two reasons. Liquid savings for future needs would be one. Another is the much discussed effort to prevent the dollar from depreciating against their national monies in a way that would hinder the U.S.'s ability to buy foreign goods.

Each week the Federal Reserve releases a plethora of data on banks and monetary measures. Included within that data are the holdings at the Federal Reserve of U.S. government debt in the name of foreign institutions. Since this data is weekly, it provides an easy and quick way of assessing the investment inclinations of foreign central banks.

The first chart, labeled First Chart, portrays the year-to-year change in the level of those holdings, using bars and the left scale. The picture is of a mountain, and the current position appears to be on the down slope. Foreign central banks have acquired over US$200 billion of U.S. government debt in the past year. The rate of accumulation has slowed dramatically. Not too many months ago, as the chart shows, they were buying them at almost a $340 billion annual rate.

In that chart is also drawn a line that represents the trend line for the weekly change in central bank holdings, using the right axis. Again, a nice negative slope is evident. That line, in addition to the mountain shaped bars, suggests that a shift is developing toward central banks buying less U.S. government debt. We do note considerable enthusiasm being generated in Washington to reduce or eliminate the U.S. deficit. Well maybe they will actually do something about it, and perhaps pigs can indeed fly.

In the previous chart the year-to-year change in holdings of official institutions was the concern. The second chart considers the weekly changes. As with all data, week-to-week numbers can have a lot of noise in them. What is plotted in this graph is the three-week moving sum of the week-to-week changes in those holdings. Each point, therefore, represents the sum of the net change in these holdings over the previous three weeks. A tend line has also been included to highlight the tendency in the data. All data is in billions of U.S. dollars.

Notice the veracious appetite for U.S. debt by foreign central banks shortly after the end of 2003. The three-week moving sum approached $40 billion, or about $500 billion at an annual rate. Some massive purchases of U.S. government debt were being made. In April of last year purchases began to moderate, in part due to Japan's reducing its role in supporting the U.S. dollar. Maybe the Japanese finally know a bad investment when they see it, for they have lost considerable money in U.S. government debt.

That hunger for U.S. debt by foreign central banks has certainly been tempered. Is their love for buying this debt over? Perhaps so. Notice that the three-week moving sum has rarely been negative. The latest data point is negative, and more negative than the previous one. Are we witnessing "lower highs and lower lows?"

This data does not yet suggest that central banks now feel they have all the U.S. dollar debt that is appropriate, but that their buying has definitely slowed. Anecdotal evidence does suggest that central banks are in the process of diversifying their reserve holdings. The important issue is not the composition of central bank reserves last year, but rather what their holdings will be like at the end of the coming year or next year. And at some point even a central banker, except for those from the UK, will come to understand the lack of wisdom, to be kind, in selling Gold and buying U.S. dollars. Imagine how much purchasing power central banks have lost by holding dollar denominated paper assets in the past year?

Around the world we have been witnessing the process of individuals and businesses moving to monies in which they have higher faith. The average person walking the street almost anywhere in the world realizes that converting dollars to Euros has been the smart move. Converting almost any money into Euros has been the smart move. That understanding is even starting to creep into the thinking of the average American.

The collapse of the NASDAQ since the end of year is likely the beginning of the continuation of the bear market in U.S. equities. Shown in the Third Chart is the dismal record of U.S. equities for the past number of years. For more than five years, Gold has done better than stocks. And we must note that Gold has had a positive record for the past five years while equities have lost value. With the negative record of U.S. equities, are foreign investors likely to be rushing to place their life savings in dollar denominated stocks? With the record shown in that chart how does an investment advisor get someone to be invested 90% in stock and 10% in Gold? Totally baffling!

How long will it be before the ten-year record on stocks turns negative? Admittedly that question verges on heresy. How many times have you heard that stocks NEVER lose money over a ten-year period? Such a rationale is one argument for shifting the U.S. Social Security System to stocks. But, you want to know the really scarey one? Some are noting that over 60 year periods one CAN NOT lose money in stocks. That kind of absolute certainty should scare anyone out of the generic stock market. On the other hand, reruns of old Three Stooges' movies on cable business channels might be a dose of needed integrity for the investment community. Anyone remember the name of the Stooges' law firm?

If ever a reason existed to own Gold, it would be the situation with government-sponsored retirement schemes. At some point the answer to the problem is a choice between two undesirable alternatives. Taxing the citizens into poverty and rebellion in order to pay retirement benefits to baby boomers is one possibility. The other is for the central banks to purchase the bond holdings of the retirement plans through their money creation power. Worry though is not necessary. Everyone will get their retirement due from their government. The real question? What will it buy?

For several weeks many in the investment world have decided that the U.S. dollar is due for a long run of appreciation. Curious. Other than funds buying for a trade, who is going to buy the dollar? Is the average investor in China or Europe going to start loading up on dollars? This period of dollar delusion will pass, and when it does $Gold will again start rising. Reality is important, for the U.S. has to find buyers for more than 13 billion green dollars each and every week. May we take your order?

When the recent trend line for $Gold is broken,
a giant flashing BUY will be signaled.
That ensuing rally will carry to a new high!

In the last chart is drawn a trend line down the recent correction in $Gold. Every individual with a charting system, or access to one, has drawn that trend line. No technical pattern has probably become as popular as that one. That brings us to one of the most important rules of charting. All popular support and resistance levels, which includes trend lines, are taken out with a vengeance. That trend line will be broken, and it will flash a massive buy signal. Will you be long Gold or watching?

Silver is in a different pattern, as widely known. A lateral pattern has been building in Silver for some time. Lateral patterns are some of the favorites of long time charters as they are so powerful when they end. Silver above $7 will quickly become Silver at $8.

For a thought to close with, think about all these discussions of government retirement plans. So many baby booms will be retiring that globally these government-sponsored plans are going to be hemorrhaging cash. Ok that is one matter, but another question needs to be answered. To whom are all those retired people going to sell their houses?

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