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, More Going With The Flow.
In Moneyization Part Eight we talked about the difference between thinking of money as a stock, or balance, and a flow. That article is good background material for gaining an understanding of money. In particular, the reader will gain a fuller understanding of two important money concepts. The first relates to the need to think of money as a flow rather than a balance. In short, where money is going is more important than where it resides at any one single nanosecond.
Second, investors need to understand the concept of moneyization. In previous eras the Westphalian view of nations and money dominated. Sovereign governments determined what would be money and which money the citizen would carry around in their purse. Enforcement was simple. Tax collectors arrived at your door accompanies by sword wielding assistants and demanded "sovereigns" from you in payment of your taxes. Over time and especially since the abandonment of the Gold standard, individuals have been increasingly making their own choices regarding which national money they will hold.
Individuals learned that holding their wealth in a money in which they had a higher degree of faith made more sense than depreciating paper money. As long as they produced the required legal tender in payment of taxes, freedom to choose money was available to them. Technology has enhanced the ability of individuals to choose their money. Wealth now flows around the world to those national monies with a higher store of faith, and that process is moneyization.
Around the world, bad money is driving good money out of circulation, a kind of Gresham's Law II. This action is making good money rarer and pushing the price, or value, of that good money higher. Such is the reason that the dollar price of Gold has risen along with the dollar value of the Euro. Gold is "good" money and the dollar is "bad" money. Those monies with a higher store of faith will rise in value!
Attention is now being given to the many government reports on the denominations of the holdings of individuals and government. The Bank for International Settlements(BIS) also produces a quarterly data dump. That report has received some attention as analysts try to come to grips with the status of holdings in dollar denominated assets. For those with a need to fully test their printer, the statistical section of the BIS report runs 111 pages. Once in hand, you will probably start coming to understand it about the time this time next year. While extensive, the data being considered below does only cover those countries that report data, about 38.
Our focus here is on the banking system, rather than central banks. Assets of banks are interesting, but they are a "residual." The assets of a bank are determined by the liabilities of the bank. Periodically some financial institutions will attempt to ignore their liability structure. That effort generally is what provides employment security for those responsible for closing failing financial institutions.
Who determines the liability structure of a bank? You and all the other individuals around the world determine the liability structure of a bank. Individuals and consumers make the decision on how much money will reside in their demand accounts. They determine the size of their time deposits, and the maturity of those deposits. Banks make an attempt to influence those decisions with a myriad of confusing offers. (Oh for the days of simplicity again, 3% interest and a free toaster.)
Governments can not determine the way the citizens hold their bank deposits. Any control they had has been diluted or destroyed by technology and the era of capital mobility. People in every country have learned how to move their wealth to "good" monies. Ultimately the consumer is able to get close to what they deem is appropriate for their bank deposits.
This development is now worldwide. Despite the U.S. banking industry remaining bogged down somewhere early in the last century, many countries have more modern deposit offerings. In many countries, depositors may choose which national money will be the denomination of their deposit account. For example, the IMF estimates that at the end of 2001 on average 34% of bank deposits in 85 countries were denominated in national monies not of the location of the bank (De Nicolo' et al,2003). Banks around the world exist that permit consumers to denominate their accounts in almost any of the major currencies. Perhaps someday the U.S. banking industry will move into the 20th century. U.S. consumers would certainly have benefitted from their bank deposits being denominated in Euros rather than depreciating dollars.(Ask your banker why they do not offer Euro deposits?)
Perhaps getting back to the subject would be wise. The BIS data lets us take a look at how people around the world are denominating their money. This data tells us how much of deposit accounts are in the major national monies. With that, we can then look at what shifts consumers around the world are making. Which national monies depositors prefer can be identified.
The First Chart is a stock or balance concept. In it are portrayed the percentage of bank deposits in each of the major national monies. Clearly the U.S. dollar still dominates. When saying that, we need to note three conditions. First, the U.S. is included in the data. The citizens of that country have little choice but to denominate their bank accounts in U.S. dollars. Essentially that is the only choice offered by the unimaginative U.S. bankers, causing totally dollar deposits to be higher than they might be if U.S. consumers had more financial freedom.
Second, remember how many U.S. dollars are being put in the hands of people around the world each and every day. The statistic, common now, is that foreign investors need to recycle to the U.S. almost $3 billion dollars every business day. Why is that? The answer to that question is important here. The answer is that because U.S. consumers are sending foreign producers almost $3 billion dollars a day for goods. About $700 billion a year in dollars is being paid to individuals and businesses outside the U.S.
If foreign investors take time for a long lunch, the dollars will start piling up in their bank accounts. Quite frankly, that they manage to recycle that many dollars is amazing. The sheer size of the dollar flow from the U.S. importing goods inflates the size of the dollar holdings of the world. One can almost picture those little Bobcat loaders moving piles of dollars around in the vaults of the world's banks. Finally, with oil prices being higher and denominated in dollars, the world simply needs a lot of dollars to pay for oil. Higher oil prices artificially inflate dollar deposits.
Now though, let us turn to the Second Chart. This chart shifts our thinking from a balance concept to a more appropriate flow concept. Money, remember, needs to be thought about as a flow. This chart shows the change in both dollar and Euro denominated bank deposits in the first half of 2004 and in the third quarter of 2004. The time lag for data is long, but not when one thinks about the complexity of the problem. Individual banks have to forward data to the national level. That data has to be checked and then forwarded to the BIS. Then, the BIS has to put it all together. These numbers are annualized.
During the first half of 2004 depositors, around the world, increased their U.S. dollar denominated bank accounts at about a $250 billion annual rate. Euro denominated deposits grew at about a paltry $50 billion annual rate. The ratio, shown by the triangles and using the right axis, of dollar accumulation to Euro accumulation was well over five times.
A shift occurred in the third quarter. By this time the much larger working balances of dollars needed to pay for higher priced oil had been accumulated. The annualized rate of increase of Euro deposits moved up dramatically. During this period the ratio of the shift to dollar denominated deposits to Euro denominated deposits fell to slightly over one. This much lower rate indicates a significant change in the desire to hold more Euros relative to dollars.
Clearly, the world has changed its preference for national monies. A year ago the world was willing to add five times more dollars to their deposits than Euros. Apparently the world sobered up or quit watching tout TV. The rate of dollar acquisition relative to Euros, despite the vast quantity of dollars being shipped outside the country, fell to a little over one. Depositors around the world are definitely shifting to a money in which they have a higher faith, and that is not the U.S. dollar.
As dollars appear to still being accumulated by many sources around the world, heavy selling of the dollar does not seem to be the source of the dollar's weakness. Rather, the shift in preference to buying other national monies seems to have made them stronger. Given two conditions, the U.S. dollar's value can only continue to lose value relative to national monies such as the Euro and Gold. First, the preferences of individuals around the world have shifted away from the U.S. dollar to other national monies. The current state of bureaucratic tyranny now rampant in the U.S. financial services industries is exacerbating the situation. Any individual of another nation would have to be an ultra masochist to attempt open a bank account in the U.S. or move money to a U.S. account. Second, the structural nature of the U.S. trade deficit of the U.S. means that a reversal of the situation is not likely.
The argument that a goodly part of the U.S. trade deficit is structural continues to be ignored. Thinking remains focused on the notion that a depreciating dollar will turn the U.S. trade deficit lower. That might happen if the U.S. produced the goods in demand. That however is not the case. In the Third Chart is plotted the ratio of U.S. importation of goods divided by U.S. retail sails. All of the value of imported petroleum products was not included as some clearly does not go through the retail trade system. As is apparent in the chart, the ratio rose dramatically.
Recognizing that some data discrepancies do exist with this approach, imported goods rose from a low of 30% of retail sails to about 36%. A shift of that magnitude is definitely significant. The goods U.S. consumers are buying are increasingly coming from foreign production. U.S. manufacturing, what little remains after the Federal Reserve's decimation of it, simply does not produce the goods consumers want. This structural problem with the source of production means that the dollar's depreciation to date is not having material impact on the importation of foreign goods. However, the U.S. has created an incredibly fast system for processing mortgage applications on the internet, an accomplishment right up their with landing on the moon.
In that chart is also plotted the monthly average dollar price of Gold. The other side of importing goods is the exporting of green dollar bills. As that ratio has risen in the chart, the amount of green dollar bills exported has risen. With the global money preferences shifting to the Euro and others, the only direction for the value of the dollar is down. The ability of the world to simply absorb the current massive exportation of U.S. dollars has been overpowered. Selling of dollar positions has not yet started, but the willingness to accept dollars is falling.
The U.S. dollar will be ONLY the FIRST casualty of the reordering of money preferences around the world. Other national moneys will also fade over time. Gold, and Silver, will gain in popularity as monies. Destroying the credibility of the world's largest national money will not enhance over time the credibility of other fiat monies. As the last chart show, opportunities are created on a regular basis for individuals to increase their holdings of the preferred money.
The most recent rate increase by the Federal Reserve is creating another buying opportunity for Gold investors. Foreign exchange markets often over react to interest rate changes, called "over shooting" in the literature. Recently the U.S. dollar has been stronger because of the U.S. interest rate increase. As a consequence, the U.S. dollar has become over bought. Gold has reacted as it should to this rising value of the dollar, and retreated in price. Such events have repeatedly been excellent buying opportunities.
Both Gold and Silver investors should be adding to their positions on this price weakness. Indicators are moving to buy signals on both metals, like those shown in the last chart. While the U.S. dollars is trading at an extended price, Gold and Silver should be bought. The Gold Super Cycle will not be thwarted by the "measured and meandering" policies of the Federal Reserve. Will you be profiting or watching?
De Nicolo, G., Honhohan, P. and Ize, H.(2003). Dollarization of the banking system: Good or bad?(IMF Working Paper 146). Washington, D.C.: International Monetary Fund.