Net Asset Value of Certain Precious Metal Trusts and Funds

The Difference Between Eurodollars and M3 Eurodollars

My friend Bart at Nowandfutures.com and I have discovered the cause of the discrepancy between his, and presumably John Williams' estimate of Eurodollars for their M3 estimates, and the BIS reports of Eurodollars.

The Fed's estimate seems to be limited to foreign branches of US banks only.

The Board of Governors of the Federal Reserve discontinued the Weekly Report of Eurodollar Liabilities Held by Selected U.S. Addressees at Foreign Offices of U.S. Banks (FR 2050; OMB No. 7100-0068) in March 2006. In November 2005, the Federal Reserve decided to cease collecting, constructing, and publishing the M3 monetary aggregate, effective in March 2006. As a result of the Federal Reserve's decision to cease constructing the M3 monetary aggregate, data collected on the FR 2050 are no longer needed.

This voluntary report collected two items of daily data once a week: (1) total non-negotiable Eurodollars and (2) negotiable term Eurodollars held in custody accounts, both payable to U.S. addressees other than depository institutions and money market mutual funds. The primary use of the data was to construct the Eurodollar component of the M3 monetary aggregate. The data were also used for analysis of depository institutions' funding practices.

This puts a more practical cast on the discontinuance of the M3 report.

As the BIS reports make very clear, the Fed's method was greatly underestimating the amount of dollars held by overseas banks, which is how the marketplace had come to define Eurodollars.

"A dollar-denominated deposit made in foreign banks or foreign branches of U.S. banks. Depositors sometimes transfer their funds to European banks in order to take advantage of higher interest rates. The Eurodollar is one type of Eurocurrency. Eurodollars are US currency deposited in banks outside the United States but not always in Europe. Certain debt securities are issued in eurodollars and pay interest in US dollars into non-US bank accounts. Eurodollars are a form of eurocurrency."

I think the term Eurodollars outgrew its origins, as it had come to refer to all dollars held overseas outside the jurisdiction of the Fed and the US Federal Government.  As you may recall, eurodollars started as a movement by certain entities to hold their US dollar assets outside the Fed to avoid the freezing and seizure of their assets, but it become much more broadly used as the dollar grew into the global reserve currency.

The Fed was faced with the choice of incurring the expense of going back and correcting their numbers to reflect the broader definition.  And since they have no authority over non-member banks, they would have to rely on BIS to provide them the data.  Their decision was to either redefine M3, or simply discontinue it.  They chose the latter.

So to avoid confusion, Eurodollars will refer to any US dollar held as foreign currency as defined by the BIS. M3 Eurodollars will refer to the discontinued series by the Fed which estimated the dollars held overseas at branches of US banks.

I would agree with the Fed that their definition was becoming quaintly irrelevant to the markets. I estimate that today the M3 eurodollars represent less than half of Eurodollars held around the world if one includes official reserves as well as reported commercial bank holdings.

Since it is the total amount of dollars held overseas in liquid form that is of interest to us, we will be using the BIS data to track eurodollars as we have been doing.  It does render M3 estimates less interesting however.

Gold and US Official Debt Instruments Held by Central Banks

If the Eurodollars chart wasn't enough heartburn for the paper-huggers, here is a chart from Ed Yardeni showing the correlation between the price of gold and the amount of US Treasury and Agency Debt held by Central Banks.

Personally I like to track the Eurodollars and the real interest rates, but this works about the same as I had suggested.   Central banks are not profit-seeking organizations and are notorious for mispricing risk when it suits them.

Gold, Eurodollars, and the Black Swan That Will Devour the US Futures and Derivatives Markets

The Eurodollars estimate in the chart below is based on the BIS Banking Statistics from Commercial Banks and may not include official reserves held by Central Banks. 

As you know the Federal Reserve stopped reporting Eurodollars some years ago, with the consequence that it also stopped reporting M3 money supply.

I like to think of Eurodollars and banking system derivatives as the Fed's off-balance-sheet method of monetization and policy implementation, with plausible deniability.  

Swap lines are provided to other Central Banks, and they in turn make the loans to their member banks, and from there to their customers.  So this eurodollar creation is made outside the real domestic economy, and therefore has no immediate effect on domestic money supply and prices at the end of the money chain.  But the effect is there, and the smart money closer to the financial system sees it coming. 

I do not know if the Fed's swap line activity actually shows up immediately in their Balance Sheet and therefore the Adjusted Monetary Base.  But I think it is fairly obvious that if swaps are used to create dollars by foreign central banks, who in turn loan those dollas to their own members, the impact of that broader dollar creation will only be felt with a significant lag in the domestic US economy.   But it will be felt at some point.

When the Fed was tracking Eurodollars, I believe that they were not counting certain assets, or liabilities from the banks point of view, as money.  What exactly those assets might be and how liquid they are is a open question.  How much of them were held in Agency debt, and how much in Treasury debt?  Is a liquid obligation held by a foreign source part of the broad money supply, or not?  Since it can be quickly converted into dollars, and then into another currency, leaves little question that it is potential money at least.

At least part of the problem being faced by Europe in this crisis is the sharp point of the deleveraging of US assets underlying dollar denominated debt.   And if foreign confidence in the US dollar debt breaks, the losses would be daunting for the holders of that debt, so there will first be a rush into Treasuries and away from Agency debt and CDOs.  This will be like the ocean retracting, causing people to flock to the shore in wonder at the cheapness of the debt.  But eventually the returning tsunami of US dollars may very well swamp the Fed's Balance Sheet and the domestic US economy and the savings of many.

The hyper-inflation of financial paper is happening quietly and  off the books. The growth rate in derivatives held by the Banks is mind boggling.  And how this will manifest in the real world economy is not fully known.  A good sized chunks of the financial system may simply vaporize.  And I suspect that the policy makers will heavily allocate the damage to the least powerful members of the private sector. 

Ownership of the real economy will continue to be concentrated in fewer and fewer hands. Stagflation is the most likely outcome because of this lack of reform and the rise of a self-serving oligarchy.

As for the US Dollar, as I have said on numerous occasions, inflation and deflation are at the end of the day a policy decision.  Period.  Those who see a hyper-deflation or a hyper-inflation as inevitable elude my knowledge of the facts as they are.   The Fed owns a printing press, and it uses it selectively. 

Speaking of lags, I think the unusually long lag between the growth in Eurodollars and the price of Gold can be attributed to the gold sales programs by the Western Central Banks. Once those programs were suspended, and the Banks turned again into net buyers, the gold price rose dramatically.

The most recent Eurodollar operation of the Central Banks in relieving the Dollar short squeeze in euro is not yet in the totals.

It should also be noted that there are other correlations one can use in determining the gold price, most notable 'real interest rates.' However, there are linkages amongst all the variables, given a non-organic increase in the money supply and artificially low interest rates for example being among them.

So, when will the price of gold stop rising? Most likely when the Central Banks stop printing money, and return to transparently set market based interest rates and a productively reformed financial system.

'Not on the horizon' does come to mind.

I do not know if it will happen in gold or silver first, but the price management schemes that have been in place for a few decades now in the metals markets are reaching a tipping point.

To paraphrase what Kyle Bass recently said, 'There is $80 billion in open interest in gold futures and options, and there is $2.4 billion in deliverable gold at the exchange. The exchange is a fractional reserve system, and they plan for a one percent redemption. In the event of a greater demand for redemption, they assume that price will take care of it. The decision for a fiduciary is simple; take your billion in gold out now.'

And the situation in the silver market is even worse. It is a disaster waiting to happen.

At some point a 'black swan' event, or perhaps something the classical world would have simply called 'nemesis,' is going to knock the US futures market off its foundations.   The government and exchanges will seek to force a solution on market participants through the de facto seizure of positions and accounts, with a settlement dictated by the Banks.   MF Global looks like a dry run for that much larger default.

They will say once again that 'no one could see it coming.'  And the truth will fall into the same credibility trap that has swallowed all the other financial scandals, cover ups and bailouts since the S&L crisis.

"Why is surprise the permanent condition of the U.S. political and economic elite? In 2007-8, when the global financial system imploded, the cry that no one could have seen this coming was heard everywhere, despite the existence of numerous analyses showing that a crisis was unavoidable.

It is no surprise that one hears precisely the same response today regarding the current turmoil in the Middle East. The critical issue in both cases is the artificial suppression of volatility -- the ups and downs of life -- in the name of stability. It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability "tail risks" to disappear from policymakers' fields of observation...

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface.

Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained
systems become prone to “Black Swans” — that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.

Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems."

Nassim Taleb, The Black Swan of Cairo, Foreign Affairs

It is not yet clear when, or exactly how, but it seems inevitable that this scheme of the Anglo-American banking cartel will founder on the hard rocks of gold, silver, and the will of the people to be free, if they have but the mind to use it.