Monday, November 24, 2014

Germany’s Gold Delusion

WASHINGTON, DC – Germany’s gold is on the move. For the first time since official gold transactions became more transparent, the Bundesbank has given notice that a significant portion of its holdings will be transferred home from France and the United States. Ostensibly, this is just a matter of monetary housekeeping. But why now?

One possibility is that German policymakers believe that we are approaching an every-country-for-itself scenario – and only gold guarded by one’s own police is worth anything.

But this is more than far-fetched. The world in which financial trust breaks down completely between Germany and France or Germany and the US is one in which we have much bigger problems than where a country’s gold is located. International trade would collapse, and major global companies would struggle to sell their products. Having more gold at home, rather than in the vaults of the New York Fed, would be neither here nor there in such a situation.

Does Germany think that its gold will be subject to sanctions or some form of confiscation – as sometimes happens to rogue nations? Again, this is hardly plausible. Countries like Iran and Venezuela work long and hard to become international pariahs. Germany, by contrast, is a mainstay of the democratic world. That is not going to change.

Perhaps German central bankers sense a longer-term shift in international preferences away from the dollar and want to be ready in some fashion. This is plausible in terms of a future decline in the dollar’s importance as a reserve asset and safe haven. Reserve holdings of dollar assets (primarily by central banks) were worth around 2% of US GDP in 1948 and about the same in 1968. Today, such holdings are at least 15% of US GDP – with some estimates as high as 30%.

Much of this rise stems from growing prosperity and current-account surpluses in middle-income countries. When you sell more to the world than you buy, you accumulate claims on the rest of the world – and you need to decide the form in which you want to hold those claims.

At present, the world holds a lot of US dollar assets, and greater diversification of portfolios in coming years would not be shocking. There is certainly much discussion of the renminbi’s rising international role – an issue on which Arvind Subramanian, my colleague at the Peterson Institute for International Economics, continues to do the most interesting work.

But moving Germany’s gold is hardly helpful in this regard. What would help is to turn the euro around – in the sense of convincing investors that the common currency has a bright future, because it is underpinned by a stronger monetary, fiscal, financial, and political union. When seen in this light, the physical location of gold is purely a distraction.

It is as if German political elites think that they are back in the era of the gold standard. But, even back then, what mattered was the amount of gold you owned – not where it was actually stored.

The broader and more worrying trend is the politicization of central banking. Leading German political figures are becoming increasingly suspicious of the European Central Bank, while also worrying aloud about the US Federal Reserve’s monetary policy.

Their motivating fear is the prospect of inflation. But the real fear is not inflation itself – that is, that prices might rise at a surprisingly fast clip this year or next. Rather, the fear is that central banks will not see inflation coming until it is too late, and that this will cause a major upward shift in inflation expectations.

Again, moving gold does nothing to keep inflation under control or change the behavior of central banks. The link between currencies and gold was irrevocably broken in 1971, when US President Richard Nixon decided to suspend the convertibility of dollars into gold for central banks. We have lived in a purely fiat money system ever since – meaning that our money’s value is not backed by gold or any other physical item. Such monetary systems can succeed only as long as the central bank can credibly commit to keeping inflation under control.

German politicians would thus seem to be suffering from some serious delusions about the importance of gold and the effects of shifting its location. But they are right to worry about the ECB’s policies: Providing unconditional credit to eurozone governments is unlikely to make these governments more careful. There is a real danger that so-called “fiscal dominance” will undermine monetary policy and make it much harder to control inflation.

The German fascination with gold is a red herring. Its fear of wayward monetary policy is not.

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    1. CommentedAnonymous HopefulSkeptic

      Dear Dr. Johnson,
      I find you to be one of the best and most open-minded economists that exists in today's world. Your documentary on the fiscal crisis was one of a kind, and I think that anyone who wants to know what happened would be well-advised to watch it. I also am impressed with your projections of threats to the US Dollar and proposed solutions to protect its status in the world.
      In spite of all this, I respectfully disagree with you on the issue of gold repatriation to Germany. Gold repatriation is, so to speak, realpolitik. It is indeed Germany that is in charge of the European Union. Germany is the largest economy in the EU, and it possesses the greatest economic and political clout of any nation in the EU. Germany is repatriating its gold because it wishes to be in control of its assets. Consider the colossal failures of two European nations: Britain and Switzerland. Both nations lost billions of dollars by selling gold at its lowest points.
      Former Prime Minister Gordon Brown's ill-advised selling of the UK's gold cost the nation £9 billion.

      Michael Paprotta cost the Swiss $60 billion USD when he sold 1300 tons of the precious metal.

      "The broader and more worrying trend is the politicization of central banking."
      I must say that I find it rather ironic that an economist of your caliber is talking of politicization of central banking as if it represents anything other than the status quo (though it ought not be status quo). I'm not sure if you are aware or not, but the BIS (Bank for International Settlements, which was initially part of the World Bank Group) was the meeting place of central bankers around the world during World War II (WW2). Bankers around the world funded both sides of the war, even though their respective countries were at war with each other. What this demonstrates is that some central bankers were essentially financial mercenaries during WWII.

      While a global gold standard is ill-advised (because nations and central banks always overspend beyond their means) it is rather telling that the World Bank for International Settlements (BIS, from which "World" has been removed to hide its relation from the World Bank Group, i.e. the quasi-secret Global Central Bank that exists in Switzerland) once proposed a global gold standard.

      But this is only part of the story. Germany is the true master of Europe. It is a sad tale, but the other nations have given up their sovereignty so that they could join the economic and political union that is the EU. When citizens of nations voted against being part of the Union, as the Irish did, they were blackmailed with bankruptcy and forced to revote a year or two later. What kind of so-called union demands its citizens to reconsider their opinion on so grave a matter as being part of a political union?
      The other rarely considered question is why political unions almost always end in failure. The main reason is that the peoples under whom the unions are created are extremely diverse; they are diverse in ethnicity, religion, and culture. There was a Latin Monetary Union (France,, Belgium, Italy, Switzerland) that was supported by the US in Europe, which was founded in 1865 and failed in 1927.
      There is a little known history about how the European Coal and Steel Community was formed. Declassified documents show that the elite members of the Third Reich planned for a Fourth Reich before World War II had ended. The Fourth Reich was planned to become an economic empire. The document is real. All one has to do is take the number "

      I did an advanced google search for the Red House Report and came up
      with this link which shows that a FOIA request for Document EW-PA 128 did in fact occur (In google advanced search, I limited search resultsto pdf files only, to government websites only, and to the exact
      phrase, "EW-PA 128"), so the document is real:
      (see roughly page 26 ... use the find function (control + F) and type in EW-PA 128):

      The EU is very different from the US; the two cannot be glossed over as though the EU is the United States of Europe. The colonists banded together to fight outside oppression under a common cause; in Europe, more and more Europeans are growing ever more skeptical about being united under one government. Further, Belgium went without a formal government for 535 days.

    2. CommentedDennis Zelkowski

      Anyone who has investigated the gold market will easily see its coordination with western central banks to support fiat currencies along with the utter taboo of anyone who knows to speak about it. Paul Volcker at least once let it slip that the price of gold needed to be controlled. There is a long history of dishonesty with the public here. Questions have been raised for years now about whether the gold is actually in the vaults and the public is right to be suspicious. Furthermore the reasons originally given for Germany's gold to be kept in the US are no longer valid. From that perspective there is nothing wrong with Germany taking it's gold back so why make a mountain out a molehill? There is much more here than meets the eye and it is not being addressed by those who are in the know (and I am not saying that Simon is in the know).

    3. CommentedCarol Maczinsky

      Germans know that is is insignificant. Still it is outrageous to keep German Gold on the other side of the Atlantic. You cannot trust other jurisdictions with your property. We learned that with the SWIFT scandal and the euro crisis (where the creditor nations become scape goats).

    4. CommentedJANKO SVARC

      Mr. Johnson could be right when he says the actual location of anyone's gold is not important. I'm not about to ask him whether he has any gold or where he keeps it. It's not my gold, so it's not important to me. Personally, if I had a few thousands of tons of gold I'd be at least somewhat concerned regarding ITS location. You know I'd ask about it once in a while.

    5. CommentedShane Beck

      In a modern economy the true wealth is energy. In a pre-modern economy the true wealth is land. All the gold in the world is not going to do any good if the masses are rioting in the streets from overly high unemployment or food riots....

    6. CommentedProcyon Mukherjee

      In the chapter, “A brief history of economic dominance”, taken from the book Eclipse, Arvind Subramaniam has aptly pointed out citing the example of the Suez crisis that “whether irony or symmetry, the upshot of it all was that as an economically dominant net creditor, the UK, acquired the Suez Canal, and as an enfeebled net debtor she lost it”. The example of gold and its transfer by Germany is one such example of the mysterious ways the creditor country dominance unfolds unilaterally, much to the annoyance of the debtor countries; at least in this case it is for a benign denouement, that is defensive in nature.

    7. CommentedFrank O'Callaghan

      Are we entering the end game of fiat currency? What happens when there is a run on currency in general? The hard reality under all economies is that value is only what we ascribe or use. The true value of currency is an illusion that we have all agreed upon. There is a real danger in seeing through the illusion.