Germany’s gold rush to the head

Published in Business Spectator (Melbourne), 1 November 2012

How would you feel if you suddenly discovered that you were much wealthier than you thought? Well great, obviously. But after the initial amazement, your mind would turn to what you should to do with your unexpected riches. And that’s where things usually get complicated.

Germany has just experienced such a wealth surprise. Following revelations that about two thirds of the Bundesbank’s gold reserves are stored abroad, a public debate has begun about what to do with the country’s gold treasures. It’s no small fortune we are talking about but almost 3,400 tonnes of the precious yellow metal, worth roughly €144 billion.

The background to the story is rather quaint. For decades, dating back to the Cold War era, Germany had stored some of its central bank gold outside its borders. A little is held at the Banque de France in Paris (374 tonnes), a bit more is locked in the vaults of the Bank of England in London (450 tonnes), and a staggering 1,536 tonnes of German gold are decorating the cellars of the Federal Reserve in New York.

How the gold got there and why it remained there is the stuff for a doctoral thesis in economic history. To cut a long story short, part of Germany’s trade surplus under the old Bretton Woods system had been converted into central bank gold. To avoid the hassle of physically moving the gold from the trade deficit countries to Germany, and also for security concerns at a time of Soviet threat, it was agreed that the ownership of thousands of gold bars was simply transferred to the Germans. The gold itself, however, remained where it had always been: in Paris, London and New York.

All of this would be little more than historical curiosity had it not been for a report by the Federal Court of Auditors. Germany’s supreme bean counters recently admonished the Bundesbank for being too lax in its gold management.

Astonishingly, Germany’s accumulated foreign-stored gold has never been properly inspected and catalogued let alone checked for purity or quality. The Frankfurt based Bundesbankers were effectively relying on the word of their international colleagues. It may seem extraordinary, but the Bundesbank never felt it necessary to ensure that assets worth roundabout €100 billion actually existed.

If the original carelessness of the Bundesbank is bizarre, the debate about what to do about the reserves is even more remarkable. Federal MPs are now travelling the world to knock on the doors of central banks to see the German gold. With no success: guided tours are not usually offered at the world’s largest gold depots.

Even a grassroots campaign has started under the headline “Bring home our gold!” One can almost imagine how many Germans will soon be wearing yellow-golden ribbons for the good cause of repatriating their national treasure.

But beyond the rather tabloid excitement, there are some serious people who suddenly realised the wonderful things that could be done with €144 billion worth of gold. Or not.

Financial Times columnist Wolfgang Münchau scolded his fellow countrymen via his Spiegel online column for being overly excited about the foreign gold scandal. Considering that German GDP was roughly twenty times larger than all the Bundesbank’s gold, Münchau opined that we were really talking about “peanuts”. Compiling a proper gold inventory was just occupational therapy for underemployed central bankers but not an exercise in macroeconomic policy, he blustered. In any case, if 3,400 tonnes of gold are peanuts, one wonders where serious economic policy questions begin for Herr Münchau.

Gustav Horn, head of the Institute for Macroeconomics and Business Cycle Research, a trade union supported Keynesian think tank, was a bit more practical. Why not sell off the gold and fund some stimulus programs with the proceeds? Herr Horn argued that since the Bundesbank is no longer in charge of monetary policy (at least as long as the euro exists, one might add) there is no need for any gold holdings anyway. A sudden realisation that more than €140 billion could be instantly deployed on basically anything is obviously too great a temptation for any Keynesian economist to remain calm.

Wolfram Weimer, columnist of the business daily Handelsblatt, had a more creative proposal. Yes, sell the gold for all the reasons that Münchau and Horn had given. But then reinvest the money straight away. According to Weimer, holding gold is silly – not only because he suspects a giant gold bubble which may eventually pop. It is also dead capital because gold does not yield any interest.

So what’s the solution according to Weimer? Invest the proceeds in Italian, Spanish and Portuguese government bonds. This way, the Bundesbank may actually receive interest payments of around €10 billion a year! Instead of repatriating Germany’s gold, Germany would repatriate at least some of its bailout funds given to the European periphery.

So brilliant is this idea that it is surprising nobody else had thought of it. The only question is why sell just gold? If investing in periphery sovereign debt is such a great business, why not sell Germany’s other government assets in order to speculate around the Mediterranean?

Well, maybe because that’s the difference between gold and paper. If the eurozone collapses tomorrow, at least Germany could anchor its new currency based on its holdings of the second highest gold reserves (and the highest per capita gold reserves) in the world – no matter where they are stored. It might be somewhat more difficult to base a new Deutschmark on worthless Portuguese government bonds.

But only auditors and other bean counters would worry about such peanuts.

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