Why do the Germans want their gold back?

Much of the German gold is being held in New York, London and Paris. Now there is a campaign under way in Germany to bring the metal back home and it is gaining strength. Germany, the second largest national reserves in the world, controls 3.396 tons of gold.

By Matthew Lynn
Oct. 31, 2012, 2:00 a.m. EDT
Market Watch

LONDON (MarketWatch) — Where does Germany keep its gold reserves? It might sound like a silly question. In Germany, of course. Probably in a very deep vault somewhere in Frankfurt, surrounded by the best security systems that Teutonic technical brilliance can create.

As it turns out, however, that is the wrong answer.

Much of the German gold, the second largest national reserves in the world, is held in New York, London and Paris. Now there is a campaign under way in Germany to bring the metal back home — and it is gathering strength all the time.

That tells us three things about the global monetary system, none of them especially reassuring.

The German gold reserves are among the most significant in the world. The country controls 3,396 tons of the stuff. That is a lot less than the United States’ 8,133 tons, but then Germany is a smaller country, and it has never had the world’s reserve currency. It is a lot more than the 2,451 tons held by the Italians or the 2,435 tons held by the French.

Much of it was built up under the old Bretton Woods system that operated from the end of World War II until 1971. Trade deficits and surpluses were settled by central banks in gold, and since Germany regularly ran big surpluses it ended up with a lot of the metal.

But most of it was not held in Germany itself. Much of it was held abroad, mostly in the U.S., U.K. or France. An estimated 66% is held at the New York Federal Reserve, 21% at the Bank of England, and 8% at the Bank of France. The old West Germany was on the front line of the Cold War and if the Russians had ever invaded their tanks would have headed straight for the bullion vaults. There was no point in leaving such a tempting target open to attack.

With the Cold War a distant memory, many Germans want the gold returned to their own country. A campaign called ‘Bring Back Our Gold’ has gathered significant support. Politicians and the popular press have jumped on the bandwagon.

Earlier this month the German Court of Auditors demanded that the Bundesbank audit its official gold holdings, and called for the repatriation of 150 tons in the next three years so that its quality can be inspected. As anyone who has ever bought some gold jewelry in a market will know, there are all kinds of tricks that an unscrupulous dealer can get up to — all that glitters is not necessarily gold.

And while it takes a fairly fevered imagination to speculate that staff at the Federal Reserve or the Bank of England have been nipping down to the vaults and replacing the German gold with some ingots they picked up at a souk in Cairo, the hysteria around the issue is growing so intense an audit is now judged necessary.

The Bundesbank doesn’t usually give in to popular pressure – it is not that kind of institution — but last week it put out a statement attempting to reassure people the gold was safe and promising to check on the stocks held abroad.

The cargo planes are not quite being loaded yet. But within the next five years, it is a fair bet that some new vaults will be needed in Frankfurt and some space will be going spare in New York and London.

What does the campaign tell us about the state of the global economy? Three things.

One, this generation of Germans is far more assertive about their national interest than their parents were. For 50 years, most Germans were anxious to show they were citizens of the world. They dealt with post-war guilt by signing up for every international body available. Now they are quite happy to be citizens of Germany, and to stand up for their own interests.

Two, trust in financial institutions is dwindling all the time. Central banks built up a system of debits and credits because it was easier to move gold around on a ledger than to move it around on trucks. There are few more tempting targets for thieves, after all, than a cargo of ingots.

So it made sense for German gold to be stored elsewhere. But now people no longer trust those systems. They are increasingly unhappy with assets that are simply recorded on a bank’s balance sheet somewhere; they want something physical they can see and touch. That is true of national gold reserves, but it is increasingly true of other assets as well.

Thirdly, and most importantly, German sentiment is hardening against the single currency with each month that passes. After all, what is a whole vault full of gold in the basement of your central bank good for exactly? Starting a new currency, of course. And, er ... that’s about it.

There’s nothing else you can do with it. In the most extreme circumstances, if the euro broke down chaotically, and national currencies were bought back overnight, one of the key things the foreign exchange markets would look at when putting a value on the new deutschemarks, lire or francs would be the amount of gold the central bank could back it with. That gold would seem a lot more valuable if it was held in your own country rather than a foreign one.

The campaign to bring back the German gold is in reality a campaign to bring back money that people can trust. The political establishment might not have caught up yet. But popular opinion believes it was sold a dog when it joined the euro EURUSD -0.14% , and is already looking forward to the day when it escapes responsibility for endless bailouts of its neighbors.

Yet it is hardly confined to Germany. Distrust of central banks rigging the monetary system is spreading from country to country. There will be many staging posts in the long road back to some form of gold-backed money — and the German campaign is just the beginning.

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