Germany is Prepared for a Return to the Gold Standard

Observers and speculators have been confounded by the strength of the Euro; despite the ongoing European Sovereign Debt Crisis. ECB purchases of sovereign debt have been equated with monetization; and put forward as another reason for a weakening Euro, that has so far failed to materialize. The Euro was created in the image of the Deutsche Mark; and the ECB in the image of the Bundesbank. It is here that observers should be looking for the reasons that the Euro remains so strong.

On October 24th 2012, evidence appeared in the public domain that Germany had prepared for the eventual challenge to the Euro's existence as a reserve currency at its inception. It was revealed that the Bundesbank had recalled two thirds of its Gold Reserves from the Bank of England when the Euro was created. More recently, it was revealed that the Bundesbank was requesting an audit of its remaining Gold Reserves; to establish their quality and security. Observers speculated that the Bundesbank was concerned that there was counter-party risk in the Gold Loans being undertaken with its Gold by the Fed and the Bank of England. What was interesting to observe was that the news of the German Gold repatriation and this audit were instigated after the Fed embarked on its latest phase of Unlimited Quantitative Easing.

Taken together, in the context of the current programme of Quantitative Easing, the Bundesbank's moves signal a critical point has been reached in the global financial system. What was surprising, was the market reaction to the Bundesbank's news. Gold was already selling off; and accelerated its decline on the revelations from the Bundesbank. Logic would dictate that such news should create the opposite reaction.

A possible explanation for the behaviour of the markets is that the liquidity for Quantitative Easing comes from the creation of US Dollars using Gold as collateral. Gold is therefore sold short by the Bullion Banks; they then cover this short by borrowing from central banks such as the Fed. As a consequence, US Dollar credit is created by the Bullion Banks from the proceeds of their short sales of Gold. Each phase of Quantitative Easing since the 2008 Crash has been attended by this initial fall in the Gold Price, that has then turned into a sustained rally for the metal.

The fall in the Gold Price, after the Fed announced Unlimited Quantitative Easing, is nothing more than the Bullion Banks shorting Gold and creating new US Dollar credit. On this occasion however, the Bundesbank has been quick to announce that it is not associated with this process; and is keeping its Gold off the market. Clearly the Bundesbank feels that this next wave of credit creation is going to challenge the global financial system; by creating a race to the bottom to devalue against Gold. It has therefore positioned itself and the Euro which it backs, as a hard safe haven currency in a world of falling safe havens.

The Bundesbank has also positioned Germany for any potential break up of the Eurozone. Those who have opined that nobody was thinking about a break up of the Eurozone, when the rules were set up, should think again. German past experience with failed currencies caused it to prepare in advance for the conditions that we are seeing today. Social chaos and the collapse of global currencies is something that Germany has tried to prepare the Euro for in advance.