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What if the Fed is short Germany’s gold?

Gijsbert Groenewegen
Jan 29, 2013

Why are central banks buying gold, the opposite of their own creation, paper money?

Money is the opposite of gold and silver. Fiat money is based on ordinance and credibility and is not self-limiting (can be printed infinitely) whilst gold and silver is commodity based and physically limited to the amount of physical gold and silver available and mined, you choose either one or the other. One is purely based on credibility hence why notes need to mention the nominal value in order to give the piece of paper value. American paper money is backed by only the size and strength of the American economy. The other money is based on real value, the value of the gold itself. And especially for that reason investors should be warned considering the fact that more and more central banks are buying gold, the opposite of their own creation: paper money. This is so contrarian. It is like the butcher who doesn’t want to eat his own sausages because he knows what is in it. Why would central banks buy gold, which “limits” their creation of credit? The answer is: the fear of lost credibility of paper money, because of the constant undermining, dilution, debasement of their currencies with quantitative easing measures not sorting the desired effect of sustained economic growth because we have passed the tipping point whereby the overwhelming debt levels (Debt/GDP > 77-90%) have started to depress economic growth.

Central banks have been buying gold since 2008!

In this context it is interesting that the world's central banks have been net buyers of gold since 2008. In 2011, global central banks continued to be net buyers of gold as they attempted to “diversify” from their dollar and euro holdings, rebalance reserves, and protect national wealth. Why, if gold has no monetary function any longer, why buy gold? Why buy the opposite of the US dollar, the anchor of the financial systemden="false" UnhideWhenUsed="false" Name="Medium Grid 2 Accent 6"/> Total world production is around 2,700 tonnes, in other words central banks are purchasing about 20% of the world’s gold production!

A growing number of emerging countries have also increased their purchases of gold in recent years to bolster their rapidly growing currency reserves, as sovereign debt crises have weighed on traditional reserve currencies such as the U.S. dollar and the Euro. Nations from Brazil to Iraq to Russia are buying the precious metal to add to official reserves. National Bank of Ukraine (NBU) said in late December it raised the percentage of gold in its reserves in 2012 to 7.72% from 4.36% a year ago. The bank said it is boosting its gold reserves “to avoid the negative impact of the global crisis on the economic development of the country as it works on diversifying the components of international reserves in Ukraine.” Brazil doubled its gold holdings in two months last year, buying 17.2 metric tons in October and 14.7 metric tons in November. According to data released late last month by the International Monetary Fund, Iraq bought gold during August-September, lifting its official precious metals reserves from 5.8 metric tons to 31.07 metric tons. The worldwide stimulus measures and ultra low interest rates will continue to support investor interest in gold in the absence of low-risk investments that can offer acceptable yields. The conclusion is that the central banks have been a major force behind the increase in the gold price. The gold price rose more than threefold between 2007 and late 2011 -- from around $600/oz to a peak of $1,895/oz. The most important question is why all these banks buy gold, the opposite of their own creation: paper money?

The “objective” of the Washington Agreement was “reversed”.

The irony is that the central banks created the so-called Washington Agreement in 1999 in order to ensure an orderly disposal of their gold inventories. The agreement came in response to concerns in the gold market after the United Kingdom treasury sold the UK gold reserves through Bank of England auctions starting in 1999, coupled with the prospect of significant sales by the Swiss National Bank and the possibility of on-going sales by Austria and the Netherlands, plus proposals of sales by the IMF. Under the agreement, the European Central Bank (ECB), the 11 national central banks of nations then participating in the new European currency, plus those of Sweden, Switzerland and the United Kingdom, agreed that “gold should remain an important element of global monetary reserves” and limited their sales to no more than 400 tonnes (12.9 million oz) annually over the five years from September 1999 to September 2004, being 2,000 tonnes (64.5 million oz) in all. These agreements were extended every five years with varying quota ranging from 2,000 to 2,500 tonnes. As above mentioned its purpose was to deal in a controlled way with the fear that central banks had abandoned gold as a reserve asset, and were planning to sell all that they had in their vaults. Well that fear has clearly been reversed since 2008 when they started buying gold instead of selling it!

Many central banks store part of their gold reserves at the NY Fed

Many central banks besides the Bundesbank store their gold at the vaults of the Fed of NY and the BOE and this should make people think. Why would a country, when there is no geopolitical threat, keep an important part of it wealth in foreign hands. According to a recent report The Bank of Mexico holds less than 5% of it’s gold reserves within Mexico, while the remaining 95% of it’s ‘physical’ gold reserves are held in the US and London (translation - nearly the entirety of Mexico’s gold reserves are held at the Bank of England and the NY Fed basement, and have likely been leased more times than MFG client’s assets).

The Austrian central bank keeps most of its 280 metric tons of gold reserves in the United Kingdom, Vice Governor Wolfgang Duchatczek was quoted as saying in the finance committee of the country’s parliament, according to Bloomberg.

According to Former Dutch central bank governor Nout Wellink, the Netherlands now holds 612 metric tons of gold and has no plans to sell. The Dutch gold reserves are vaulted in New York, Ottawa, London, and Amsterdam. The Dutch central bank declared that it has no plans to physically inspect its gold reserves held in other countries, despite recent demands of the German Bundesrechnungshof to do so with respect to the German gold reserves. Finance Minister Jeroen Dijsselbloem cited yearly accounting procedures and his trust in foreign central banks where Dutch gold is stored, in a letter to parliament published in December 2012. Dijsselbloem said that 51% of Dutch gold reserves are in New York, 20% per cent in Ottawa, 18% in London and 11% in Amsterdam.

But what do you really have if you don’t have real possession of the country’s gold reserves, why hold the reserves in foreign vaults, why give foreign powers “possession” over “real money” that belongs to the Dutch people. We all know that trade surpluses and the Cold War and fear of a Russian invasion were the main reasons to keep most of the gold reserves with the New York Fed. Though that situation doesn’t exist any longer and therefore the question begs why keep a large part of the Dutch gold reserves in the NY Fed vaults? What ensues if the markets and the financial system or credit system collapse? What happens then to the Dutch gold in foreign central vaults? Who can one trust if all the trust and credibility in the financial system is completely erased? I can’t emphasize enough; paper obligation or no possession of a physical asset represents counter party risk. Counter party risk is the risk to each party of a contract that the counterparty will not live up to its contractual obligations. When the proverbial *&%$#@ hits the fan will the gold still be in the vaults or will there be only an IOU and a letter stating, “I am sorry.”

Why did the Dutch central bank order a pension fund to reduce its gold holdings?

In the context of the “relaxed” stance of the Dutch vis a vis the Dutch gold being stored in foreign vaults the following case is the more remarkable. In February 2011 a Netherlands-based $400 million pension fund for workers at several Dutch glassmaking plants was ordered to significantly reduce its gold allocation, from 13% to 3%, by De Nederlandse Bank (DNB), the Dutch central bank and also the Dutch pensions regulator, which ruled the scheme's exposure to the precious metal as too risky. How risky can it be to hold gold when the gold price has risen from $255/oz in 2001 to $1,700/oz today as a result of the debasement of the currencies and fall in purchasing power? Spurred by concerns over inflation and the stability of the euro, the pension fund began purchasing gold in July 2008. "We invest in members' interests, and have benefited from the appreciation in the gold price. Especially in uncertain economic times, it proved a refuge, we trust in gold as an investment." Since then, the price of gold has increased substantially from $600 per ounce. The pension fund had wanted to maintain its gold allocation. Yet a Rotterdam court sided with the Dutch central bank. The regulator argued that the average fund has just 2.7% in commodities, including gold.

The DNB expressed concerns that the pension's solvency ratio could be hurt if the price of gold were to suddenly drop now. The DNB claimed that investment of such amounts in gold is too risky; the price of gold fluctuates too much for it to be classified as an investment and that it does not share the risk analysis of the pension fund! And that wouldn’t be the case with other investment classes!? I think the DNB should first check the volatility and performance of other asset classes before it makes a statement as stated. In fact gold has a lower volatility than many other asset classes. However, the scheme says the gold was kept as a security against the instability of the Euro and there is only one obligation the scheme has to consider; to pay members upon retirement. How are pension funds going to meet actuarial interest rates of between 7-8% when worldwide interest rates are sub par because of massive stimulus measures? It had no risky investments such as equity and holds gold as a back up against the dangers of a turbulent Euro market and rising inflation. The argumentation of the pension fund couldn’t have been more spot on and the reasoning of the DNB couldn’t be more wrong see an article by Blackrock’s iShares.

Gold reduces the risk and volatility of a portfolio

iShares by Blackrock: How does gold impact your portfolio?

Many investors today already diversify their portfolios across style, sectors and geographies. By including new asset classes that have low historical correlation to asset classes that are currently in their portfolio, investors can help further reduce portfolio volatility. Gold has historically shown little to no correlation to major asset classes, including commodities. And while the price of gold is volatile, gold has historically displayed lower volatility than major asset classes over both long and short time periods. As a result, a small allocation to gold may help improve the risk/return trade-off of investment portfolios. The following chart illustrates the historical effect of adding small amounts of gold to a diversified portfolio. As you can see, allocating 5% of the portfolio to gold improved the risk/return relationship of the portfolio primarily by reducing risk. You can see the effect of adding 10% or 20% as well.

Portfolio Risk v. Return as of 12/31/12

A higher court sided with the pension fund. Why would central banks be allowed to buy gold and not pension funds?

A decision of a higher court of March 2012 says the Dutch Central Bank (DNB) was wrong to force SPVG, a Dutch pension fund, to sell off its gold, and has to compensate the company for its loss. The court’s ruling said that DNB didn’t convince the court why the 13% allocation wasn’t adhering to the prudent person rule but the 3% allocation was.

The DNB clearly didn’t do his homework and clearly didn’t know what it was talking about stating that gold was not a safe, prudent and non-volatile investment, or did it? So what was the real argumentation behind the decision of the DNB? I strongly believe that the only way to safeguard pensions can only be achieved by having gold and silver investments against the ongoing debasement of the currencies and monetary systems. The central bank directly ordered the fund how to allocate its gold assets, because it explicitly disagreed with the fund’s statement that gold is money. Then why are central banks buying “gold, a commodity” instead of money!? And if central banks can add gold reserves who is the DNB then to tell the pension fund to sell most of its gold position? The DNB was clearly trying to demonetize gold using nonsense arguments. It is clear to me that paper money is losing its luster and that gold is gaining credibility as the ultimate currency. You just have to ask yourself if you could choose what you would prefer these days, $100m in paper US dollars or $100m in physical gold?

Contrary to the Dutch the Germans wanted to audit their gold reserves held abroad!

Although the Dutch central bank apparently still has much confidence and trust in the accuracy and trustworthiness of the foreign monetary authorities the Germans are getting cold feet having more than $183bn of their reserves in foreign hands. By the way, wouldn’t you under the current economic, financial and geopolitical circumstances? Germany withdrew two thirds of its vast holdings of gold from the Bank of England vaults shortly after the launch of the euro more than a decade ago according to a confidential report by German auditors. The revelation came, as Germany's budget watchdog the Bundesrechnungshof demanded an on-site probe of the country's remaining gold reserves in London, Paris, and New York to verify whether the metal is really present (When was the last time the gold inventories of Fort Knox or the NY Fed were audited!?).

Cold war fears and settling trade surpluses were the main reason for vaulting the gold with the NY Fed.

As with other country’s gold reserves nearly all of the German gold was shifted to vaults abroad during the Cold War in case of a Soviet attack and next to that trade surpluses were settled by increasing the gold reserves. German reserves peaked in 1968 at about 4,000 tons, several years before the collapse of the so-called Bretton Woods system of fixed international exchange rates, which was underpinned by gold reserves. The end of Bretton Woods in 1973 eliminated some, though not all, of gold’s importance as a universal currency. The total gold reserves have fallen to about 3,400 tons after Germany transferred some of its treasure to international institutions in which it participates, including the European Central Bank and the International Monetary Fund!! You have to wonder why gold was transferred to these monetary institutions if gold supposingly doesn’t have any monetary function any longer. A dispute has broken out between different German institutions over whether the central bank needs to check on its gold, or if Germany can trust its international partners.

The country has 3,396 tons of gold worth €138bn (109,183,935 ozs x €1,260/oz) or $183bn (109,183,935 x $1,680/oz), the world's second largest holding after the US. Roughly 66% ($122bn) is held at the New York Federal Reserve, 21% ($39bn) at the Bank of England, and 8% ($15bn) at the Bank of France. Germany's federal audit office, the Bundesrechnungshof, which monitors the German government's financial management, told legislators in a redacted report that the gold had "never been verified physically" and ordered the Bundesbank to secure access to the storage sites.

Paper assurances are different from actual/tangible audits

For the German gold that is stored on the Bundesbank's behalf by the US Federal Reserve in New York, the Bank of England in London and the Banque de France in France, the German central bank, the Bundesbank, “relies on the assurances” of its foreign counterparts that the gold is where it should be. The three foreign central banks give the Bundesbank annual “statements” confirming the size of the reserves, and the Germans do not usually carry out physical inspections of the bars. Though be aware this is about a situation of “paper versus physical!” Of statements versus possession of the physical gold that is accounted for.

The Bundesrechnungshof recommended in its confidential annual audit of the Bundesbank for 2011 that the Germany's central bank check its foreign gold reserves with yearly spot checks. The Bundesbank originally rejected the demand, arguing that central banks do not usually check each other’s reserves. "The scope of the checks that the Bundesrechnungshof wants does not correspond to the usual practices among central banks," the Bundesbank said in a statement quoted by the Frankfurter Allgemeine Zeitung newspaper. "There are no doubts about the integrity and the reputation of these foreign depositories." One has to wonder if the Bundesbank is naïve or if all the central banks are in cahoots! Who is the Bundesbank protecting? If all the gold is there why not allow for a physical inspection and audit. Under many legal systems there is a difference between having an ownership in a pool of gold and owning specifically allocated gold bars. Hence therefore the importance of having your gold allocated specifically to the owner or even better have it in your physical possession and thus the request of the Bundesrechnungshof.

The whole issue got so much attention that now even the finance committee of the German parliament, the Bundestag, has gotten involved being skeptical if the gold reserves are all there. In times of uncertainty about the future of Europe's common currency, gold is a hot topic, and some Germans take a dim view of the fact that much of the country's gold -- which as above mentioned theoretically belongs to the people -- is held abroad.

What if the gold is not allocated and/or the NY Fed is seriously short?

Philipp Missfelder, a member of the conservative Christian Democratic Union (CDU), traveled recently to New York in person to inspect the holdings, according to the newspaper Frankfurter Rundschau. His trip was apparently unsuccessful, because when he visited the Fed's safes in New York, the staff was either unable or unwilling to show him exactly, see remarks above about the specific allocation of the gold bars, which bars belonged to Germany. If the gold bars are not specifically numbered and allocated they can also have been shown to another central bank as being their gold. That would mean that the NY Fed would be short gold. Peter Gauweiler, a Bundestag member with the CDU's Bavarian sister party, the Christian Social Union (CSU), doubts that the Bundesbank would have immediate access to all its gold if necessary, suggesting that part of the gold may have even been lent out -- a claim that the Bundesbank rejects. As we know in the past central banks were leasing out (basically shorting) their gold reserves. The theory is that the central banks that were leasing their gold were caught out when the gold started its steadily climb from $255/oz in 2001 to the current levels today and as a result are now heavily short gold. This would be a very significant blow to the credibility of the monetary authorities especially with the ongoing debasement of the currencies.

History shows that the Germans don’t want to sell their gold.

Now the issue has been highlighted some Germans argued that the gold reserves should be brought back to Germany. The initiative alleged that there is an "acute" danger that the German gold could be expropriated as a result of the financial and debt crisis. They argued that the German government could soon be forced to sell gold to cover the costs of the crisis. But the Bundesbank originally wanted to leave the gold where it is. Observers pointed out that apart from the high cost of transporting the gold back to Frankfurt, the symbolic effect of Germany repatriating its gold reserves might unsettle the nervous financial markets, which could see it as a sign of an impending collapse of the euro. Next to that the Bundesbank argued that it still made sense to store some gold in major financial centers so that it could be sold quickly if necessary. Why would the Bundesbank want to sell gold considering their experience with the “Weimar Republic”? This doesn’t make sense at all. Especially considering the fact that despite the public criticism, the Bundesbank has not let go of its gold easily. It has continually rejected periodic attempts by political leaders to convert the reserves to cash and has not sold any gold on world markets!

Next to that, as pointed out in the German newspapers, we know many central banks leased out their gold because gold was replaced by paper money and was believed not to have a monetary function any longer. Gold was considered the opposite of money, the US dollar. What if most of the gold is leased out and third parties have a claim on the countries gold inventories because centrals banks wanted to force the validity of fiat money and tried to demonetize gold as the world currency.

The Bundesbank capitulates though why by 2020 and not by 2014? 7 years is a long time.

Following all the commotion the German central bank now intends to make a big withdrawal from the NY Fed - 300 tons in all. The new policy will include the complete withdrawal of 374 tons of German gold stored at the Banque de France in Paris, about 11% of the total. Bundesbank officials were quick to note that the decision was not a reflection of French trustworthiness. Rather, because France and Germany now share the euro, there is no need for reserves as insurance against currency crises. The goal is to house more than 50% of German gold in Bundesbank vaults in Frankfurt by 2020, up from a little less than a third today, the bank said. It remains the one currency that is accepted everywhere. In the event of a currency crisis, the gold could be quickly deployed in financial markets to help restore confidence. But as mentioned why are the reserves moved by 2020, that is seven years from today, a lot can happen in 7 years?

How much trust is there between central banks?

One has to wonder!!!! As Bill Gross of Pimco also stated, how much trust is there between Central Banks! In the end every country has its own interest. As General De Gaulle said, “a country doesn’t have friends it has interests”.

Gold and silver are the opposite of the US dollar.

The commotion surrounding the gold reserves has to be viewed in the light of the dynamic between the US dollar and gold. Real money with intrinsic value, with a true value of its own, it is commodity backed, such as physical gold and silver, is rapidly gaining popularity. The transformation between the two systems from intangible money to tangible money is clearly underway hence the stratospheric rise of the gold price since 2001! Precious metals can’t be manipulated contrary to paper money.

It is the constant manipulation of paper money, because it can easily, at will, be reproduced or printed, that undermines the credibility and value of the fiat currency whilst at the same time boosting the attractiveness and value of gold and silver. The US dollar is inversely correlated to the gold and silver price. In general under normal economic circumstances if the dollar is weak gold is strong and visa versa. Other currencies, not being the US dollar, of course first need to be exchanged into US dollars before they can be exchanged for gold. Gold and silver, as all other commodities, are expressed, valued in US dollars, the reserve currency. Gold and silver are thus the opposite of paper money and specifically the opposite of the US dollar. So if central banks prefer buying gold instead of the US dollar they are in fact buying the opposite of their own creation of paper money and the opposite of the world currency. Paper money has its nominal value printed on it to give it its value whilst gold doesn’t have a nominal value printed on it because it doesn’t need it, it has inherent value, in other words it has value of its own! That says it all. We would like to emphasize again it is like the butcher that doesn’t eat his own sausages because he knows what is in it. It therefore is so interesting that several Central Banks (Russia, Brazil and several Asian countries) are adding to their gold reserves. What does that tell you about their belief in the fiat money system and the anchor of that system: the US dollar?

The US authorities can’t buy gold because it would void the US dollar, the anchor of the financial system.

It is important to understand that having the reserve currency also “doesn’t allow” the Treasury to buy gold. Gold is expressed in US dollars, the reserve currency or world currency, the crux of the financial system, and if the US would buy gold adding it to its reserves it would basically mean that it has lost its confidence and trust in its own creation: the US dollar and thus the whole financial system. The US dollar is the anchor of the financial system. Gold is the opposite of the US dollar, hence its inverse correlation. Moreover if you have the ability to print the reserve currency and buy all the gold, the only real currency with intrinsic value, sellers of gold would soon not accept the US dollar in return for gold. Why sell something that has real, intrinsic value for something that is worthless, paper, even if $2,000, $10,000, $100,000 or more is printed on the paper. In my point of view it is very important to understand this dynamic of paper currencies versus gold. Especially when the financial system is undermining itself with stimulus measures that don’t sort the desired effect. Remember the moment people won’t sell their gold anymore for currencies/paper the currencies will have lost their value.

Conclusion: The repatriation of gold reserves shows the vulnerability of the US dollar and the financial system and more specific the credibility of the paper money system.

In simple terms, the repatriation could be explained as that Germany doesn’t trust the US Fed.

2020 is when they will transport back the gold to Germany! Why then? Only one reason in my point of view, the fed doesn't have all the gold. What is there against taking delivery now? Especially in the context of the Weimar Republic experience with the Germans very wary of inflation so repatriation by 2020 doesn't make sense! That is seven year from today and as already mentioned a lot can happen in seven years.

Considering the demonetization of gold that has been going on for many years leasing/shorting the gold, it can’t be excluded that the Fed NY is short other country’s gold. This would mean that the NY Fed or US Treasury would have to buy gold which would support and/or drive up the price of gold.

Though theoretically the fed can't buy any gold because it would mean it abolishes the trust, the credibility it has in the reserve currency, the US dollar. If the Treasury or NY Fed would buy gold and if this gets into the open it would mean a major break of confidence in the US dollar! As I said I don't believe the fed/treasury can buy gold for this reason. That is different for other central banks because they are anchored through the US dollar, “the spill of the financial system” and need to exchange their currency into the US dollar before they can buy gold. In other words either the fed buys gold secretly through other central banks or does it secretly in a different way!!!!

Remember, the only thing holding the financial system together is belief in the Central Banks. If the Central Banks stop trusting one another or grow openly antagonistic, then things could turn ugly very quickly. This could force the monetary authorities to confiscate gold! Therefore physical silver, a precious metal and a proxy of gold and “the penicillin of the future” because bacteria can’t build up resilience against silver, is my preferred choice.


Gijsbert Groenewegen

Groenewegen Report

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