Who shot the sheriff?
It’s the end of the World Trade Organisation as we know it
And America feels fine
“Winter is coming,” warned a Norwegian representative on November 22nd, at a meeting of the World Trade Organisation (wto). The multilateral trading system that the wto has overseen since 1995 is about to freeze up.
On December 10th two of the judges on its appellate body, which hears appeals in trade disputes and authorises sanctions against rule-breakers, will retire—and an American block on new appointments means they will not be replaced. With just one judge remaining, it will no longer be able to hear new cases.
The wto underpins 96% of global trade. By one recent estimate, membership of the wto or General Agreement on Tariffs and Trade (gatt), its predecessor, has boosted trade among members by 171%. When iPhones move from China to America, or bottles of Scotch whisky from the European Union to India, it is the wto’s rules that keep tariff and non-tariff barriers low and give companies the certainty they need to plan and invest.
The system is supposed to be self-reinforcing. Mostly, countries follow the wto’s rules. But if one feels another has transgressed, then instead of starting a one-on-one trade spat it can file a formal dispute. If the wto’s ruling displeases either party, it can appeal. The appellate body’s judgments pack a punch.
If the loser fails to bring its trade rules into compliance, the winner can impose tariffs up to the amount the judges think the rule-breaking cost it. It is that punishment that deters rule breaking in the first place.
It is no surprise that President Donald Trump has axed these foreign arbiters, given his general distaste for internationally agreed rules. On November 12th he declared himself “very tentative” on the wto. But the problems run far deeper than dislike of multilateral institutions.
They stem from a breakdown in trust over the way international law should work, and the more general failure of the wto’s negotiating arm. Had the Americans felt that they could negotiate away their grievances, resentment towards the appellate body might not have built up. But with so many members reluctant to liberalise, including smaller countries fearful of opening up to China, that has been impossible.
America has had some wins at the wto: against the European Union for subsidies to Airbus, an aircraft-maker; and against China for its domestic subsidies; theft of intellectual property; controls on the export of rare earths, which are used to make mobile phones; and even its tariffs on American chicken feet.
But it has also been dragged before the appellate body repeatedly, in particular by countries objecting to its heavy-handed use of “trade remedies”: tariffs supposed to defend its producers from unfair imports. Time after time, it has lost. In such cases, it has generally sought to become compliant with the rules rather than buy the complainant off.
Though previous administrations had grumbled, and occasionally intervened in judges’ appointments, the Trump administration went further. Its officials complained that disputes often dragged on much longer than the supposed maximum of 90 days, and—more seriously—that the appellate body made rulings that went beyond what wto members had signed up to. They made it clear that unless such concerns were dealt with, no new judges would be confirmed.
Judicial overreach is in the eye of the beholder. Losers will always feel hard done by, and America has been quick to celebrate the wto’s rulings when it wins. But plenty of others think that the appellate body had overstepped its remit. A recent survey of individuals engaged with the wto, including national representatives, found that 58% agreed with that verdict.
Getting so many countries to sign up to the wto was a remarkable achievement. One way negotiators managed this was by leaving the rules vague, and papering over their differences with ambiguous language. Take “zeroing”, for example: using dubious mathematics to calculate defensive tariffs on unfairly traded imports. The Americans claim that the rules do not say they cannot do it. But others counter that the rules do not say they can. It is such long-running differences that have set the scene for the latest showdown.
Offer me solutions
The American trade lawyers happy to kill the appellate body see a fundamental difference between their attitude to international law, and that of Europeans. Their position is that only clear contractual terms can be enforced, and they see Europeans as more comfortable with resolving ambiguities by going beyond what is written.
Essentially, they regard the appellate body as too European. Moreover, in its eagerness to rule where terms are unclear, and in the American government’s willingness to change its laws in response, they feel an affront to America’s sovereignty.
Under the gatt, which lacked a proper enforcement system, ambiguities were hashed out in smoke-filled rooms. But the wto was supposed to make naked power politics over trade obsolete. Had it worked as intended, there would have been a balance between settling disputes and writing new rules.
Policy is best made with a vibrant judiciary interpreting the law, and a functioning legislative arm to fix any mistakes. Whenever the appellate body made decisions that annoyed members, they could have resolved their differences at the negotiating table. Perhaps America could have got others to agree to higher tariffs on imported steel, or been granted some flexibility in its defensive duties.
But the wto’s negotiating arm has been broken for years. With the current count of members at 164, it has become more inclusive, but is unable to get much agreed. Each member has a veto over any further multilateral trade liberalisation. And without new negotiations, resentment towards the appellate body has built up.
If you think this has a happy ending…
Had the multilateral system been more effective at dealing with the rise of China, perhaps the single biggest issue of its times, then calls to save it might be louder in Washington. Although various American administrations pursued and won several cases, the process was slow and occasionally frustrating.
America can justly claim that, when it tried to hold China to account for its breaches of trade rules, it got little support. America has been responsible for more than half of all complaints against China. And other wto members’ complaints were generally copycat, filed in America’s wake.
Now that the Trump administration has bypassed the wto and taken the fight straight to China, there is nothing remaining that it particularly wants from the wto. And so the chances that it will relent and allow nominations to the appellate body by December 10th are slim to none. In response to proposals from other members to change the body’s rules, an American representative said that they were not persuaded that the rules would be stuck to.
On November 26th the Trump administration suggested slashing the pay of members of the appellate body. In October Chuck Grassley and Ron Wyden, the top Republican and Democrat politicians on the Senate Finance Committee, published an editorial saying that while they saw the value of an appellate body, it “needs to operate as the members agreed”.
Of the wto’s 163 other members, 117 have signed a joint letter calling upon America to end the impasse. Although America has been the heaviest user of the dispute-settlement system, others will miss it too (see chart). Some have already begun preparing, for example by agreeing at the start of any disputes to forgo the right to appeal.
The eu, Canada and Norway have agreed on an interim arbitration mechanism that will use retired members of the appellate body as judges. And the eu is considering beefing up its own enforcement mechanism to fill the hole left by the appellate body, though it would probably cleave more closely to the outcomes of first-stage rulings in wto disputes.
But some members are likely to shun such alternatives—especially those that expect to be sued a lot. And it is unclear how robust they will be if disputes turn nasty. Some wto members may try to choose their dispute-settlement mechanism case by case. An organisation as ambitious as the wto, for all its faults, will be easier to break than replace.
All this means that global trade is about to become a lot less predictable and a lot more contentious. Without the appellate body to act as honest broker, disputes between the biggest members may escalate. Under the gatt America acted as global trade sheriff, launching investigations at will and bullying disputatious countries into submission. It is not impossible that it will resume this role.
On November 27th the Trump administration announced that it had nearly finished an investigation into a French tax on digital services, which America reckons discriminates against its tech giants. That could lead to tariffs.
You’ll miss it when it’s gone
In the 1980s American unilateralism was no fun for countries on the receiving end. But at least back then Uncle Sam could point to the lack of any other power even theoretically capable of doing the job.
Now the absence of independent referees is America’s own doing.
And of all Mr Trump’s trade policies, it may prove the hardest to reverse and have the longest-lasting effects.
by: Jan Nieuwenhuijs
Summary
- The IMF considers all financial assets to have counterparty risk, except gold.
- All central banks quoted agree gold preserves its purchasing power through time.
- Shortly after the Great Financial Crisis (GFC), central banks as a sector became net buyers; and Germany, the Netherlands, Austria, Hungary and Turkey, among others, repatriated gold.
Stating that gold is the ultimate store of value, that it preserves its purchasing power through time and is a global means of payment. Such statements, combined with actions that will be discussed below, reveal that more and more central banks are preparing for plan B.
The Bundesbank (the German central bank) published a book last year named Germany's Gold. In the introduction, written by the President of the Bundesbank Jens Weidmann, the view of this bank leaves no room for interpretation. Weidmann writes (emphasis mine):
Ask anyone in Germany what they associate with gold and, more often than not, they will say that it is synonymous with enduring value and economic prosperity.
Ask us at the Bundesbank what our gold holdings mean for us and we will tell you that, first and foremost, they make up a very large share of Germany's reserve assets ... [and they] are a major anchor underpinning confidence in the intrinsic value of the Bundesbank's balance sheet.
The Bundesbank produced this publication to give a detailed account, the first of its kind, of how gold has grown in importance over the course of history, first as medium of payment, later as the bedrock of stability for the international monetary system.
For Keynesians these comments might read like the Bundesbank (BuBa) is a "goldbug."
Its remarks, however, are simply common sense.
Gold has enduring value.
The world over it is associated with economic prosperity.
Its remarks, however, are simply common sense.
Gold has enduring value.
The world over it is associated with economic prosperity.
Every reserve currency in the world today is underpinned by vast gold reserves.
Otherwise, monetary authorities wouldn't trust holding the respective currencies, next to holding their own gold reserves.
Gold truly is the bedrock of stability for the international monetary system.
Otherwise, monetary authorities wouldn't trust holding the respective currencies, next to holding their own gold reserves.
Gold truly is the bedrock of stability for the international monetary system.
Central Banks and Exter's Pyramid
What springs to mind when reading Weidmann's statement is Exter's Inverse Pyramid.
John Exter was an American economist that in the 1960s conceived an upended pyramid of financial assets.
Underneath the pyramid is gold that forms the base of most reliable value; all asset classes within the pyramid on progressively higher levels involve more risk.
Exter would sometimes refer to his model as the debt pyramid; hence, he positioned gold outside of it as it's the only asset that has no liability against it.
Tellingly, when Exter addressed the Economic Society of South Africa in Johannesburg on November 16, 1966, he said (source):
Gold is the hard core of our international monetary system.
"Bedrock" (Weidmann) and "hard core" (Exter) are similar, and both point to gold's strength and what it can carry. An essential element of capitalism is investing - directly, indirectly, through bonds or equity - that involves risk.
The higher the risk, the higher the return. The lower the risk, the lower the return. What falls outside of the investment realm has zero risk and no return, but provides the base that carries the debt system. This safe haven is gold, the only asset refuge that has no counterparty risk.
In the Balance of Payments and International Investment Position Manual (BPM6) drafted by the International Monetary Fund (NYSE:IMF), we read:
Financial assets are economic assets that are financial instruments. Financial assets include financial claims and monetary gold held in the form of gold bullion … A financial claim is a financial instrument that has a counterpart liability. Gold bullion is not a claim and does not have a corresponding liability. It is treated as a financial asset, however, because of its special role as a means of financial exchange in international payments by monetary authorities and as a reserve asset held by monetary authorities.
The IMF considers all financial assets to have counterparty risk, except gold.
On page 112 of BPM6 the IMF lists all international reserve assets by descending order. Crowning the lineup is physical gold, followed by cash, debt securities, equity, and finally derivatives. Nearly an exact copy of Exter's Pyramid.
Another appearance of the pyramid can be found on the website of the Dutch central bank, De Nederlandsche Bank (NYSE:DNB). Since April 2019 DNB's gold information page reads:
A bar of gold always retains its value, crisis or no crisis. This creates a sense of security.
Shares, bonds and other securities are not without risk, and prices can go down. But a bar of gold retains its value, even in times of crisis. That is why central banks, including DNB, have traditionally held considerable amounts of gold.
Gold is the perfect piggy bank - it's the anchor of trust for the financial system. If the system collapses, the gold stock can serve as a basis to build it up again. Gold bolsters confidence in the stability of the central bank's balance sheet and creates a sense of security.
Exter's pyramid all over. Kindly note the similarity between DNB's and BuBa's comments on gold providing essential confidence in their balance sheets. It goes to show these two central banks have a long history of cooperating.
I tweeted about DNB's candid approach last April (a few months later, it went viral).
Let's continue with another quote, this time from the Bank of Finland (BOF):
Gold - The basis of a monetary system
Gold is called the eternal payment instrument and has been used as a medium of exchange for thousands of years. Gold is a genuinely global means of payment that has maintained its value throughout history.
One more, from the Banque de France (BDF):
Key facts
Gold is a highly sought-after precious metal, considered to be the ultimate store of value.
All central banks quoted agree gold preserves its purchasing power through time.
Preparing for Plan B
Next to strong statements by central banks, they're acting accordingly. Shortly after the Great Financial Crisis (NYSE:GFC), central banks as a sector became net buyers; and Germany, the Netherlands, Austria, Hungary and Turkey, among others, repatriated gold. Mainly from the Bank of England in London and the Federal Reserve Bank of New York.
According to BuBa, their repatriation scheme had three objectives: cost efficiency, security, and liquidity. Cost efficiency is about the storage costs in every location. Security involves the safety of the vaults and where those vaults are.
The current trend is to have a significant fraction of gold on home soil due to the geopolitical environment. Liquidity is about owning bars that adhere to prevailing industry standards and are located in liquid marketplaces such as London, i.e., to make payments in times of changes in the financial system. This latter aspect deserves special attention.
Storage locations Germany's official gold reserves.
As we've seen, Western monetary authorities mention gold to be, "the anchor of trust for the financial system," "the bedrock of stability for the international monetary system," and, "a genuinely global means of payment." They're also saying that "if the system collapses, the gold stock can serve as a basis to build it up again."
One wonders if these entities are preparing for a new type of international gold standard. They see it as one possible outcome, as in recent years, several central banks have upgraded their gold reserves to current gold industry standards, also referred to as London Good Delivery.
Throughout history, bars of different purities were traded in wholesale markets. By 1954, every new bar accepted in the London Bullion Market - the center of gold trade since the 18th century - was required to be at least 995 parts per thousand fine and weighing in between 350 and 430 fine troy ounces. Although not every old bar was promptly upgraded. Some remained as they were, in vaults in London and other places. These bars now trade at a discount, usually equal to the cost of upgrading and, if necessary, transporting them to London.
After the GFC, many central banks were holding bars that were cast before 1954, which are currently not liquid in wholesale markets. In response, the French, Swedish and German central bank, that I know of, have upgraded their gold reserves to solve this liquidity issue.
From the Banque de France:
Since 2009, the Banque de France has been engaged in an ambitious programme to upgrade the quality of its gold reserves. The target is to ensure that all its bars comply with LBMA [London Bullion Market Association] standards so that they can be traded on an international market.
From the Swedish Riksbank:
To ensure that the Riksbank has the most liquid gold reserve possible, in 2017 the Riksbank upgraded the part of its gold reserve that did not meet the LGD [London Good Delivery] standard by replacing these bars with new gold bars that do meet the standard.
I don't have a quote from BuBa itself on their upgrade operation. However, connecting a few dots uncovers when and how they did it. BuBa released a bar list in 2015 disclosing all their gold to be 995 fine or higher. In the book Germany's Gold, a bar is displayed on page 110 with the subscription:
In the course of the relocation [repatriating] of gold holdings in 2013 and 2014, this bar … was melted down from old bars stored at the Fed and newly manufactured. The remelting served to obtain a detailed picture of the fineness of bars which were produced by various refiners in different years. They are among the Bundesbank's newest gold bars.
While BuBa states this bar was melted for assaying purposes, in reality, it was part of making their entire stack at least 995 fine. One, because it doesn't require melting a whole bar for assay testing. Two, on November 11, 2017, the Financial Times published an article on how BuBa repatriated its gold. The article states:
more than 4,400 bars transferred from New York were taken to Switzerland, where two smelters remoulded the bullion into bars that meet London Good Delivery standards for ease of handling.
Just like that one bar wasn't melted to 'obtain a detailed picture of the fineness,' an additional 4,399 bars weren't melted 'for ease of handling.' They were all refined for one reason: to meet London Good Delivery criteria and make Germany's gold reserves wholly liquid.
Conclusion
According to John Exter, when the debt pyramid has grown in excess and becomes unstable, bubbles burst. Investors, seeking safety, will run down the ladder until they find solid ground (the bedrock).
This foundation is gold, which can't default or be arbitrarily devalued.
The GFC was caused by too much debt (a credit binge). When Lehman fell, and the house of cards came crumbling down, the quickest solution authorities could think of, ironically, was more debt. We went from "extend and pretend" to "delay and pray." Central bank intervention can be effective, for a while, until the underlying problem resurfaces with a vengeance. Presently the world is more in debt than before the GFC. The Institute of International Finance estimates global debt to GDP is now 320%.
When reading the mainstream media, one can be persuaded to think all central banks are willing to "print" money to infinity and lower interest rates as far as they can - or launch a variety of the same - pushing us further into the abyss. Some of them, though, aren't that ignorant and are actively preparing for when paper currencies are forced to be devalued by the weight of debt issued in said currencies.
There's one more development at a Western central bank I like to share. The Banque de France - whose vaults were a vibrant part of the global gold market during the classical gold standard - has not only upgraded its metal but also enhanced its entire vaulting infrastructure since the GFC. From BDF:
Since the 2008 financial crisis, there has been renewed interest in gold from reserve managers.
As well as upgrading its stock, the Banque de France is taking various other steps to ensure it meets LBMA criteria [these standards apply for trading across the globe] …
The renovation of the historical vaults housing the gold reserves has nearly been completed: the floor will be able to support heavy forklift trucks, and intermediary shelves have been inserted between the existing shelves to ensure the gold is only stacked five bars high, making handling easier. Other storage facilities will be available soon: either strong rooms for storing bare bars on shelves or large vaults to store sealed pallets, facilitate handling, transportation and auditing. By the end of the year, a new IT system will be in place to improve our ability to respond to market operation needs and other custody services.
So, after the GFC, not only have Western central banks changed the way they talk about gold - that is, they have become more honest regarding gold's function as a safe haven - but, as a sector, central banks have also become net buyers. Many central banks have redistributed their gold, carefully considering all possible future risks and developments. A few central banks have upgraded their gold to current industry standards to be able to trade frictionless in international markets. One central bank, BDF, has even enhanced its entire vaulting infrastructure. And this is just based upon publicly available information.
We're all too familiar with central banks in the East openly buying gold, stimulating citizens to buy gold, setting up new gold exchanges, and de-dollarizing. In the West, these subjects are more sensitive for political reasons. As a result, since the GFC, Western central banks gently started moving towards gold, not to cause any shocks in the market. In 2015, I called this "the slow development towards gold," and it's continuing still.
It's beyond the scope of this article to discuss every probable international monetary development and attribute a percentage chance to each of them. I think it's clear though, that many central banks are preparing for gold to play a resolving and pivotal role in future global finance. Why else buy, redistribute and upgrade gold, next to enhance trading facilities, increase transparency and then advertise gold's financial features? Keep in mind what Pericles said around 500 BC, "the key is not to predict the future but to prepare for it."
Currently, Exter's Pyramid has grown too big and is unstable. The moment the pyramid falls, "gold will do its job." History teaches us gold protects its owners through all types of weather, and central banks know this. Ever wondered why virtually every central bank owns gold? Because gold is physical. Immutable, yet divisible. Independent and without counterparty risk. It is the ultimate store of value-as it retains its purchasing power through time-and works as an eternal payment instrument.
