Germany is falling out of love with economic orthodoxy
Growing numbers of policymakers and voters back increased investment at home
Simon Tilford
Workers build the Stuttgart 21 railway project. Germany’s leading business lobby and trade union federation recently called for a €450bn public investment package © Thomas Kienzle/AFP/Getty
Many instinctively see Germany as a fairer, less market-driven economy than, say, the US or UK.
And they are partly right: the German state redistributes more than the British one, and far more than the US one. But Germany has also been the driving force behind the dominant economic orthodoxy in Europe over the past 20 years: balanced budgets, deep-seated scepticism about the role of the state in the economy and a strong focus on export competitiveness.
Is this now changing? And what could it mean for Germany and Europe as a whole?
Outsiders have long expressed frustration at the apparently strong consensus in Germany over economic policymaking. For the best part of 20 years, there has been little to separate the Christian Democrats and Social Democrats. For successive US governments, Germany has been seen as a significant cause of global imbalances through its unsustainably high export surplus. For many Europeans, Germany’s obsession with fiscal probity and trade competitiveness has hindered attempts to confront the challenges facing the eurozone.
The signs are now multiplying that change could be afoot, not least because the country’s economic prospects have worsened sharply. The global slowdown is hitting demand for German exports, while years of fiscal constraint have lowered economic potential; the country’s infrastructure and skills base urgently need upgrading.
Last week, Germany’s leading business lobby, the BDI, together with the trade union federation, issued a joint call for a €450bn public investment package. The hitherto robust orthodox consensus among the country’s Council of Economic Experts — an academic body that advises German policymakers — is crumbling.
And there is even a new readiness to acknowledge the risks of the country’s export dependence.
But the real reason that change could be in the offing is that Germans themselves appear to have had enough.
A large new poll of Germans’ attitudes to government and the economy commissioned by Forum for a New Economy threw up some striking results, suggesting that a large majority could support a much less “German” economic policy agenda. The survey revealed overwhelming support for more public spending, including a surprising degree of support for this to be financed through debt.
Four-fifths of those surveyed believe that business has too much influence over government policy; a similar proportion think privatisation has gone too far. Little more than a third believe that Germany’s social market economy is producing socially just outcomes, and 80 per cent want the state to provide greater protection to those affected by globalisation or technological change.
What this suggests is that Germany is far from immune to the problems we see in the US and UK, where large numbers of people have lost trust in those countries’ economic systems. In Germany’s case, this has led to a surge of support for the populist rightwing Alternative for Germany in struggling regions, contributing to the worsening crisis of the two main political parties.
At 15 per cent in the polls, the SPD appears to have little to lose, and there does indeed seem to be an increasing willingness within the party to question the orthodox consensus. The CDU has doggedly clung to its mantra of whatever is best for business is best for the economy as a whole, but now even influential figures close to the party are starting to entertain doubts.
But perhaps the determining factor will be what happens to the economy. Germany has formidable strengths but now faces mounting challenges.
The factors that underpinned its heavily export-dependent recovery from the financial crisis — strong growth in China, booming global demand for cars and investment goods German companies specialise in — has gone into reverse, helping to explain why industrial production is down 5 per cent in a year.
Output in the crucial automotive sector declined by 12 per cent in the first half of this year. All this is contributing to a growing sense that the country needs policies focused on boosting domestic consumption and investment.
Could this all be good news for Europe? Weak global trade and persistent trade tensions will emphasise the importance of a healthy European economy to Germany. This could persuade the country to end its opposition to reforms — such as more risk-sharing and a major common budget — needed to improve the eurozone’s economic performance.
Trying to discern a shift away from Germany’s economic orthodoxy can sometimes feel like waiting for Godot. But the country’s economic policy has undergone profound shifts before, such as the embrace almost 40 years ago of market liberalism and small-state ideology.
We could be on the cusp of another paradigm shift.
The writer is the co-founder of Forum for a New Economy. His co-author, Thomas Fricke, is the forum’s director
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.
