The recently publicized move by the German central bank to bring its gold home is sending a major message about trust in the United States.
The bank holds 45% of its 3,396 tons of gold in the vaults of the Federal Reserve Bank in New York, and wants to reduce those holdings to 37%. It also plans to take back all of its 11% of holdings currently stored at the Banque de France in Paris.
The immediate reaction to the German central bank's decision to repatriate some of its gold was to assert that the Bundesbank no longer trusted overseas central banks to look after their gold.
The German Federal Court of Auditors (Bundesrechnungshof) has ordered the Bundesbank to audit its gold reserves "because stocks have never been checked for authenticity and weight."
Prior to that, the Bundesbank had simply relied upon written certification from the central banks where its offshore gold is stored that the correct amount of gold is actually in the vaults and is of the appropriate fineness.
What's more, samples of gold from the Fed and the Banque de France will be melted down and tested for fineness or quality.
Suppose Germany's gold isn't all it is supposed to be?
The "full faith and credit" of the United States would certainly be called into question.
The U.S. and Gold: Nasty Rumors
There have been persistent rumors that tests of gold bars from the Fed in New York have not been up to "good delivery' standards, meaning that they were short on weight and were not of appropriate fineness for central bank reserve gold.
Zero Hedge blog highlights a May 31, 1968 memo from the Bank of England to the New York Fed pointing out the poor quality of gold bars from the U.S. Assay Office.
Johnson Matthey, a British gold refiner working for the Bank of England put 172 "bad delivery" gold bars from the U.S. Assay Office into "good delivery" for the account of the Bundesbank.
What's more, Matthey complained verbally to the Bank of England that "over a long period of years they had had experience of unsatisfactory U.S. assays."
"No indication should, of course, be given to the Bundesbank, or any other central bank holder of U.S. bars, as to the refiner's views on them," the memo continued."…We should draw the attention of the Federal [Reserve] to the discrepancy in this (and any similar subsequent such) result and add simply that the refiners have made no formal comment but have indicated that, although very small differences in assay are not uncommon, their experience with U.S. Assay Office bars has not been satisfactory."
If Germany now finds something it's not happy with among its gold reserves, this would be a huge blow to the entire global banking system.
What Would Happen Without Central Bank Trust
Within a national banking system, the central bank is the lender of last resort when banks do not trust each other's credit. This is exactly what happened during the financial crisis of 2008.
Banks would not lend to each other after the collapse of Lehman Brothers so the Fed stepped in to ensure that banks could get enough liquidity to meet their obligations.
But, if central banks no longer accept each other's credit, there is no institution that can step in as the lender of last resort to the central banks. That could trigger a complete collapse of the global financial system as the validity of all fiat currency would be called into question.
So far, reaction to the Bundesbank's decision to move some of its gold back to Germany has been muted. The German central bank has been careful to assert that it does not imply a lack of faith in its U.S. and French central bank partners.
But if it did turn into a breakdown of central bank trust, what would that mean for the price of gold?
How Gold Prices Would React
We do have one example of the complete collapse of a currency in the fate of the Reich mark in Weimar Germany in 1922 and 1923.
In January 1919, an ounce of gold cost 170 marks. By January 1923 it took 372,447 marks to buy that same ounce of gold.
On November 30, 1923, just before the Reich mark was replaced with a new currency, the Renten mark, an ounce of gold cost 87 billion marks!
Bottom line: Keep an eye on gold prices.
Related Articles and News:
- Money Morning:
Your 2013 Guide to Investing in Gold
- Money Morning:
Gold Prices: Don't Let Faber Scare You
Charles de Gaulle Takes Back French Gold 1965 (Video)
- Zero Hedge:
Exclusive: Bank Of England To The Fed: "No Indication Should, Of Course, Be Given To The Bundesbank…"
- Zero Hedge:
German Court Demands Bundesbank Audit Sovereign Gold Holdings
- The Telegraph:
Bundesbank to pull gold from New York and Paris in watershed moment
- Bloomberg News:
Bundesbank to Repatriate 674 Tons of Gold to Germany by 2020
Germany's Bundesbank brings gold reserves home