Published On: Mon, Mar 25th, 2013

Is Germany Preparing for a Currency War?

currency warQuantitative easing by the Federal Reserve Bank of the United States has put every other central bank in the world in a position of having to counter punch.  No other central bank has the financial resources to engage the Federal Reserve on an equal footing due to the trillions of dollars that have been unleashed by the various rounds of quantitative easing since 2008.  But the Bundesbank of Germany might have found a way to counter the superior arsenal of the Federal Reserve.

Being a member of the Euro Zone, it is difficult enough for Germany to mount any attacks to defend its currency.  This is particularly true since Germany needs the weak Euro to protect its export sector.  If the Euro Zone was to collapse and its members reverted back to separate currencies, Germany would suffer the most due to the strength of its economy and its robust export sector.

The new German Deutschemark would undoubtedly challenge the US Dollar as reserve currency.  Due to the size of the Germany economy (fifth biggest) and is export strength (second biggest), the Deutschemark would be welcomed by global investors.  Based on fundamental supply and demand, that would take the Deutschemark to a very high value.  That would be devastating to Germany’s export sector, which presently enjoys a competitive advantage with the weak Euro.

But the Euro has been strengthening in recent market action with the US Dollar down due to renewed devaluation efforts by the Federal Reserve.  Over the same period, the Bundesbank has announced that it will be repatriating its gold reserves back to Germany.  At present, German gold reserves are held by the Federal Reserve in New York City and the Banque de France in Paris.

In taking so much of the world’s gold reserves (second biggest amount) out of circulation, the Bundesbank will cause the Euro to fall in value.  This will happen for a variety of factors.  The first is that there will be less gold to be lent in the financial market.  That tightens up the physical supply.

This will raise the price of gold and lower the value of the Euro through basic supply and demand.  Central bankers bought the most gold this year in decades.  The Bundesbank is raising the price of The Yellow Metal higher by reducing the supply.  That will lower the value of the Euro, and other paper currencies.

From this, eventually the US Dollar will rise again.  The Greenback has risen almost 28% since The Great Recession.  Why?  A few basic reasons: the historic role of the US Dollar as the world’s reserve currency is still unchallenged.  After all, even after the United States credit rating was downgraded by Standard & Poor’s in August 2011, the value of the Greenback rose again.

Unless the Deutschemark is brought back, there is no other economy with a currency that could challenge the US Dollar in its reserve role.  Europe is in a recession.  Japan is in the 23rd year of “The Lost Decade.”  There is no way that China would ever loosen up to the extent necessary to allow for the Yuan to float freely as a competitive reserve currency.

In addition to its historic role as a safe haven asset, US Dollar instruments are the only financial markets with the depth to absorb all the liquidity in circulation around the globe.  While it is often stated that the Swiss Franc, Australian Dollar, New Zealand Dollar, or Canadian Dollar can absorb global capital flows, each would quickly be overwhelmed if placed in a reserve currency status.  The central bank of each country would immediately counter any efforts at utilizing these currencies as reserve holdings.   Only the Greenback can siphon off the amounts global liquidity sloshing around without disrupting the markets.

So the Bundesbank is doing what it can to keep the Euro from rising too much in value to protect its export machine.  Increasing the appeal of gold through reducing the physical supply will drive down the price of fiat currencies, such as the Euro.  Germany is fighting this currency war with what it has, and the world’s second largest holding of gold is a good place to start.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.