Gold in Deutschemarks

AMID ALL THE BROUHAHA over gold hitting $1,000 per ounce for three short days this month, another milestone in this nine-year bull market went completely unnoticed.

Like the media-friendly $1,000 mark, this level offers a nice round number for evening news anchors to proclaim. It even comes with an extra digit — and it also remains to be reached and breached decisively, too.

But this level may prove much more important than $1,000 per ounce — and for plenty more people, too — because it shows just how strong and solid the uptrend in gold prices has been to date. Historically, it points to the underlying trends of both dollar weakness and gold strength.

Trouble is, this new level for the gold price comes in terms of a dead, defunct currency. So it speaks to ages past, rather than trying to shout above the short-term noise of talking heads on CNBC.

And whispering in a voice of paper ashes, it says currencies come and go, but metal can be buried for only so long…


That tired old warhorse of Germany’s glorious inflation fighting past, the deutsche mark was finally put to sleep by the Bundesbank on New Year’s Day 2002.

That was the day when Germany — along with the rest of the 12-nation eurozone — finally swapped its currency for the euro. The new pan-continental notes and coins were to be used in cash transactions and settlement of debt, while “DM” was scratched off shop signs and the paper itself was stuffed into a blazing furnace.

The new euro would rise from its ashes and bring German-style stability to the currency union’s 300 million citizens. Or at least, that was plan.

Now Jean-Claude Trichet, current president of the European Central Bank, warns that eurozone inflation will stay “significantly” above two percent for the rest of 2008. Track the price of gold forward from 1999 in deutsche marks — the last entry in the Bundesbank’s list of daily Frankfurt gold fixes — and you can see that the gold price, a leading indicator of inflation to come, agrees.

Ask any technical analyst with a blunt number two pencil and a shatterproof ruler. Now back at 40,000 deutsche marks per kilo, the price of gold has touched very long-term resistance. Since Feb. 21, in fact, gold has recorded an afternoon fix in London equivalent to 40,000 deutsche marks or more on 10 separate occasions.

In the days of the Frankfurt gold fix, gold managed that feat only 15 times in total. And if you think the gold market action so far this month has been frantic, just check how violent the action was on either side of those DM peaks back in the early 1980s.

“Monetary stability is linked up with general social stability — and with political stability,” as Otmar Emminger said in his inaugural speech upon becoming president of the Bundesbank in 1977. Who could ask a bundle of notes and coins to do more?

“The German public,” as the economist Rudolf Richter noted in an essay of 1999, “after losing its savings twice within 25 years (1923 and 1948), definitely wanted a stable currency. No Bonn government in its right mind would have put the Bundesbank under pressure.”

Hence the West German central bank’s mandate to cap consumer prices by capping the supply of money itself. Memories of the Weimar inflation that followed World War I — plus the worthless Nazi reichsmarks piled up during World War II — still stand in sharp contrast with the American media’s obsession with the Great Depression.

Where Ben Bernanke now sees soup kitchens and deflation, the central bankers working to defend the German currency in Bonn for five decades could see only runaway inflation of the money supply. Twice.

“In 1923, when Germany could no longer pay its World War II reparations,” writes Mike Hewitt on his DollarDaze blog, “French and Belgian troops moved in to occupy the Ruhr, Germany’s main industrial area. Without this major source of income, the government took to printing money, which resulted in hyperinflation.

“At its most severe, the monthly rate of inflation reached 3.25 billion percent, equivalent to prices doubling every 49 hours. The U.S. dollar to mark conversion rate peaked at 80 billion.”

Sick of inflation yet? Come World War II, incredibly, the German people had to learn the lesson again. The Nazi state converted its debts into banknotes, pushing the volume of currency in circulation up from 11 billion reichsmarks in 1939, to more than 70 billion by the time Hitler poisoned his dog and his wife and then shot himself. The survivors were forced to use cigarettes, chocolate, canned beef, and soap as money once more — because the government-ordained notes and coins had lost all currency thanks to the huge oversupply.

With global inflation ticking higher three decades later, the Bundesbank adopted its first money supply target in 1973. In December 1974, it began announcing the target to the public each year, and inflation was whipped. By the fall of 1978, and with inflation in the U.S. and United Kingdom lurching back towards double digits, consumer prices in West Germany were rising by barely two percent per year:


But the initial relief allowed a flirtation with looser money to creep in. By 1981, inflation had reached 6.3 percent, so the Bundesbank set about slashing its money supply target.

It cut the target from a maximum of nine percent growth to just five percent annual growth by 1985. “Only in one year of this period, 1983, did money growth slightly exceed the target range,” says Robert L. Hetzel, writing in the Economic Quarterly of March 2002.

“Broad money (M3) growth fell from 10 percent in the 1970s, to six percent in the 1980s. By retaining price stability as its primary objective despite the high unemployment rates of the 1980s, the Bundesbank gained credibility for its policy of price stability.”

Come the end of the 1990s, the Bundesbank had whipped inflation for more than five decades. Politicians in Rome, Paris, London, Madrid, and Dublin looked to the West German model — but refused to apply it themselves.

So why not get the Germans to apply it, instead…now that was an idea! Only thing was, that pesky money supply target kept getting in the way of growth, debt, and real estate prices. And so with inflation — like interest rates — sitting near or below the two percent annual target, Europe quietly did away with its limit on money supply growth.

The M3 measure of the eurozone’s money supply — the same M3 measure that the U.S. Federal Reserve stopped tracking and reporting at the start of 2006 — was supposed to grow by no more than 4.5 percent per year. This initial target represented one of two “monetary pillars” supporting the entire eurozone project when the European Central Bank took over the reins of policy at the end of the 1990s.

At last count, however, Europe’s M3 money supply was ballooning at a nearly three-decade record of 11.5 percent per year in January 2008.

What does that mean for you, me, and the rest of the world trying to defend our savings and income against the global upturn in consumer prices? All too often, short-term traders looking for quick gains in gold will point you to a very short-term connection between gold and the euro. And fair’s fair.

It’s a fact that gold and the euro often do move together against the U.S. dollar day to day. Between the start of 2007 and late March 2008, for example, the euro and gold moved in the same direction on 291 of 310 trading days, according to Reuters data — some 94 percent of the time.

But the euro moved in the same direction as crude oil prices on 300 days — 97 percent of the time. And no one would claim that the euro’s rise versus the dollar has stopped the price of petrol from going up on Germany’s autobahns.

What’s more, both the euro and gold rose against the dollar on 170 trading days between January 2007 and late March 2008. So their apparent correlation is built on the plain fact that the U.S. currency has consistently lost value drip by drip and tick by tick.

On average, the dollar has lost 0.05 percent of its value against the euro every trading day since the start of 2007. Measured in gold, it’s lost a little bit more each session, down by 0.06 percent on average.

Put another way, gold’s gain over the dollar has consistently outstripped the gain for U.S. investors holding euros. All told — and trading just shy of 40,000 deutsche marks per kilo-equivalent today — the gold price in euros has risen by more than 24 percent for French and German investors since the start of last year.

Will it push higher, breaking new ground above the all-time record peak of 46,530 deutsche marks? Or might gold now turn tail, falling in the face of below-zero real dollar interest rates and a three-decade surge in the European money supply?

The long-term chart says gold faces resistance. Either that, or it’s about to break into historic new territory as the world has to relearn to conquer inflation.

Adrian Ash
March 28, 2008

The Daily Reckoning