Germany Bunds Becoming a Sort of Reserve Currency



The bimetallic standard.

Deliberations on the principles of bimetallic coinage have been out of vogue for more than a century. The question is however if we aren’t in need of some thinking and find out how we deal with coinages on two different bases?

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The reason is of course that the USD is getting a competitor as the reserve currency of the world. I’m not so much referring to the EUR, because whereas the USD has a background in the USA’s ability to pay debt no such unanimity is present behind the EUR: Very few countries have Spanish sovereign bonds in their currency reserve; but there are quite a lot that have German Bund bonds.

Germany Bunds Becoming a Sort of Reserve Currency

Normally it is impossible to form a reserve currency if you don’t run a deficit for a considerable period – a point that gives a lot of people a lot of difficult – not least conceptually: We have heard Chinese aspirations to use the RMB as a reserve currency – despite China having a considerable position as a net creditor. To understand the advantage of being a reserve currency one should note that f.i. a 100 USD bill is a sovereign bond that the FED promises to pay on demand; but without interest. This briefly means that the US government can pay their creditors without ever being presented with the demand!

The interesting factor is now, that Germany will be able to form a reserve currency on the basis of their debt – since the reunification of Germany they have been in debt. But even that rather extravagant overspending is hardly sufficient to fill the demand an effective competition to the USD gives raise to.

We have seen a heated – and rarely rational – discussion about Eurobonds. For the time being it seems like the outcome is that the sovereign bonds of distressed nations in effect are being exchanged into German sovereign bonds that to all intents and purposes are interest free. That is natural, as Germany in effect has recourse over Spain (and others) because Germany can refuse further credit and in effect close down Spain. This is evident as Spain has the greatest difficulty selling their sovereign bond at interest rates that will not lead the Spanish economy further into the bog. In this context a 2-3% interest difference between what Germany (the EU) lends money to Spain to and what the world lends Germany to.

Germany Bunds Becoming a Sort of Reserve Currency

The conclusion so far is that the USD  reserve currency is in reality the US sovereign bond and the EUR reserve currency is in effect the German sovereign bond.

This gives to major problems:

1)      It augments the world reserve currency money supply – Germany can make all the bonds they please: Not only is there plenty of debt in Europe to convert into German Bund’s; but the local governments in Germany has as large a debt as Germany has as a nation.

2)      What exchange rate between the EUR and the USD is the “correct” one? China has tried to play the market between the two by replacing some of the USD in their reserves with EUR – and have been badly hurt in the process. Russia is in somewhat better position as an oil exporter where a weak dollar has been balanced by higher oil prices.

Historic background is the belief that the reserves of precious metals are and expression of wealth in contrast to the modern concept of debt as the monetary basis. The bimetallic problem arises when both f.i. gold and silver is coined: If silver gets cheaper you can make arbitrage by melting gold coins – and vice versa. Wikipedia has a brief representation of the historical debate – where there apparently wasn’t any clear conclusion weather a bimetallic standard is inherently stable or not. To confuse everything completely Sweden issued copper coins in large denominations – so large that when the Danish insurgents in Scania in the 17th ambushed the Swedish army’s money transport – their horses had problems carrying the loot. A positive financial problem.

The other references are so old that I considered dusting off my runic alphabet. Deliberations before 1900 are not liable to be relevant considering the theoretical and technological developments since then. The legal principles should be the same, but the technical ability to confirm substance in the Greek debacle is somewhat in doubt. Clear thinking seems to be a distinctive handicap in international banking.

The more recent empirical evidence with the USD/EUR exchange rate seems to be some sort of semi stable in so far that EUR/USD relationship seems to vibrate between .7 and .8 which could indicate there are stabilizing and destabilizing factors – just to make confusion complete.

A factor is that China has tried to keep their currency undervalued with respect to the USD and wanting it overvalued in relation to EUR – but it seems like result was the reverse. The period of around 1½ year probably has something to do with the business cycle and the period between ordering raw materials and payment of finished goods – but that again is guesswork!

Another factor is the need for reserve currency in currency reserves which is considerable. Here will Greham’s law probably apply where the turnover will be in the weakest currency, but the reserve will be in the stronger. Strength/weakness understood as the relative developments – which – depending on elections – can be a genuine seesaw.