* WHAT TO DO NOW: Learn more about velocity. In the case study this lesson, we learn four ways to understand currency moves through through the examination of moving average velocities. See page two.
* EZ CURRENCY GUIDE: Look at a country’s Money Supply. Runaway Money Supply is one of the main short term reasons behind inflation and a weak currency. Learn about it on page five.
* EZ STRONG CURRENCY: The German Mark. The DMark has been one of the strongest currencies for decades. See why page five.
The sun, a salmon sliver rises. Majestic in the early morn it casts deep golden shadows across the white, sandy beach. Pelicans float in an eerie silent formation, gliding calmly across crystal clear seas. We watch in hushed awe, frozen by splendor, stillness and quiet. We walk relaxed and fulfilled by nature and its awesome beauty at sunrise.
Naples, Florida. Dawn just after a Summer Solstice. Merri and I were walking on the beach. What a message nature sends us every morning, every evening, every month, every quarter! A message of change in which flows an even deeper signal of eternal renewal, hope and sustenance. If we look for this change, we can see it in everything including our economies and the value of our currencies too.
How can we spot change in currencies? We can gain insights by understanding the currency fundamentals we have studied in these lessons and by watching the short term factors that affect currency values. We continue in this lesson looking at these short term factors.
We ended Lesson Nine looking at nine month moving average velocities and how they can help predict currency trends. We study more about velocities in the Case Study next page but I want to first express how important it is for every student of economics and for every investor to understand that each of the indicators we have studied are guides that give just a part of the whole picture.
No one indicator is ever perfect! Even if one studies all of the indicators, there is still no guarantee that the future of a currency can be accurately predicted all the time.
This is the most important point to remember: No one can always predict all the time how currencies and markets will move. It is vital that one study and follow the fundamentals and short term factors, but even then, we must accept that no matter how much we study and follow currencies and their moves, our understanding will be imperfect and limited. I explain more next page. To understand currencies perfectly we would have to know everything that has ever happened and everything that is about to happen!
Currency markets are after all just a reflection of every fundamental economic force and every belief past and present, blended together and combined to form the current moment. There is no perfect guide that tells what a currency’s value or any other market’s value will be. Most professional investors know and understand this and from this knowledge exercise great caution in their investing habits. The huge derivative losses in Orange County and the bankruptcy of Barings Bank have reminded us of this fact again.
Take the Barings Bank crash as an example. It has been reported that the major losses occurred when a trader for the bank speculated heavily on the Japanese yen and stock market. He was an expert in this market. He studied it carefully day in and day out and felt fully informed. What he did not know was that an earthquake was about to occur in Kobe which would cause the Japanese market to fall.
Our study of currencies will help us have a much better feel about how currencies will move. We will know more then 99% of all investors, but we must also never forget that no matter how much we know we will never know everything and consequently our expectations will always be imperfect.
Having reminded you about the inaccuracies which we are forced as investors to endure, I now want to say that currency velocities are one of the simplest and most accurate guides to understanding currency trends. Often they can be exceedingly accurate. An example is shown in the case study below.
I publish a weekly economic review entitled Global Guide which includes a study of the 39 week (nine month) moving average velocity of 38 major stock markets, 38 currencies and some of their interest rates every week. This case study shows how these velocities helped me (and the readers of the Global Guide) spot the sudden surge of the U.S. dollar in early May 1995.
The U.S. dollar had been on a record falling streak and had dropped nearly 40% in a year. The Japanese yen, Swiss franc and German mark were at all time high parities versus the dollar.
Then in my moving average velocity study of May 2, 1995, the velocities turned around and we saw a sudden change in the trend of the U.S. dollar. Here are excerpts of what I wrote in that May 2nd issue of the Global Guide.
HAS THE TREND PEAKED?
This month the U.S. economy showed signs of slowing down, the U.S. dollar strengthened. These moves were breaks in their current trends.
Velocities still suggest that there is weakness in stock markets and the U.S. dollar, but the velocities normally look worst just before there is a change. The next month should give us some more clues.
Let’s look at the month’s activity in more detail. In the currency markets, there were two significant changes. First, the U.S. dollar rose versus the hard European currencies and the yen. Second, several of the weakest currencies (including the Mexican peso) rose versus the U.S. dollar. Both of these facts can be considered early indicators that some of the enormous fear that has dominated the market is beginning to subside. This could also indicate that the market could well be feeling that the U.S. dollar has been oversold versus the yen and Dmark and that weak currencies like the peso have been oversold versus the U.S. dollar.
The thought that the trend had changed was totally correct. The U.S. dollar began to surge upwards in strength that very week and rose nearly 10% in just two weeks. Here are the velocity figures that we saw.
CURRENCY UNITS PER DOLLAR (except British Pounds, Irish Punt, ECU & SDR)
39 Week Rating May 2, 95 Last MO. 9 Mos. Average Velocity JAPANESE YEN 83.5000 82.9150 100.4850 96.2899 0.8672 1 SWISS FRANC 1.1315 1.1380 1.3347 1.2613 0.8971 2 FINLAND MARKA 4.2407 4.2830 5.2056 4.7012 0.9021 3 AUSTRIAN SCHLN 9.6600 9.6856 11.1450 10.5984 0.9115 4 DANISH KRONER 5.4097 5.4430 6.2209 5.9329 0.9118 5 GERMAN MARK 1.3745 1.3766 1.5822 1.5057 0.9129 6 DUTCH GUILDER 1.5410 1.5425 1.7772 1.6877 0.9131 7 BELGIAN FRANC 28.3100 28.3810 32.5600 30.9986 0.9133 8 LUXEMBOURG FRANC 28.3100 28.3810 32.5600 30.9986 0.9133 8 NEW ZEALAND $ 1.4843 1.4879 1.6550 1.5906 0.9332 9 FRENCH FRANC 4.8730 4.8830 5.4136 5.2080 0.9357 10 NORWAY KRONER 6.1964 6.2145 6.9125 6.6199 0.9360 11 PORTUGAL ESC 145.6000 145.8900 160.7000 155.3415 0.9373 12 ECU 1.3358 1.3264 1.2090 1.2526 0.9377 13 SDR 1.5757 1.5825 1.4518 1.4841 0.9418 14 CHILE PESO 388.6500 392.2500 420.5214 409.1181 0.9500 15 SPANISH PESETA 122.7500 123.6500 130.0000 128.9385 0.9520 16 GREEK DRACHMA 223.6500 224.8400 238.9000 234.8763 0.9522 17 SINGAPORE $ 1.3923 1.3955 1.5067 1.4587 0.9545 18 IRISH PUNT 1.6294 1.6323 1.5239 1.5659 0.9611 19 S.KOREA WON 760.7000 764.3000 802.7000 790.8167 0.9619 20 MALAYSIAN $ 2.4675 2.4660 2.5745 2.5474 0.9686 21 TAIWAN T$ 25.4100 25.4015 26.5075 26.1659 0.9711 22 SWEDISH KRONER 7.2330 7.4134 7.7420 7.4227 0.9744 23 BRITISH POUND 1.6183 1.6064 1.5415 1.5797 0.9761 24 THAILAND BT 24.5400 24.5500 25.0350 24.9380 0.9840 25 CANADIAN $ 1.3621 1.3678 1.3868 1.3813 0.9861 26 INDIAN RUPEE 31.3500 31.4200 31.3700 31.4019 0.9983 27 SAUDI ARABIA SR 3.7500 3.7505 3.7505 3.7507 0.9998 28 US DOLLAR 1.0000 1.0000 1.0000 1.0000 1.0000 29 ARGENTINA PESO 1.0000 0.9996 0.9985 0.9997 1.0003 30 HONG KONG $ 7.7377 7.7327 7.7261 7.7326 1.0007 31 S.AFRICA RAND 3.6135 3.6111 3.6213 3.5658 1.0134 32 INDONESIA RUP 2231.0000 2229.0000 2168.0000 2194.2949 1.0167 33 PHILIPPINE PESO 25.9400 26.0500 26.4000 25.2973 1.0254 34 AUSTRALIAN $ 1.3734 1.3639 1.3489 1.3376 1.0267 35 ITALIAN LIRA 1698.0000 1721.5000 1578.2500 1616.7051 1.0503 36 BRAZILIAN RL 0.9200 0.9155 0.9115 0.8653 1.0632 37 TURKISH LIRA 42581.00 42689.00 30776.00 37249.4359 1.1431 38 MEXICAN PESO 6.1200 6.0150 3.3760 4.6425 1.3183 39
What We Can Learn
This case study can help us understand what to look for when we study moving average velocities. Let’s review the velocity figures above so we can see what signals correctly led us to assume the break in the trend of the falling dollar.
First, on page three we can see that most currencies rose against the U.S. dollar fro that month. At the beginning of April the U.S. dollar bought about 82.9150 yen. By the beginning of April, the dollar parity was 83.5000. The dollar bought more yen which meant it was stronger versus the yen. This was the second month of slight strength.
However we do not place too much importance on the monthly moves, which is why we calculate the nine month (average) average. The movement of a currency over the entire nine months is more important.
Second, the yen and Swiss franc nine month velocities had dropped from the month before. Both velocities still showed that the trend of the Swiss franc and yen was rising, but usually 39 week moving averages show a currency a its greatest strength just before the currency weakens.
Important point to remember: When a moving average shows an enormous upwards move of a currency (when the velocity number is well below 1.00),this becomes a signal that the currency is rapidly rising and may be overbought (too strong).
Third, the suspicions that the yen and the Swiss franc were overbought was confirmed by the fact that the velocities of these two currencies were much stronger than any other currencies. For example, the velocity of the yen was 0.8672 and the Swiss franc was 0.8971. While the velocity of the German mark was only 0.9129. Most currency had velocities of 0.9100 or lower. This suggested the Swiss franc and yen were too strong. They were rising quickly against all currencies-not just against the dollar.
But there was more that led me to feel that the dollar would recover. We also reviewed the interest rate velocities below:
EURO CURRENCY INTEREST RATES (3 Month CDS)
Indicative rates only subject to change 39 Week Rating Current Last 9 Mos Average Velocity % % % % FRENCH FRANC 7.75 7.75 5.31 6.08 1.2736 1 CANADIAN $ 7.81 7.81 5.50 6.64 1.1767 2 ITALIAN LIRA 10.63 10.81 8.31 9.23 1.1514 3 BRITISH POUND 6.88 6.63 5.50 6.19 1.1111 4 SPANISH PESETA 9.19 9.19 7.69 8.42 1.0909 5 DANISH KRONER 6.75 6.81 5.75 6.27 1.0767 6 USA $ 6.06 6.13 4.75 5.78 1.0485 7 PORTUGUESE ESC. 10.38 10.31 11.25 10.39 0.9988 8 BELGIAN FRANC 5.25 5.31 5.25 5.41 0.9704 9 GERMAN MARK 4.50 4.50 4.81 4.94 0.9114 10 DUTCH GUILDER 4.50 4.56 4.81 5.03 0.8948 11 SWISS FRANC 3.38 3.38 4.19 3.87 0.8717 12 JAPANESE YEN 1.38 1.38 2.25 2.19 0.6270 13 SINGAPORE $ 1.88 2.00 4.63 3.58 0.5241 14
The fourth factor which led us to believe the weak dollar trend would end was that the interest rates of the yen and the Swiss franc were falling very, very rapidly, while the U.S. dollar interest rate was rising. Three month dollar CDs were paying almost four time as much interest as the yen.
In this study, we have seen how understanding moving average velocities can help investors spot breaks in the trends of currencies. For more information about the weekly or monthly Global Guide which follows the moving average velocities of currencies, call the publisher of this course.
* Short-Term Factor #5: Money Supply. The Money Supply of a currency is another final short term factor that affects currencies.
Money Supply is the rate at which money is growing in a country. Money-supply growth is usually expressed as a percentage, showing how much the money supply has increased during the past year. If this percentage is larger than the Gross National Product (GNP) percentage growth, inflation will almost always follow (and consequently a weakness in the currency if the inflation is higher than with other currencies).
Important point to remember: A useful figure can be obtained by subtracting the GNP percentage from the money-supply percentage (money- supply %-GNP %). This figure indicates the relative growth of the money supply in terms of the GNP. When this figure is higher for one country than for another, the currency in the country with the faster growing money supply will eventually weaken compared with the other currency.
For example, if the U.S. had a money-supply growth of 8% and a GNP growth of 2%, one could expect 6% per annum inflation. (This, of course, has other variables factored in.) The dollar would lose value when compared with the yen if Japanese money supply growth was 2% and GNP growth was 3%. The loss, if all other factors were equal would be 6%.
How fast would the dollar lose value in this example? This can be calculated by comparing the money-supply percentage less GNP figures. Example: The U.S. has 8% annual money growth and 2% GNP growth. That means the dollar can be expected to inflate at about 6% annually. Japan has 2% annual money growth and 2% GNP growth — or, by similar calculation, an expected inflation rate of 1%. Therefore, the dollar is inflating at a rate that is 5% faster then Japan’s (6%-1%=5%). You can always find out how long it will take something to double by dividing the inflation rate (or interest rate) into 72. In this example, divide 72 by 5 (the difference between U.S. inflation and Japanese inflation). The result is, if this inflation gap continues at this rate, the dollar would fall 5% a year and lose half its value to the yen in a little over 14 years.
Having looked at the short term factors that affect currencies, we now want to look at the fundamental and short term factors of the other two major currencies in the world, the German mark and the Japanese yen. We start here with the German mark.
Currency and Culture: A Look at German Business
To understand the current strength and the future potential of the German mark, or Deutsch Mark or DMark as it is called, one must first realize how dominate the German economy is on a European and global scale.
German business is looked at in Europe today as an unstoppable juggernaut. The recently completed unification of the country in which the formerly communistic East Germany has been united with its capitalistic cousin, West Germany, has resulted in the seemingly perfect blend of high-tech industrial expertise (West) with a skilled and willing labor force (East).
Germany has two key resources within its cultural heritage: citizens with a strong work ethic and an educational system that seems obsessed with science. In fact, engineering has been the most common field of study for German business managers. A study taken shortly after WWII found that 36% of all managers had engineering degrees, 19% has graduated from law school, and 17% had earned degrees in economics. By the 1970s, these percentages (for engineers, lawyers and economists, respectively) were 61, 22 and 14. For this reason, the technical and engineering aspects of business are foremost in the majority of German companies today.
A great deal of money has been spent on the unification, and even more will be spent in upcoming years. In the early 1990’s, after the dissolution of the former Soviet Republics, East Germany came to the union essentially bankrupt from its seventy years of communistic living, and a large percentage of West Germany’s GNP during the last few years has gone to welfare, infrastructure development, and subsidies for businesses that promote integration of the West German workforce into the unified German economic mainstream.
Before unification, unemployment was running near 18% in East Germany, as compared with about 6% in West Germany. Many factories in the East had been built decades before and were functionally obsolete. Add to this the welfare state mentality rampant in East Germany, and you begin to see the problems the divided country took on in the initial stages of bringing itself together.
Even today, with the unification process only several years underway, Germany’s economy is the largest in Europe and is exceeded worldwide only by the U.S. and Japanese economies. In 1993, Germany exported over US$362 billion, exceeded only by the U.S., which exported over US$450 billion. This put Germany on a par with Japan (exports of US$362 billion). The next largest European exporter was France, with US$209 billion as shown below in this list of top exporters:
U.S. $464 billion Germany $362 billion Japan $362 billion France $209 billion UK $180 billion Italy $168 billion Canada $145 billion Hong Kong $135 billion China $92 billion Taiwan $85 billion Korea $82 billion Singapore $74 billion Switzerland $58 billion Spain $63 billion Sweden $49 billion Malaysia $47 billion
The first seven nations on the above list are the G-7 countries. You can see how hard they are being pushed by Hong Kong and Taiwan.
In addition, Germany is also second on the list of largest importers, with $327 billion in imports during 1993, following (at some distance) the voracious U.S., which had $603 billion in imports. In comparison, Japan had $242 billion in imports, the UK $202 billion, France $201 billion, Italy $139 billion, and Canada $139 billion.
In essence, Germany is running neck and neck with the United States as an exporting nation, even though the German economy is only one- quarter the size of the United States economy. This telling factor, perhaps more than any other statistic, reveals the robustness of the German business system. Germany is the leading trading partner with every country in Europe, with the exceptions of the long-standing partnerships between Ireland and Britain and Spain and Portugal. Also, Germany leads all Western countries (the U.S. included) in trading with the formerly communist countries of Eastern Europe.
The German infrastructure is perhaps the most advanced overall in Europe. Recently, major government investment was undertaken in the development of a high-speed railway. The German Autobahn is famous worldwide. And planning for urban streets sewage systems are as advanced as any in the world.
German Banking System
Any report on German business inevitably moves to the subject of German banks. German banking has been labelled “the universal banking system,” because German banks are allowed to own everything and anything. In the United States, anti-trust laws passed in the 1930s and 1940s make it illegal for banks to own shares in outside corporations or in other banks. But in Germany, as in Japan (as will be seen in the following lesson), banks are allowed and even encouraged to own stock in outside companies. This practice has expanded to the point that German banks have a hand in practically every business transaction within the country. They are involved in every possible financial activity: commercial banking (the taking in of deposits and making loans), investment banking and venture capital lending (the lending of funds and eventual ownership or partial ownership of the company), asset management, mutual funds, insurance, and so forth.
As the premier example, the Deutsch Bank, Germany’s largest and 14th largest worldwide (1993 capital assets $15 billion), owns significant stakes in many of the country’s largest corporations. It holds 28% of the country’s leading industrial company, Daimler-Benz. It owns 10% of Allianz, the country’s largest insurance company, and 10% of Munich Re, the world’s largest reinsurance company. It owns 25% of Karstadt, the country’s largest department store chain, and over 30% of Philipp Holzmann, the largest construction company. Deutsche Bank executives sit on the boards of over 150 blue-chip companies.
The power of banks in Germany is supported by laws that give minority shareholders significant rights. To change its capital structure, such as by issuing new shares or bonds, a public company has to have approval of over 75% of all shareholders. Thus, any bank that holds a 25% share in a company has what is known in Germany as “blocking rights.” In addition, German proxy laws allow banks to vote shares deposited in their accounts if the actual shareholder has not formally registered his voting intentions. Since most German shareholders don’t bother, banks usually vote a higher percentage of shares than they formally own.
This structure of power is unparalleled in the United States. The largest U.S. bank, Citicorp (1993 assets $17 billion), would have to own controlling interest in large numbers of U.S. corporations to even come close to the Deutsch Bank’s power, but by law Citibank can own no controlling interests whatsoever. Only in Japan is the German banking system paralleled.
This ownership of companies by banks has several distinct advantages. First and foremost, it allows management to focus more on long-term, rather than short-term profit. In the U.S., corporate stock ownership is continually examining short-term profits. When the stock goes up a point or down a point, stockholders get jittery. For this reason, management does not have the luxury of focusing as much on long- term research and development, which by definition requires capital but does not offer short-term payback.
The German universal banking system encourages company decision- makers (banks and management working together) to become jointly involved in long-term planning. This puts less pressure on a company to jump through hoops for the quarterly report, which can make or break a U.S. stock.
This form of bank ownership also makes it harder for outside hostile takeovers. When owners and management are working closely together, the total stockholder’s wishes are more often than not represented fairly well in terms of the company’s direction, executive pay, and shareholder dividends.
This universal banking system has taking on new dimensions during the last decade. There is a trend toward networking between banks, in which two, three or four banks will work together to provide financial services for a company or a network of companies. This provides an extremely flexible and broad-based funding source for corporate ownership. In most cases, executives from the banks sit on the boards of the companies, and vice-versa. This firmly interlocks the banks and companies, giving much of the blue chip German corporate world a Japanese keiretsu arrangement of interlocking business and financial institutions. In this arrangement, resources within an organizational umbrella can be diverted from profitable firms to firms undergoing financial difficulty.
Can you imagine top executives from GM, Ford and Chrysler sitting down at a table discussing pricing arrangements and future R&D expenses? They’d quickly end up in jail, and the companies would be heavily fined or even sanctioned. But it happens, in essence, all the time in Germany as well as in Japan, (as will be discussed later). This interlocking network of businesses and banks makes for deep-rooted financial strength and organization that cannot be matched by U.S. firms.
German Business Mentality
In his fine book, Juggernaut: The German Way of Business (Simon and Schuster, 1992), author Philip Glouchevitch argues that the German system of universal banking is a logical extension of the German business ethic, which values conservatism and stability above all else. Germans consider that allowing bankers to have a central hand in so much of the business activity of the country assures an organized, conservative approach to growth and change. Then, too, the conservative aspect in the German psyche is deeply rooted within the population.
As noted in the internationally-published booklet “The Monetary Policy of the German Bundesbank” (Germany’s central bank), the German currency has twice within the last one hundred years undergone complete collapse due to inflation. The mere thought of this sends chills down the spine of the average German citizen. During the currency reform of 1948, the Bundesbank was charged with the responsibility of maintaining a stable currency. Since that time it has maintained strict anti- inflationary policies.
With their vastly diversified holdings, large German banks are nearly too powerful to fail. Even so, German law closely regulates capital reserve requirements. These limit the amount of loans a bank can have outstanding at any time (and, as noted in previous lessons, serves to control the growth of money supply, holding down inflation tendencies while propping up the value of the currency on foreign exchange markets). The German reserve rate has always averaged around 8%, while the U.S. rate has been around 4% and the Japanese rate around 1%. Because of these rigid ratios, German banks have not grown as large as the largest Japanese banks. The German banks simply have not been able to lend as much of their reserves. Nonetheless, the high reserve requirements give great stability to the entire German business system and, directly, to the economic system as a whole.
The German Bundesbank
After WWII, the German currency collapsed. The economy was in ruins, the spirit of the German people at lowest possible ebb. The resurgence of the economy over the last fifty years has been hailed as an economic miracle. The resurgence began, it can be argued, immediately after the war when the occupying Allied forces set up a central banking system in West Germany (remember, East Germany was behind the Iron Curtain, controlled by communist Russia, and was completely out of the international financial loop). This new banking system was modeled on the structure of the Federal Reserve System in the United States. The German version consisted of two tiers: independent banks operating throughout the country (known as Land Central Banks) and the Bank deutscher Lander, located in Frankfurt. In their territories, the Land Central Banks acted independently, but the Bank deutscher Lander was solely responsible for the issue of banknotes, the coordination of national economic policy, and control of foreign exchange.
The policy-making body of this two-tiered system was the Board of Directors at the Bank deutscher Lander. This board included the President of the Bank deutscher Lander, the Presidents of the land Central Banks, and the President of the Board of Managers. This board determined discount policies and reserve requirements.
From the start, the Bank deutscher Lander was independent of German political organizations, including the central Federal Government, which officially took up its functions in 1949. Full autonomy was granted to the German government by the Allies in 1951.
The issuing of bank notes (currency) was begun in 1948, with no redemption commitment whatsoever. This means that the Deutsch Mark was not convertible in any way into a precious metal. Thus, the Deutsche mark has been a pure fiat currency from inception. The generally-held policy of the Bank deutscher Lander was to control the value of the currency via a tight-money policy.
Creation of the Bundesbank
Under the Bundesbank Act of July 26, 1957, the two-tier central banking system was abolished, and a unified central bank, the Deutsche Bundesbank, was established. The Land Central Banks were merged with the Bank deutscher Lander, and the name of the system was changed to the Deutsche Bundesbank. The Land Central Banks, no longer legally independent, became part of the Bundesbank as “main offices.” However, they retained the name Land Central Banks and have independent administrative powers.
When German unification became final during July 1990, the Deutsche mark became the sole legal currency in both German states (West and East). At the same time, responsibility for monetary policy in the former Eastern Germany was transferred to the Deutsch Bundesbank in Frankfurt. A provisional Bundesbank office was set up in Berlin in 1990, but was dissolved on October 3, 1992, at which time the Bundesbank was headquartered solely in Frankfurt.
Framework of the Bundesbank
The Bundesbank is a Federal corporation under public law. It is held by the Federal Government as the body controlling monetary policy. Any profits on the operations of the Bundesbank flow to the government, unless they must be used under legal restrictions to form reserves.
Yet, the Bundesbank functions with complete autonomy from the government. By law, the government cannot, according to Bundesbank literature, “derive any rights which might affect the independence of the Bundesbank. On the contrary, despite being required to support the general economic policy of the Federal Government, the Bundesbank is not subject to any directives from the government in exercising the powers conferred on it by the Bundesbank Act.”
Members of the Federal Government are entitled to attend meetings of the Central Bank Council, but they do not have voting rights. The Federal Government nominates members of the Central Bank Council, and members are appointed by the President of the country.
The governing bodies of the Bundesbank are the Central Bank Council, headed by the Directorate. The Central Bank Council is composed of the President and Vice-President of the Bundesbank, the other members of the Directorate, and the presidents of the Land Central Banks. Each of these individuals is appointed by the President of Germany. The Council’s meetings are held every two weeks, and decisions are by simple majority of votes cast.
The Directorate is the central executive organ of the Bundesbank, and as such is responsible for implementing the decisions of the Council. It directs and administers the Bundesbank. The Directorate consists of the President and Vice-President of the Bundesbank and up to six other members. Appointed by the President, they serve for a period of up to eight years. They cannot be removed from office before the end of their term, except for personal reasons. The Bundesbank does not lend to private companies, so the administrative responsibilities of the directors is limited to Bundesbank operations.
Since 1992 there have been nine Land Central Banks, each carrying out transactions and administrative tasks in their regional areas.
Only the Bundesbank is entitled to issue Deutsche marks, which are the only legal tender in Germany. There are eight different denominations of banknotes: DM 5, 10, 20, 50, 100, 200, 500 and 1,000.
The Deutsch Mark
The Deutsch Mark (DM) is completely convertible into other currencies. Its strong position internationally is reflected in the large amount of reserves the Bundesbank has accumulated since Germany entered the Bretton Woods economic system in 1948. Particularly at the end of the 60s and in the early 70s, when the dollar was growing weaker on foreign exchange markets, the Bundesbank bought large amounts of foreign currency to maintain international currency stability. At that time, the DM was just too strong, and by the Bretton Woods Agreement, the Bundesbank had to buy dollars to maintain the agreed-upon parity between dollars and DM.
Gold holdings account for a large percentage of Germany’s total reserves (over 14%), but the majority of reserves is in U.S. dollars. At the end of 1983, Germany had the largest total reserves of any country, but was edged out by Japan and Taiwan by the end of 1993 as shown below.
1983 Gold and Foreign Exchange Reserves Totals (In US$)
Country Total Reserves Share in World Germany 46.162 billion 11.1% U.S. 32.278 billion 7.8% S. Arabia 27.455 billion 6.6% Japan 25.489 billion 6.2% France 22.850 billion 5.5% Italy 22.548 billion 5.4% Switzerland 18.086 billion 4.4% China 15.451 billion 3.7% UK 12.035 billion 2.9% Taiwan 12.009 billion 2.9% G-7 total 165.568 billion 40.0% oil-exporting 70.355 billion 17.0%
1993 Gold and Foreign Exchange Reserves totals (in US$)
Country Total Reserves Share in World Japan 99.689 billion 9.2% Taiwan 84.225 billion 7.8% Germany 82.215 billion 7.6% U.S. 74.938 billion 6.9% Singapore 48.360 billion 4.5% Spain 41.796 billion 3.9% UK 37.663 billion 3.5% Switzerland 36.638 billion 3.4% Netherlands 32.969 billion 3.0% Italy 30.749 billion 2.8% G-7 364.612 billion 33.6 % oil-exporting 64.613 billion 6.0%
Breaking the above information down even further, the following table shows reserves in gold held in 1993.
1993 Gold Reserves (in US$)
US 12.585 billion Germany 4.575 billion France 3.934 billion Italy 3.205 billion Japan 1.164 billion UK .886 billion Canada .290 billion
The Bundesbank does not have the option of imposing direct limits on borrowing by non-member banks, or of fixing interest rates in the credit, deposit and securities markets. It does, however, set the country’s discount and “lombard” rates. Lombard loans are given to credit institutions against collateral. They are limited to terms of no longer than three months.
Setting these rates is the cornerstone of the Bundesbank’s interest rate policy. The discount rate represents a sort of lower limit for the rates of one-to three-month funds, and ultimately helps determine medium-term and long-term bond rates (public and private). The lombard rate greatly determines the money market trends, since the banks are dependent on lombard loans for meeting their peak day-to-day needs.
The lombard rate is usually a point to a point and a half above the discount rate. Currently, the discount rate is 5.25% and the lombard rate 6.75%. Both of these are down considerably from several years ago. In 1992 the discount rate was 8.75% and the lombard rate 9.75%. The discount rate, which ultimately helps determine the rate of German Treasury issues, was set high to attract investment capital for help with reunification costs.
It’s an interesting point that during the early 1990s, the U.S. (along with many European nations) was lowering interest rates to rev-up recessed economies. Germany, however, insisted on raising rates, to the outcry of other countries. In 1992 U.S. discount rates were under 5% in the U.S. and under 4% in Japan.
Next lesson we will continue looking at Germany and will provide details about the German mark and why it has been a strong currency. The next lesson will also include contacts for investing in Germany, since most investors should almost always include investments in Germany and Japan as well as the U.S. in their portfolio. Then after the contacts we will review Japan, its history in world economics and learn more about the yen and why it is so strong as well.
The Deutsche Bundesbank was most helpful in helping us prepare this lesson on Germany. They provided a wealth of information. For those who wish to delve more deeply into the German economy or to know more about the German mark the address of the Bundesbank is below:
Deutsche Bundesbank, PO Box 100602, 60006 Frankfurt am Main, Germany. Tel: 011-49-69-95-6686-04. Fax: 011-49-69-95-6686-06.