Although the city of Rome is worse than Sodom and Gomorrah, nevertheless there remain in it Baptism, the Sacrament, the voice and text of the Gospel, the Sacred Scriptures, the ministries, the name of Christ, and the name of God. Whoever has these, has them; whoever does not have them, has no excuse, for the treasure is still there. Therefore the Church of Rome is holy, because it has the holy name of God, the Gospel, Baptism, etc. If these are present among a people, that people is called holy. Thus this Wittenberg of ours is a holy village, and we are truly holy, because we have been baptized, communed, taught, and called by God; we have the works of God among us, that is, the Word and the sacraments, and these make us holy.
I say this in order that we may distinguish sharply between Christian holiness and other kinds of holiness. The monks called their orders holy, although they did not dare call themselves holy; but they are not holy, because, as we said above, Christian holiness is not active but passive. Therefore let no one call himself holy on the basis of his way of life or of his works—fasting, prayer, flagellation, almsgiving, or the consolation of the sad and afflicted. Otherwise the Pharisee in Luke (18:11 ff.) would be holy too. Such works, of course, are holy, and God strictly demands them of us; but they do not make us holy. You and I are holy; the church, the city, and the people are holy—not on the basis of their own holiness but on the basis of a holiness not their own, not by an active holiness, but by a passive holiness. They are holy because they possess something that is divine and holy, namely, the calling of the ministry, the Gospel, Baptism, etc., on the basis of which they are holy.
Therefore even though the Galatians had been led astray, Baptism, the Word, and the name of Christ still continued among them. Besides, there were still some good men who had not defected from Paul’s doctrine and who had a proper understanding of the Word and the sacraments, which could not be defiled by those who did rebel. For Baptism, the Gospel, etc., do not become unholy because I am defiled and unholy and have a false understanding of them. On the contrary, they remain holy and exactly what they were, regardless of whether they are among the godly or the ungodly; men can neither defile them nor hallow them. By our good or evil behavior, by our good or evil life and morals, they are defiled or hallowed in the sight of the Gentiles (Rom. 2:24) but not in the sight of God. Therefore the church is holy even where the fanatics are dominant, so long as they do not deny the Word and the sacraments; if they deny these, they are no longer the church. Wherever the substance of the Word and the sacraments abides, therefore, there the holy church is present, even though Antichrist may reign there; for he takes his seat not in a stable of fiends or in a pigpen or in a congregation of unbelievers but in the highest and holiest place possible, namely, in the temple of God (2 Thess. 2:4). Thus our brief answer to this question is this: The church is universal throughout the world, wherever the Gospel of God and the sacraments are present. The Jews, the Turks, and the fanatics are not the church, because they oppose and deny these things.
Luther’s Works, Volume 26, pages 24-26