Switzerland's Keynesian Dunderheads

There is an initiative underway in Switzerland to once again increase the gold backing of the Swiss Franc. Readers may remember that the Swiss Franc was the currency that held out the longest with an almost 100% gold backing. Then came the 1990s and plenty of political pressure, until the Swiss buckled and began to sell most of their gold – at ridiculously low prices, natch.

We don't know what kind of thinking informed Switzerland's central bankers at the time, but we certainly know that their modern successors are a bunch of Keynesian dunderheads and committed central planners. If you don't believe us read their papers, which can be found on the SNB's web site, or just look at their policies (the SNB does maintain a very good web site by the way, we have to give it that. A number of euro area NCBs would do well to adapt their useless web sites along similar lines).

Not surprisingly, they have been printing money like crazy in recent years, as they are suffering from deflation-phobia, similar to most modern-day central bankers (as you will see further below, this fear is quite misguided).

The SNB's flexibility may be curtailed a little bit if a higher gold reserve at a fixed percentage were to become a legal requirement. From the perspective of central bankers, the problem with gold is that they cannot print it, although it is certainly not immune to shenanigans in the hands of minions of the State.

Given the current thinking at the central bank, the above mentioned efforts have brought its members and its political supporters to the barricades to sotto voce denounce the initiative to increase the franc's gold backing. Parliament has already rejected it, but there will be a referendum, and that referendum will be binding.

Destroying 'Credibility' with Gold?

In the course of the debate over the gold initiative, a number of absurd arguments have been forwarded by all those who directly benefit the most from the central bank's inflationary policies (the government) and those whose power is derived from the status quo.

Mineweb reports:

“Swiss parliamentarians urged rejection of a popular initiative that would curtail the Swiss National Bank’s independence by requiring it to hold a fixed portion of its assets in gold.

Members of the Swiss parliament’s lower house voted 129 to 20 with 25 abstentions today against the plan, which demands that at least 20 percent of the central bank’s assets be in gold. It would also disallow the sale of any such holdings and require all SNB gold be held in Switzerland.

No date for a national vote has yet been set. The government in November also recommended the initiative be opposed, saying it would impinge upon the SNB’s ability to conduct monetary policy. Parliament and the multi-party government issue recommendations on all national referendums as a matter of procedure.

“The corset this initiative wants to put our central bank in is so tight, it would suffocate,” Prisca Birrer-Heimo, a member of the Social Democrats, told lawmakers in Bern. “Gold investments aren’t risk free.”

The balance sheet of the SNB, which owned 1,040 tons of gold as of end March, has expanded due to the currency market interventions it has used to defend the cap of 1.20 per euro on the franc, set in September 2011. The SNB held foreign-exchange reserves of 438.4 billion francs ($500 billion) in April, a sum equal to about three quarters of the country’s annual economic output.

“Accepting this initiative would crimp the bank’s ability to act globally at a particularly sensitive time,” said Dominique de Buman, a member of the Christian Democrats.

Members of the Swiss People’s Party SVP started the initiative and collected the requisite 100,000 signatures last year after failing to get backing for the matter in parliament.

“We need gold to give the Swiss franc a credible backbone,” said Luzi Stamm, a member of the SVP who founded the campaign “save our Swiss gold.”

SNB President Thomas Jordan took the extraordinary step of commenting on politics last year when he urged rejection of the initiative, saying it would crimp the Zurich-based institution’s independence and force it into “large-scale” purchases to meet the required 20 percent threshold.

As of April 2013, more than 70 percent of the SNB’s gold was in Switzerland, with about 20 percent at the Bank of England and 10 percent at the Bank of Canada, according to Jordan. The initiative “reduces the credibility of the SNB’s policy and limits its ability to act when its necessary,” Finance Minister Eveline Widmer-Schlumpf told the chamber.”

The arguments against the initiative highlighted above would all be regarded as arguments for it by us. There would be absolutely nothing wrong with putting the central bank into a “tight corset” (which is in any case a hopeless exaggeration.  The initiative's proposal is far too modest, if anything). In fact, it would be a boon, especially at “this particularly sensitive time”.

It could not possibly lower the 'credibility' of the SNB if it were really shorn of a bit of its power. In any case, who cares about the credibility of a bureaucracy, when the thing that really counts is the credibility of the coin of the realm?  How on earth can a larger gold backing “diminish the credibility” of the issuer of the currency? This is probably the most absurd argument we have ever heard in such a context.

What Thomas Jordan and Ms. Widmer-Schlumpf are really referring to is the absurd 'deflation fighting' policy of the SNB (in short, the SNB wants to be a 'credible' inflationist!). This is all the more bizarre when considering that Switzerland has some of the highest prices in the world. It could sure use a bit of genuine deflation.

The central bank has introduced a floor rate for the EUR-CHF exchange rate, and in order to defend it, has done everything from introducing 'ZIRP' to buying up truly staggering amounts of foreign currency (but it would be a problem to buy a little gold?). It has of course done so with CHF created from thin air, in the process embarking on the biggest monetary inflation Switzerland has ever experienced in such a short time span.

The Swiss monetary aggregates M1 and M2 in CHF billion. M1 consists of currency, sight and transaction deposits, all of which are available on demand. M1 thus corresponds to money TMS-1 (or money AMS as Frank Shostak refers to it). M2 cannot really be regarded as a broader 'true money supply', as it includes savings deposits.  While these are not time deposits, they do sport an annual limit for withdrawals without notice. UBS e.g. has a limit for such withdrawals of CHF 50,000 per year per savings deposit. Larger amounts are subject to a three month notice period. However, this means that a certain percentage of these savings deposits is indeed available on demand (all deposits that amount to less than CHF 50,000 and CHF 50,000 of every deposit sporting a higher balance). The rest is probably available at a penalty discount, but the notice period enables banks to delay payouts in the event of a bank run. We were not able to ascertain  how large the amount in savings deposits that is theoretically available on demand is, but  the actual broad money supply 'TMS-2' must be somewhere between M1 and M2. The growth in Switzerland's money supply aggregates since 2000 and since 2008 has been vast. Since September 2008: M1 + 63.1%, M2 + 56.81%. Since September 2000: M1 + 114.82%, M2 + 137%. Some 'deflation'! – click to enlarge.

Conclusion:

There should be no 'flexible currency' and no central planning of money. They are at the root of the boom-bust cycle, the very reason for the various crises that have beset Western economies in recent decades. Switzerland would be far better off if no-one had the power to meddle with its money supply. As it is, there has been plenty of meddling already, and quite a bit of suspension of disbelief would be necessary to conclude that there will be no price to pay. As always in monetary matters, the bill will be presented at an unknown future date, but it could be a very big bill in this case.

After falling into a low in the year 2000, Swiss real estate prices have embarked on a major increase in concert with the spurt in money supply growth that started at the same time. This is of course no coin coincidence. In foreign currency terms this is a much larger boom, as the CHF has been extremely strong. Prices in Switzerland are generally so high, that the world's highest minimum wage is also going to be subject to a referendum – click to enlarge.

Charts by: acting man, globalpropertyguide.com