|
On November 30th, the Swiss
are voting whether to amend their country’s constitution on an initiative
entitled ‘Save our Swiss Gold.’
 
The motivation
The initiators of the gold
initiative appeal to Swiss citizens desire not to sell out the ‘family
silver.’ In the late 90’s, the Swiss National Bank (SNB) owned 2,590 tons of
gold; since then 1,550 tons have been sold at prices far lower than today’s
prices. While the Swiss might like their gold, they are fiercely independent.
That’s relevant because by imposing a ceiling of the Swiss franc versus the
euro, the SNB has de facto imposed the euro on Switzerland, a step closer to
joining the euro – something many Swiss object to. More importantly, many
Swiss may find it inappropriate for what is supposed to be an apolitical body
like the SNB to impose policies with major political ramifications.
Not surprisingly, the Swiss
government – which opposes the initiative - does not frame the discussion
this way, but instead talks about the flexibility the SNB needs to implement
its policies. It also points to the ‘losses’ incurred in 2013 when the price
of gold fell.
Let’s look at the
initiative and arguments in more detail. The initiative would amend
Switzerland’s constitution such that:
• Gold reserves of
the SNB must not be sold;
• Gold reserves of the SNB must be held in Switzerland;
• Gold reserves of the SNB must be ‘significant’ and must not fall below 20%.
As transitional measures:
• Switzerland has 2
years to repatriate its gold;
• Switzerland has 5 years to phase in the 20% reserve requirement.
Central bank
independence
The Swiss government states
the SNB’s independence would be at risk if the initiative passed. Former
Federal Reserve Chair Alan Greenspan had this
to say about central bank independence: “I never said the central bank is
independent.” He did not imply the government tells the Fed where to set
policy on a daily basis, but made it clear that it is the government that
sets the rules. He fought back against accusations that the Fed finances huge
government deficits, arguing critics have it backwards, as the Fed merely
goes along. He then added that the Fed’s policies are driven by ‘culture
rather than economics.’
It should not be surprising
that the Swiss government is against any outside restrictions imposed on the
SNB, but not because it jeopardizes central bank independence, but because it
reduces the flexibility the government has. But that, of course, is precisely
the purpose of constitutional initiatives available in Switzerland.
Gold a risk for the SNB?
The Swiss government claims that the sharp drop in gold prices in 2013 lead
to heavy losses at the SNB. It’s sad when the official pamphlet representing
the government’s view resorts to polemics. Let’s get a few things straight
about central bank accounting:
• The gold held by
the SNB was purchased at dramatically lower prices. If more gold were sold,
no losses, but substantial gains would be recorded.
• In an effort to keep the Swiss franc from rising, the SNB has “printed” a
great deal of money, as the chart below shows – almost as much as the Fed:
• Currency isn’t
actually printed, but the Fed or SNB purchase securities from banks; they pay
for these securities by crediting the account of banks with the stroke of a
keyboard. Money is literally created ‘out of thin air.’
• What most are not aware of, however, is that the more money a modern
central bank ‘prints,’ the more interest bearing securities it buys, the
greater the “profit” of the central bank. That’s why central banks brag how
‘profitable’ their policies have been.
• However, while the Fed has only purchased domestic securities (US
Treasuries and Mortgage Backed Securities), the Swiss National Bank has been
buying Euro and U.S. dollar denominated securities. In doing so, the SNB has
truly introduced massive currency risk.
• Except that central banks don’t really care about losses: the Bank of
Israel, for example, has had a negative net worth for over 20 years. Losses
for a central bank make for bad PR, but a central bank can simply ‘print’
money to pay for its obligations. Some central banks, such as the European
Central Banks, have in their statues that member states must pay-in
additional capital should the ECB suffer losses.
Gold sales needed
in times of crises?
The Swiss government argues
a central bank must be able to sell its gold in times of crisis. Let’s think
about this: such a ‘crisis’ might occur when a bank is over-leveraged and
must be rescued. To facilitate a ‘rescue’, the SNB is likely to provide
“liquidity” (money printing with the promise that it’s only for the
short-term). If a bank is insolvent rather than illiquid, it might require a
capital injection. That capital has to come from somewhere. If gold is sold
for this purpose, it is the people’s gold that’s being sold. The government
likes to keep an option open to socialize losses.
We would argue that the
very reason “too big to fail” exists is because governments play rescuers
that are all too willing to sacrifice the wealth of the public. They say such
measures are for the common good – because depositors might lose their money
in a bank. Indeed, when a bank collapses, it is the savers that lose out, as
the savers are the folks that have loaned money to the bank.
The way to protect savers,
though, is through prudent policies that require those that take risks to be
responsible for losses.
Gold is the
people’s money
Gold is the
people’s money, not the government’s money to splurge. If a currency is
backed by gold, then the currency represents the gold. It’s not for the
government to give away: that’s why the initiative argues against selling any
of the gold, ever. It’s for that reason as well that the gold does not need
to be kept abroad: gold is a store of value that ought to back the currency
in circulation.
20% minimum backing
of reserves
Marc Faber, for example,
says he has been asked to publicly support the initiative, but has so far
declined to do so because he argues it is a haphazard solution; only 100%
backing would be worth supporting publicly. In our assessment, Marc is too
quick in discarding the merits of the initiative. Combined with the
requirement that the SNB will never, ever, be allowed to sell gold, there are
major ramifications:
• Assume that 20%
of the SNB’s assets are backed by gold and the price of gold drops. The SNB
would be immediately required to purchase more gold. As such, over time, the
SNB’s reserves would likely be above 20%. In our assessment, dynamics may
well move them to be closer to 100% over time. Basically, whenever there is a
crisis and the SNB might be tempted to ‘print money’ to bail out an
institution, it would chip away at the SNB’s flexibility for future bailouts,
more gold is held that cannot be sold.
• An activist SNB that continues to buy foreign securities may, over time,
have a hard time defending a ceiling on its currency. That’s because a
ceiling on its currency is akin to a bailout to the country (Switzerland) as
a whole, arguing that debasing the currency is good for the country.
Competitive Swiss
franc?
The Swiss government argues
that the strong Swiss franc is a concern to exporters. No kidding. Other
concerns are competitors – maybe we should get rid of those, too. And those
pesky customers that don’t always feel like buying gadgets and services that
are Swiss made. Kidding aside, we would argue that it is impossible for an
advanced economy to compete on price. An advanced economy has to compete on
value. Very few low-end consumer goods are exported from advanced economies.
Look at beer, as the one
area where low advanced economies have tried to compete with what might be
considered as a low-end product: first, beer is branded as a premium product
these days. In order to have pricing power there has been massive
consolidation in the brewing sector over recent decades in much of Europe;
Switzerland has been left behind in this trend – but note that these are
trends that have been firmly in place well before the financial crisis. A
weaker Swiss franc wouldn’t fix these challenges. The alternative to scale is
to then try to be profitable at the local level; indeed, microbreweries with
no export market have succeeded in many high cost areas.
Swiss multi-nationals have
long learned to have natural hedges in place, matching revenue and expenses
in their export markets.
Switzerland usually retains
the headquarters, possibly R&D. Switzerland has lots of seasonal workers;
policy makers should think out of the box, such as paying seasonal workers in
euros. It may be far better to pay workers in a depreciating currency than to
throw away one’s gold reserves in order to attract more seasonal workers…
Switzerland has always had
a tough market. It is said that because of how critical Swiss consumers are,
that if someone can have a product succeed in Switzerland, it can succeed
anywhere.
We live in a world
drowning in debt. The U.S., European Union, Japan, to name a few, cannot
afford to pay all the promises they have made. As Alan Greenspan recently
said, a welfare state cannot support a gold standard. These other countries
will debase their currencies over time in an effort to make their liabilities
more affordable.
It won’t be easy to
sell to countries that have put policies in place that we believe may
impoverish their middle class. The solution, however, is not to impoverish
Switzerland. It won’t be easy, but the sooner Switzerland embraces the
reality that competitive devaluation is not in its interest, the better.
Back to reality
Having made the case for
Switzerland’s gold initiative, note that passing the initiative would only be
a first step. Unless policy makers embrace the spirit rather than the letter
of the law, it may be an uphill battle. We have already received research reports
how the SNB could circumvent its obligations by spinning off assets. The SNB
might also engage in derivatives to undermine the spirit of the initiative
should it pass.
Let’s also keep in mind
that the SNB has five years to implement the 20% backing of its reserves by
gold. That should allow the SNB to conduct purchases without disrupting
markets. In the short-term, the signaling effect might be the most powerful
one: the ceiling of the Swiss franc versus the euro may well get tested. Such
ceilings are enforceable only when they represent an unconditional
commitment. As soon as someone blinks, the market will test the resolve of
policy makers. The passing of such tests may well qualify as resolve. The SNB
may be well served to start buying gold from day one if they accelerate their
purchases of euros.
Ultimately, people
should never rely on their government to pursue a gold standard, but consider
pursuing their own, personal gold standard. On that note, we
will expand on our discussion of Switzerland’s vote to force the Swiss
National Bank to hold a minimum of 20% of its reserves in our upcoming
Webinar (click here
to register), on November 20, 2014. As part of the webinar, we
will also discuss how investors can build their personal gold standard
Axel Merk
|
