The Swiss National Bank SNB has tied the Swiss franc to the euro in recent years and purchased a huge amount of foreign exchange – especially euros and dollars – which were paid with nearly half a trillion newly created Swiss francs. In the last days, the ECB decided to purchase mainly government bonds for over a trillion euros, which it will also pay by printing new money. The money presses respectively their electronic equivalents are running hot – in other countries as well, and the central banks have increasingly become the focus of public attention and criticism. Today we have the impression that a real currency war is in progress. Many citizens observe the events with great concern and ask themselves what the responsibilities of a central bank really are and what consequences the present policy will have for the population. When for obvious reasons the SNB (Swiss National Bank) stopped to support the minimum rate on 15 January, the rate of the euro against the Swiss franc dropped immediately by about 15 percent, and the SNB was faced with high losses. Hedge funds and other speculators who had bet against the minimum rate on the other hand, made billions in profits. – “What’s wrong with our monetary system?”, we wonder. The banking system is monitored by the authorities with a lot of tax money – better than a few years ago. But has it really become stable?
To understand such basic questions and also to be able to classify the role of the Swiss franc in the global monetary system, it makes sense to go back to basics.
When in 1848 the Swiss Federal State was established, it was one of the first tasks of the newly founded Parliament to create the Swiss franc. This happened quite simply. The franc was defined as the coin that contained 4.5 grams silver. The Federal Government was given the monopoly to mint coins and it subsequently founded the Swiss Mint. But soon – in 1863 – Switzerland joined the European Monetary Union, which had been estblished at the time, the Latin Mint Union. It included especially countries that at present are having problems with their debt in today’s euro system. These are countries such as France, Italy, Belgium and Greece. The Union worked quite simply. Each country kept – in contrast to today’s euro system – its monetary sovereignty and its full responsibility for the budget and the debts. Different countries adjusted the silver and later the gold content of their coins, so that one could easily pay with the Swiss franc in Paris, Brussels, Rome or Athens, since it contained the same amount of silver as the local currencies. The coins had their own characteristics, but were equivalent in their silver and gold content. The Italian lira, the French and Belgian franc were accepted as means of payment in Switzerland. The system earned the population’s confidence and worked for many decades; it was formally dissolved in 1926. It formed the monetary framework for a time of economic boom, which was marked by private initiative and enterprising and is now called the Industrial Revolution. It was the time when the foundations of the “economic miracle” were laid in Switzerland and other countries. Unlike today, both the Confederation and the cantons were debt-free at the beginning of the 20th century.
Today there are significant differences between the central banks of the countries. Several countries had had state banks as early as in the 19th century which were centrally responsible for the monetary system. In federalist, small-scale organized Switzerland, however, there was still no single central bank – or there were very many central banks who issued their own notes. Issuing the notes was the business of the cantons and the commercial banks. Over the decades, 51 commercial banks (see Ernst Baltensberger. “Der Schweizer Franken”, p. 90) issued their own banknotes, which differed in appearance, however, were equal to each other via concordat. The banknotes were used as a substitute and complement of the silver or gold coins, and they could always be changed for gold coins. The Swiss “Goldvreneli” (the “Swiss Miss”) had almost cult status. Until 1936, when the Swiss franc was devalued in the economic crisis by 30 percent, about 56 million “Vrenelis” were minted, and they have enjoyed great popularity until today.
How was the financial system then monitored in Switzerland to prevent bank failures and crises? Unlike today, the system worked quite simply – without complicated bureaucracy – and was very effective: the citizens had the system under their own control. In contrast to silver and gold coins, banknotes were no legal means of payment. The private business and cantonal banks (which issued the notes) had to try to gain their fellow citizens’ trust by means of reputable business policies. If a bank attracted negative attention because of dubious or speculative wheelings and dealings, the citizens could reject their banknotes as means of payment. That would have been the end of each bank. This scheme worked so well that this case never happened in Switzerland until the founding of the Swiss National Bank in 1907. The banks were always aware of that danger and tailored their policy accordingly. The system was very stable. The community-based monitoring, which is closely connected with the direct democratic principle, worked better than any institutional control and it kept the franc stable in its value. Abroad, however, it was already common practice that a state or a government declared the notes legal means of payment (which the citizens had to accept) and then abused the note printing machine for all kinds of wars and political purposes. In the 20th century, this principle has almost become the rule to fund the many wars.
The system of direct citizen control of the monetary system was strongly supported as early as the 19th century. So the Federal Constitution of 1874 said in Article 38: “The Confederation is entitled in the way of legislation to decree general rules on the issue and redemption of banknotes. It may, however, not set up any monopoly on the issuing of banknotes and also no legally binding regulations on the redemption of the same.” That is, although the Federal Government could establish rules on the issuing of banknotes, the commercial banks could continue to issue their own notes at any time which could be exchanged into gold coins.
The Swiss citizens controlled the monetary system with numerous referendums. After the people had adopted the 1874 Federal Constitution with the above-quoted currency article, the Federal Council and the Parliament worked out an implementing law. This set the conditions (for example, the minimum capital) that the issuing banks had to comply with, and it provided for a federal supervision of the banks. Citizens took the referendum and in 1876, 62 percent of voters said No to the new law. They did not want any federal control but maintain the control of the monetary system in their own hands. Only a few years later, a motion in Parliament followed that wanted to give the Federal Government the monopoly to issue banknotes. This motion failed. Proponents did not want to give in and launched a popular initiative with the same objective. It was massively rejected in 1880 with 68 percent of the votes.
In 1881, Parliament passed the bill law, which went significantly less far and only standardized the note issue of the numerous commercial banks. The discussion among the people and in politics about financial matters did, however, not stop. The economy was booming, not only in Switzerland. The Industrial Revolution with numerous start-ups and strong growth was in full swing.
But then the mood changed. This happened in the context of other economic sectors. The industrial, economic development in the 1880s was already well advanced in many European countries and characterized by a spirit of enterprise. In Switzerland, many companies were founded at the time such as Nestlé and Hoffmann-LaRoche, which were to develop into global companies over the decades. Many private railway companies – organized as joint stock companies – built today’s railway network in cooperation with the cantons with large momentum. The need of citizens for greater governmental coordination and control, however, grew. In 1891, the people still voted against the nationalization of the private Central Railway which led to the Gotthard with 63 percent. In 1896 and 1898, there were two other votes. Now the people clearly said Yes to the nationalization of the major railway companies. This was the birth of the Swiss Federal Railways SBB. But there are still many railways in Switzerland that are joint-stock companies and in which citizens are directly involved and which have been under control by the cantons and communes until today.
The monetary system experienced a similar trend. In parallel to the debates on the nationalization of the railways, the Federal Council and Parliament worked out a new constitutional article that should give the Federal Government the exclusive right to issue banknotes. They left it open, however, which institution should take over this task. This might be entrusted to a central state bank or a central equity bank under federal supervision, the draft proposed. This time, 59 percent of voters said Yes to the issuing and control of banknotes by the Federal Government. But still the Swiss National Bank was not yet born. The discussions continued.
In 1897, the Federal Council and Parliament worked out the Implementation Act for the new constitutional article. A majority of parliamentarians decided on the establishment of a national central bank, a Swiss Federal Bank (from the idea similar to the Swiss Federal Railways). The opponents seized the referendum. The public interest in this motion was extraordinarily high. Historians counted around 150 large public meetings, where the future of Swiss money was hotly debated. Both sides described the Federal Bank vote as a vital question for Switzerland. Voter turnout was extremely high at 65 percent. To the great disappointment of politics, 57 percent of voters clearly said No to the Swiss Federal Bank in the form of a national central bank.
The starting point for further events was the following: In two votes Swiss citizens had said Yes to the idea that the Federal Government should take over the responsibility on financial matters, but No to a national central bank. This paved the way for the establishment of the Swiss National Bank as a state-controlled corporation. This idea met with general approval. The Federal Act on the Swiss National Bank became effective on 16 January 1906 without a referendum, so that the Swiss National Bank could begin operating on 20 June 1907. The 51 private commercial banks ceased to issue their own notes, as this was now the SNB’s task.
Based on the direct democratic proceedings in communes and cantons, the Swiss population then already had a high level of forming their political opinion and thus the ability to vote on extremely challenging and complex questions.
How then, after these numerous referendums, was the Swiss National Bank established? Its constitutional foundation is now enshrined in Article 99 of the Federal Constitution (BV):
Art. 99 Monetary policy
1 The Confederation is responsible for money and currency; the Confederation has the exclusive right to issue coins and banknotes.
2 The Swiss National Bank, as an independent central bank, shall pursue a monetary policy that serves the overall interests of the country; it shall be administered with the cooperation and under the supervision of the Confederation.
3 The Swiss National Bank shall create sufficient currency reserves from its revenues; part of these reserves shall be held in gold.
4 A minimum of two thirds of the net profits made by the Swiss National Bank shall be allocated to the Cantons.
Switzerland is integrated into the global economy, so the SNB must coordinate its actions with other countries. In September 2011, the SNB introduced a minimum exchange rate of CHF 1.20 for 1 euro to support the Swiss export industry and comply with the wishes of the ECB. Therefore almost half a trillion Swiss francs were newly “printed” which meant that the SNB put its head far above the parapet. As a result, mountains of foreign currency piled up in its balance sheet, mainly euros and US dollars. Everyone knew that the SNB had to do something one day.
On 15 January, it stopped this linkage and removed controls on the exchange rate.
The subsequent collapse of the euro and the dollar exchange rate is now leading to significant losses, which inevitably raise questions.
You hear and read again and again that the National Bank could not go bankrupt, because it could create any amount of money. This is not quite true. Other central banks are organized as state-owned banks, the state is liable for them and therefore they cannot be declared bankrupt. The SNB, however, is a stock corporation. A bankruptcy would therefore theoretically be possible.
UBS, for example, as a stock corporation went almost bankrupt six years ago – not because it ran out of money to pay its bills or wages, but because the losses in value of their speculative assets amounted to an extent that threatened to exceed its equity. The equity capital plus reserves does not only entitle the shareholders to a dividend, but is also liable for losses and has to compensate for them. If the losses are larger than the equity, the losses cannot be fully covered and the company goes bankrupt. This is the basic idea of a stock corporation which is governed by the Code of Obligations.
This is basically true for the Swiss National Bank as well – except that a special provision in the National Bank Act is binding for it, which – for obvious reasons – says that it can be dissolved only by political decision (i.e. by an Act adopted by Parliament). Therefore, it can – in theory – continue to operate when its reserves are fully depleted and its equity is resolved by the losses. However, there is the problem of credibility. How can the SNB request our big banks to hold more equity or more reserves when its own, not particularly high reserves are used up and it stays without equity?
How can the SNB form new reserves? The SNB cannot print its own reserves in the same way as it provides money to the commercial banks.
In a stock corporation equity capital and reserves can be newly created in two ways: The SNB may retain its earned profits and thus build up reserves. Only that will not happen overnight. Or equity capital or reserves are supplied from the outside, i.e. from politics or by the taxpayers. The bank must be recapitalized, as it is called in the jargon. This can be expensive.
As mentioned above, the reserves of the National Bank are not too high. However, it shares responsibility for it, because its reserve base has been weakened by itself in recent years. The reason is not only the gold sales, a topic that this newspaper has already discussed many times. In the postwar decades the former Board had set up hidden reserves to a large extent by entering the gold reserves permanently at a cost of 4,500 francs per kilogram. When the price of gold increased over the years, hidden reserves developed (valuation gain) amounting to dozens of billions. These hidden reserves have all been resolved, and the National Bank has turned to pay out the rise in prices of gold (i.e. the valuation gain in billions) immediately as cash gains to the Confederation and the cantons. If these reserves were still there, they could be used today to cover the high losses on foreign exchange. This would be possible without selling an ounce of gold. The reduction of hidden reserves, which had a long and blessed tradition in many companies in Switzerland as crisis prevention, was and is a mistake.
Today it is clear that the behaviour of the SNB in recent times has been contrary to the philosophy of the generations who – thanks to their hard work and their careful financial management – have enabled the SNB’s wealth formation. Printing money at will, as it is usual today, is inconsistent with the principles of sound financial management – not only in Switzerland. The SNB has again become firmly anchored in the population since 15 January because it has recovered the monetary and political sovereignty of Switzerland and is able to act again. There are quite a number of instruments to repel the foreign speculative funds – for example with a tax on speculation that it claims from the billions of dollars that flow into the country.
The type of policy that the population wants, i.e. the conservation of value and stability, has been clearly expressed in the 20th century through the changes in exchange rates. At the time of the founding of SNB, the pound sterling had a value of CHF 25 (today at 1.50), the American dollar was worth CHF 5.18 (today around 90 cents), 15 years ago the euro was worth CHF 1.60 (today 1 franc), etc. The value of the lira and the drachma (once equivalent to the Swiss franc in the Latin Monetary Union in the 19th century) has downright pulverized over the decades.
Today we are in a currency war. Big countries like the US, Japan and now the EU seek to devalue their currencies with unrestrained printing of money in order to be able to continue their debt economy and to gain small advantages in the global competition.
The SNB has pursued a different tradition since its foundation. History has proven that it was right. The economy has not perished since the founding of the SNB in 1907 due to the strength of the franc, as we see today. On the contrary. We can conclude that the fashionable flood of money that is being propagated downright by individual economists and the media, is not a good therapy to address mismanagement of all kinds. But it is a sign of the politicians’ inability and refusal to put their actions on a sound financial basis. The direct participation of the people in the Confederation and the cantons has certainly helped here.
It can be concluded that the direct participation of the people in the central issues of the monetary system and the economy has positive effects. The history of the Swiss National Bank in the 19th century is just one example. Numerous other votes on monetary policy and the gold reserves followed in the 20th and the 21st century. Overall, more than 100 out of 600 Swiss national referendums since 1848 have dealt with central issues of the monetary system, finances, taxes and the economy. •
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