“Trust is the hardest currency in banking”

Recently, the members of the Glarus Regional Bank (GRB) gathered for their annual general meeting. Peter Zentner, Chairman of the Board of Directors, presented an excellent 2022 business year. This had been made possible despite the difficult negative interest rate environment, despite Corona, inflation and the Ukraine war, because the locally rooted GRB “only does what it understands”. Managing Director Roman Elmer focussed the future on the basis of an unchanged starting position. GRB will remain “refreshingly sympathetic and down-to-earth”. Trust, he said, is the “hardest currency in banking”. Even the big banks had had to learn that.
  With 1588 members, the bank is neither “too big to fail” nor “too small to survive”. It was founded in 1928 and has experienced a lot – crises, wars, booms and, more recently, new financial crises – such as today’s crisis of confidence. this is a really great achievement accomplished by the motivated staff and the members of the cooperative, who give the bank a stable backbone, added Councillor Marianne Lienhard. Long-standing success confirms the basic idea of the numerous cooperative banks anchored in Switzerland. (“Fridolin” of 6 April 2023)

Fragile world monetary order

A look out into the world shows a completely different picture: today there is a lack of confidence in the world monetary order, as the events surrounding two American banks as well as Credit Suisse (CS) show. Other banks in various countries are also under “suspicion”. The authorities “pacify”, issue guarantees, try to prevent a “bank-run”, intervene massively as in the case of CS or the two American banks concerned. Yet the situation has not really calmed down. The outflow of money from the First Republic Bank in California continues even after its “rescue” (“Neue Zürcher Zeitung” of 26 April 2023).
  About fifty years ago, the Bretton Woods monetary and financial order with its gold standard and fixed exchange rates collapsed. Flexible exchange rates are now formed by the market. The convertability of gold was banned, so that central banks and to some extent also commercial banks were from then on able to create money out of thin air, as the title of Mathias Binswanger’s book “Geld aus dem Nichts – Money Out of Thin Air” puts it so beautifully.¹ Since that time money has no longer had any intrinsic value of its own, unlike in the past. It can be “printed” at will, or today it can be created electronically. This is called “fiat money”.
  Will this work? people asked themselves at the time. Can a “paper currency” that is no longer tied to anything create trust? The Glarus Regional Bank gave a positive answer with its business model. But otherwise? Financial experts continue to judge today´s situation as fragile. A look back:

On the history of the
 present monetary and financial order

The peoples of today have experienced various monetary and financial systems over the past two or three hundred years. In the decades up to the First World War, the classical gold standard applied. Money had its own intrinsic value in gold – independent of politics. Precious metals such as gold and also silver or copper have proven their worth as money in different cultures for two or three thousand years. These metals were scarce and could not be produced at will because their extraction was and still is laborious. The coins were often artistically designed. The most famous silver or gold coins in antiquity were the drachms with the owl, the city emblem of Athens. They were minted 2,500 years ago and were widespread throughout the Mediterranean region. In more recent times, the Vreneli, which was produced by the Swiss Federal Mint before and even after the First World War, was very popular and also elaborately designed. Today, the Vreneli is a popular collector’s item.
  It was not until the beginning of the modern era that, after the invention of letterpress printing, the idea of paper money emerged. From the beginning, the question of trust arose. We find a beautiful literary example in Faust II by Goethe: the emperor is plagued by money worries and he takes advice from Mephistopheles: “There is a lack of money, well then, create it,” says the emperor to Mephisto, who already has an idea: Use paper money. In Goethe’s Faust, the magical paper economy initially seems to solve all financial problems. The state can get rid of its debts, private consumption increases and there is an economic upswing. Later, however, the hustle and bustle degenerates into inflation, and the monetary system is destroyed as a result of the devaluation of money. (Goethe was finance minister to the Duke of Weimar. There was no paper money under his rule).
  This story in Goethe’s Faust had a real background. When the “Sun King” Louis XIV died in France, he left not only magnificent buildings like Versailles to his successor, but also a huge mountain of debt. So, Louis XV sought advice from the Scotsman John Law, who then showed him the way to get rid of his debts – by using paper money. The novel experiment lasted a few years until it collapsed. After that, the French wanted nothing more to do with paper money – apart from a brief experiment with assignats during the French Revolution (which also failed). Napoleon returned to the gold currency.

The Swiss monetary system

The Federal Constitution of 1848 gave the Confederation the right to mint coins. The Federal Mint minted the Swiss franc from silver – with the same silver content (4.5 grams) as the French franc. In the following decades, the Confederation also minted the five-franc coin from silver, as well as 56 million Vreneli with a face value of 20 francs (which can be bought today for about 400 francs). Somewhat later, gold coins with a face value of 10 francs and 100 francs were added. It was the time of the classic gold standard. 51 commercial banks issued their own individually designed banknotes backed by gold for 5, 10, 20 or 100 francs. These facilitated payment transactions, but were not legal tender. They could be exchanged for silver or gold coins at any time. This system functioned without a central bank. (The Swiss National Bank was not founded until 1906. It was given the banknote monopoly and standardised the system).
  When the Thurgau Cantonal Bank issued its own banknotes backed by gold, the president of the bank signed the first banknotes himself. The second half of the 19^th century was a relatively peaceful period with few wars. The classical gold standard worked quite well. It was the time of the industrial revolution. Roads, railways, bold railway projects like the Gotthard tunnel were built, numerous companies were founded ... It was a highly dynamic economic development that prepared the ground for today’s prosperity in Switzerland. Since most European countries agreed among themselves on the silver and gold content of their coins, it was possible to pay in Rome, Athens or Paris with the Swiss franc – without changing – because the silver or gold content of the lira, the drachma or the French franc was the same as that of the Swiss franc. This arrangement was simple and worked without the individual countries having to give up their currency. There were no bank failures in Switzerland during this period. It was a relatively happy, golden period almost without war. It was rightly given the name Belle Epoque.

Hyperinflation in Germany

The First World War was a disaster also for the monetary system. The gold standard was abolished and the printing press was used to finance the murderous war. Germany’s coffers were empty after the lost war, and the burden of reparations was pressing. The banknote press ran day and night until the value of the Reichsmark and the debts dissolved into nothing. Savers lost everything. The citizens were not to forget this experience quickly.
  After the Second World War, the Germans experienced something similar again. In the currency reform of the Federal Republic of Germany in 1948, citizens at least still received 1 D-mark for 10 Reichsmarks. But this was also a painful event. Internationally, the USA orchestrated a new monetary order.

Bretton Woods

On 11 July 1944, the later victorious powers adopted the Bretton Woods Agreement. 44 countries joined – including Switzerland. This was based on fixed exchange rates defined in gold and US dollars: 1 US dollar was worth 0.889 g of gold; 1 Swiss franc was worth 0.203 g of gold, so 1 dollar cost 4.37 Swiss francs. The fixed exchange rates could be changed by a complicated procedure if a country became heavily indebted. The USA used the US dollar as the global reserve currency. They promised to exchange every dollar for gold at any time – but this only referred to the participating central banks and no longer – as in the classical gold standard – to the citizens. The US dollar was as good as gold, said the US government, and so it was well suited as a trade and reserve currency. – Trust in the Bretton Woods order was based on a promise.

Swiss voters stick to gold backing

Now something happened that was unique in the history of money. In Switzerland, the electorate was able to vote on a new constitutional article based on the Bretton Woods promise. “The Confederation shall have the exclusive right to issue banknotes and shall determine the nature and extent of their backing”, this new Article 39 of the Federal Constitution stated. The Confederation could therefore have replaced gold by the dollar – altogether or in part –, as the US government recommended. The Swiss authorities, parliament, Federal Council and the management of the Swiss National Bank recommended that the electorate put a Yes in the ballot box. Things turned out differently.
  Even though the voters had only witnessed the two currency reforms in Germany on the side-lines, more than 61.5 percent of them voted Nay on 2 May 1949. Almost all cantons voted Nay. Two years later, on 15 April 1951, they approved a constitutional article that contained the central sentence: “The banknotes issued must be backed by gold and short-term securities.” This was legally possible – but not to the liking of the Americans, who considered their own currency as good as gold. The National Bank Act had already stipulated those banknotes – which were already not cashable at the time – had to be at least 40 percent backed by gold. Now, however, the gold coverage was anchored in the constitution, which meant that it could not be abolished without the consent of the people and the majority of the cantons. More than seventy-one per cent of the voters and all cantons approved.

How were the  two referendums implemented

At that time – as today – Switzerland mostly achieved surpluses in its current account, i.e. it usually exported more than it imported and thus achieved a surplus. The SNB (Swiss National Bank) now set an upper limit for its dollar reserves. As soon as this was reached, the excess amount would be converted into gold with the Americans. The SNB “turned” its dollars to gold, as this was called in the banking jargon of the time. The SNB describes this process as follows in its anniversary publication of 1981:
  “Until 1971, the SNB was able to convert a surplus of dollars into gold at a price of 35 dollars per ounce at the American Treasury, although the Americans were increasingly reluctant to make such conversions. If, on the other hand, transactions on the foreign exchange market resulted in a net outflow of dollars, the National Bank sold gold against dollars to the American monetary authorities in order to replenish its foreign exchange holdings.” (Swiss National Bank 1981, p. 237f.)
  Since during the boom, the Swiss economy was constantly generating surpluses, Swiss gold reserves rose in this way from about 800 tonnes after the war to over 2600 tonnes in 1971. These 2600 tonnes of gold (booked at 4,700 francs a kilo) were to become a political issue 40 years later. In the 1960s, other countries also distrusted the dollar, of which the Americans were printing more and more to finance their war in Vietnam. De Gaulle even sent a warship to New York to pick up the French gold.

Breach of trust and systemic change
 towards flexible exchange rates

In 1971 – when the Vietnam war was at its peak – President Nixon announced that he would close the “gold window”. That meant that the US dollar was no longer convertible to gold as had been promised after the second world war. This was the end of the Bretton Woods currency system with its fixed exchange rates. Switzerland was the first country to introduce flexible rates on 23 January 1973. The Dollar plummeted from 4.37 to about 1.35. The Swiss National Bank suffered heavy losses with their dollar reserves, but these were covered by the gold and hidden reserves.
  It came as a shock for the economy worldwide. Practically all countries went into recession. In Switzerland 300,000 jobs were lost. The FED tried to stimulate business activity with helicopter money and low interest rates which mainly increased inflation. Stagflation ensued. Economy stagnated and inflation increased at the same time – in the US up to 2digit figures. What was to be done?
  Paul Volcker was elected president of the US central bank FED in 1978. He managed to somewhat stabilise the US dollar even without gold convertibility and establish it as a new lead currency: he raised interest rates into the double digit range as well. Moreover, the US secured a treaty with Saudi Arabia. Their petrol was to be traded in dollar only. Indirectly, the US dollar had a material backing again that way. In return the government offered military protection. The petrodollar as the new lead currency without gold convertibility was born. The Dollar increased in value again and interest rates and exchange rates could be brought back to normal, economy was put back on a more or less normal track within a few years. The pressure to increase the value of the Swiss Franc decreased.

Gold keeps guaranteeing sovereignty

Swiss gold reserves in the seventies might be compared to a forest up in the Alp mountains which protects people living below from avalanches. Strategic gold reserves were big enough and no politician even entertained the idea to touch those reserves, just like nobody would ever cut down a forest in an avalanche risk area.
  In a 1981 festschrift of the Swiss National Bank this is made explicitely clear:

• “[…] mainly for three reasons the SNB was interested in maintaining the role of their gold reserve: gold seemed to guarantee stable exchange rates; being backed by gold – rather than the US-dollar, unlike many other currencies – the political independence of the Swiss franc seemed to be secured; gold was a symbol for the solidity of a currency”.
• “Although gold had lost all crucial monetary functions the national bank regarded the gold reserve as a valuable asset; its ever increasing market value compensated for the high losses in the dollar reserves during the late seventies”. (p. 237/238)

Attack on Switzerland from the USA and subsequent sale of most of the gold

This changed in the nineties. Switzerland was attacked from the USA in a concerted assault. Their narrative alleged that the Swiss banks were hoarding tons of gold in their cellars the unknown legitimate owners of which had disappeared during World War II. This way the gold appeared to be somehow connected to Nazi Germany in the public imagination. – It was a horrible concoction. In a second phase the attack was extended to target the concept of banking confidentiality. The Swiss Federal Parliament (Bundesrat) created a commission who were to look into the allegations. Former US Federal reserve bank president Paul Volcker was the chairman. The elaborate counter-measure cost more than a billion Swiss francs. – The commission managed to identify unaccounted deposits worth about 50 million Swiss francs from the time of the second world war. The two major Swiss banks paid 1.8 billion francs to holocaust survivors.
  At the same time domestic Swiss politicians claimed the gold reserve to be superfluous and suggested to sell it off and distribute the revenue. In the new Federal constitution of the year 2,000 the Swiss National Bank was charged to keep only a fraction of their reserves in gold. Therefore, the SNB sold 1,600 tons of gold for less than 300 US dollars per ounce between 2003–2007 – with the explanation, those gold reserves were superfluous. All these US-dollars were piled up on top of the gigantic heap the SNB already had in their possession. The amount of gold that was lost, or rather “sold” this way, was more or less equivalent to what the post-war generation had managed to accumulate in the fifties and early sixties. The Swiss National Bank had made a huge step towards dependency of the US-dollar system which the Swiss electorate had explicitly rejected in two referendums in 1949 and 1951.
  In 2022 the SNB was unable to compensate for the devaluation of the most important foreign currencies as well as losses at the foreign stock exchanges, resulting in a huge deficit of 132 billion Swiss francs. Presumably the SNB board of directors would be happy if the gold and hidden reserves of the post-war generation was still there.
  It is not only the strange fact that the SNB had sold the gold for a dumping prize without necessity – their activities beg further questions: The gold belonged to the Swiss post-war generation and had been acquired as a result of two explicit referendums. Principles of Swiss direct democracy would have demanded to put the question before the Sovereign to ask, whether the people agreed with the transaction to sell the gold. That did not happen. This created a disastrous precedent. It is fair to assume that the gold would still be there had a referendum been held, which would be quite helpful in today’s situation.
  In 2002 a referendum was indeed initiated, but not about the question whether to sell or not, but about how the revenue should be spent: everything for the pension fund or money for the federal and cantonal governments as well as the solidarity endowment. People rejected both “alternatives” with a clear margin and protested this way against the fact that they had no say in the only relevant question – to sell or not to sell. (At the end of the day the SNB distributed what they had earned from the deal without a referendum: one third for the federation and two thirds for the cantons, according to their usual rules.)
  There are more questions to be asked – what made the SNB change their mind? Only a few years after the gold reserve had been referred to as “valuable asset” and a “symbol for political independence and solidity of the currency” in their annual report of 1981, the same gold was dismissed as “superfluous”. How did this U-turn happen? Especially the post-war generation, who had worked hard for this gold reserve, have a right to pose this question.

The Swiss franc as a safe haven –
 back then and today

Financial transactions in Switzerland were monitored closely from abroad and many foreigners had entertained the idea to open Swiss bank accounts. Especially when it became public knowledge that it was no longer the US dollar which was as good as gold, but the Swiss franc – and mainly among affluent people in Germany, who had every reason to be suspicious of their own currency in view of its history during the 20^th century.
  This development became problematic when the Swiss franc was discovered by gamblers who started to bet on its value going up. From their point of view that made sense: in 1977/78 for-instance, the Swiss franc was upgraded by 40 percent against the 15 main currencies in the system of flexible exchange rates. Switzerland became expensive indeed. The exchange rate backfired on both export and tourism industries. What was to be done?
  The SNB came up with counter measures such as low interest rate policies and even moderate negative interest of –1 percent as early as the sixties – quite similar to what we have seen recently. This was by no means sufficient. Later they established capital transaction control emergency mechanisms. Gamblers poised for buying Swiss francs had to pay 2 percent negative interest in the beginning, later 8 and finally 12 percent and more. The people supported the SNB in these efforts in two referendums. In fact, it was not always easy for those in charge to make the distinction between speculative capital and normal business transactions.

Today

The gold of the post-war generation is lost. After the 2008 financial crash it became clear though, that the Swiss franc had not lost its reputation as a safe haven. Despite the marginalised role of gold-backing in the reserves of the SNB (only 7 percent) the Swiss franc was upgraded against most other currencies. Likewise, the turbulences around the Credit Suisse have not really challenged the status as a financial safe haven. The political stability of Switzerland, a competitive and diverse economy, the export surplus, a solid federal budget and low inflation continue to be important trump cards. Moreover, it became clear that the high number of regionally established co-operative and cantonal banks in Switzerland are doing quite well even in today´s system – unlike the globally oriented big banks.
  Once again the SNB has established financial counter-measures reminiscent of the seventies because some problems are similar. Until recently the SNB charged negative interest and established a minimum exchange rate to the Euro of 1.20, (just like the minimum exchange rate to the German Mark in 1978). However, no capital transfer control mechanisms were established. The influx of Euros, US-dollars etc. was bought off and paid for with newly-created Swiss francs by the SNB. The acquired foreign capital was used to purchase German and US-American government bonds and also shares of foreign corporations. The SNB surplus kept growing from one hundred million to two hundred million … up to one billion Swiss francs. This policy is part of the efforts to make sure the Swiss franc will not jeopardise exports by getting too strong. There is practically no inflation because the newly-created Swiss francs remain in accounts within the domestic banking system, often for saving purposes.
  For the layman the policies of the SNB look rather hazardous. Euro and Dollar keep devaluating due to inflation being higher in Germany and the US as compared with Switzerland. Conceivably the introduction of capital transfer control mechanisms would make sense now, since hedge fonds keep betting on flexible currency exchange rates going up or down with huge amounts of capital. One notorious example is George Soros, who spent billions to bring down the Sterling in the nineties (and succeeded).
  It is rather surprising that the strong Swiss francs has not weakened the export industry but even strengthened it over all. Entrepreneurs take the devaluation tendencies of the Euro and Dollar into consideration and they know they have to be on the alert to compensate for this disadvantage. Since the Euro was created in 1999 it has lost about 40 percent against the Swiss franc, the dollar has lost 80 percent since Bretton Woods and the Sterling 90 percent.

Alternatives to the dollar system

Instability is part and parcel of today’s monetary and financial system. Crises have kept coming and going: for-instance the big debt crisis of the developing countries in the eighties (triggered by the US-federal reserve raising interest rates), the Japan crisis, the Asia crisis, the Russia crisis, the dotcom crisis, the real estate crisis in the US in 2008 … and today a crisis in general trust. Each of those crises had their peculiar reasons. But in the background, there is always the systemic instability of a monetary system with flexible exchange rates. Today the amount of private and public debt is unsettling in many countries. The “money printing machine” fuelling inflation has become a favourite political tool. FED and ECB keep hoovering up debt and increase the monetary volume with newly-“printed” money. Financing wars with the «printing machine» is still popular.
  Today the central banks face a dilemma. If they increase interest rates both the banking systems and the economy get into trouble, if they don’t the inflation will exert its destructive consequences.
  Several months ago, the USA have frozen Russia’s dollar reserves although they are not even at war with this country officially. Afghanistan had made similar experiences in the past. Several countries will try to find ways out of the dependency on the dollar. Media reports suggest that the BRICS countries are working on an alternative to the dollar system which would be backed by gold and natural resources. The end of the petrodollar is already looming. More and more, oil and other goods are traded in Yuan or other national currencies. The world is heading for multipolarity. Will the concept of a globally oriented Swiss big bank still fit in there? Time will tell.  •

¹ Binswanger, Mathias. Geld aus dem Nichts, Wie Banken Wachstum ermöglichen und Krisen verursachen. (Money out of Nothing, How Banks Enable Growth and Cause Crises.), Wiley 2015

Literature:
Wüthrich, Werner. Wirtschaft und direkte Demokratie in der Schweiz, Geschichte der freiheitlich-demokratischen Wirtschaftsverfassung der Schweiz. (Economy and direct democracy in Switzerland, History of the liberal-democratic economic constitution of Switzerland.), Verlag Zeit-Fragen, Zürich 2020