The Swiss franc and direct democracy (part 2)

From Bretton Woods to a “Monetary policy without barriers”

by Dr rer publ Werner Wüthrich

In part 1 of this series (Current Concerns No. 22 of 27 September 2016) it was shown how the monetary system in Switzerland developed during the period of the classical gold standard and how the people set the course in numerous national referendums – often against government and parliament. In the thirties, the last remnants of this monetary order were dissolved, in which the central factor had been that banknotes might be converted into gold. A new monetary order became apparent, and in Switzerland, once again the people were to set the course on central issues.

The Swiss National banc in Berne. (picture snb)

Even before the end of the Second World War, in 1944, the US initiated a global monetary agreement in Bretton Woods (USA) – the gold exchange standard.

Bretton Woods

The Bretton Woods agreement was based on fixed exchange rates, defined in gold and US dollars. These were calculated as follows: 1 dollar = 0.889 g of gold;
1 Swiss franc = 0,203 g Gold => 1 Dollar = 4.37 Swiss francs. If a country got itself into serious debt, the exchange rates could be changed, but only via a complicated procedure.
The US attributed the function as a global lead and reserve currency to the US-dollar, and it declared its willingness to convert the dollar to gold at any time. However, this obligation only applied to central banks and no longer – as with the classical gold standard – to citizens.
At first sight, the US offer seemed tempting. However, it laid the foundation for the dependence of the nations of the world on the US dollar.

How did Switzerland react?

In 1949, Federal Council and Parliament were busy drawing up a new monetary article for the Federal Constitution. Article 39 contained the central clause: The Confederation has the exclusive right to issue banknotes and determines “type and extent of their backing”. This arrangement would have given the Confederation or the National Bank a free hand to back banknotes by US dollars instead by gold, as the US government at that time suggested to the countries involved in Bretton Woods. This was followed by one of those polls, in which the political class danced to a different tune than the people. While Federal Council, Parliament and National Bank were almost unanimous in their approval for the legislative proposal, the people, on May 2, 1949, voted against it by a large majority of 61,5 percent. 22 of 23 cantons were also opposed.
In accordance with this popular decision, Federal Council and Parliament devised a new currency article. This time, Article 39 contained the central sentence: “The issued banknotes must be backed by gold and short-term credit.” Indeed, the National Bank Act had already stipulated before, that the banknotes (which at that time were no longer redeemable against gold) had to be backed by gold to the amount of at least 40 per cent. Now the gold backing was to be anchored in the Constitution.This time 71 per cent of the electorate and all cantons voted in favour. – This vote shows the very well-functioning cooperation between people, parliament, executive and national bank in a central question of the monetary system in the direct democratic state.

Implementation of the Constitutional provision

The Swiss National Bank (SNB) stabilised the exchange rate as set out in the Bretton-Woods agreement (1 US dollar = 4.37 francs) as follows: At that time Switzerland mostly achieved surpluses in the balance of goods and services – as it is today –, i.e. it took in more foreign currencies (especially dollars) than it spent in foreign trade, so that its stock of dollars grew. The National Bank set an upper limit to the amount of their dollars, which it raised over the years. Once this limit was reached, the surplus was converted into gold. The bank “turned the dollars to gold”; that was the jargon in those days. The SNB describes this process in its 1981 Jubilee Report as follows: “Until 1971, the National Bank was capable to convert a surplus of dollars into gold, which it bought from the American Treasury at a price of $35 an ounce, with the Americans becoming less and less happy with such transformations. If, on the other hand, the transactions on the foreign exchange market resulted in a net loss of dollars, the National Bank sold gold against dollars to the American currency authorities in order to replenish its foreign exchange holdings.” (p. 237f.)
As already mentioned, the economy almost always achieved a surplus in the Swiss boom in foreign trade, and so the gold reserves rose from about 800 tons after the war up to 2,600 tons in 1971. After that, they practically did not change until recently. That is, these 2,600 tons of gold were to become a political issue forty years later.

Swiss franc as a safe harbour

The Swiss franc had the reputation of a hard currency as hardly any other currency did. It was therefore rightly considered to be as good as gold, even though the banknotes could no longer be redeemed. It is not surprising that foreign investors - especially from countries which were pursuing a completely different policy – started to pay attention and to shift some of their savings to Switzerland. This also included speculators who wanted to benefit from future revaluations. This was not only positive – as we can see nowadays. When the banks and the SNB increasingly exchanged foreign currencies into Swiss francs, this led to an increase of the volume of money in the homeland, and a risk of inflation arose. This danger was all the greater because in the boom period of the post-war decades there was alsways a tendency of inflation in any case. The order books were overflowing, and the economy was more than busy.

First defense actions against pressure from outside

As early as the mid-1950s, the banks agreed to pay no interest on new foreign money in an internal agreement (Gentlemen’s Agreement). Soon, a negative interest rate of 1 percent came about, which meant that investors from abroad no longer received interest, but paid a commission of 1 per cent. However, the currency situation did not relax. Because of the economic overheating, in 1964 the Federal Council and the Parliament passed, via emergency law, an urgent federal decision on the fight against inflation by means of measures in the areas of the money and capital market and the credit system. This also included the negative interest rate. As this decision, which was in violation of the constitution, was nevertheless immediately put into effect, it had to be submitted to the people within a year. This is also a special feature: in 1949, the people had accepted the initiative “Return to direct democracy” and thus had given themselves the right to vote subsequently on emergency law.
This right of the people had been rejected by all four major parties in parliament, as they felt that the emergency law was not appropriate for a referendum because of its urgency. The people disagreed. At that time, the people wanted to draw a line after having had a long time with a lot of emergency law, all withdrawn from the optional referendum – especially in the thirties. Various groupings submitted a number of popular initiatives to end this unsatisfactory state (cf Current Concerns No. 17 of 30 June 2015, “How to protect direct democracy in difficult times?”). On 28 February 1965 there was a first vote on emergency law. The topic was ambitious. To the astonishment of the politicians (who had no confidence in the capability of people to deal with such topics), 80 per cent of the people voted in favour of the policy of the Federal Council, Parliament and the National Bank. Other urgent federal decisions to slow down the economic, which were based on emergency law, such as a credit limitation, were also adopted by a large majority in the following years. The Swiss electorate expressed its confidence in the authorities and the National Bank as it had seldom done before.
However, the defence against foreigners’ money was challenging for the SNB and the commercial banks because it was often not possible to determine unequivocally whether a transfer of funds was made for the use of normal trade or a service (which should not be hindered) or whether there were short-term speculative intentions behind it.

Defense measures are tightened

The situation on the currency front continued to become more exacerbated, so that the Federal Council and the National Bank prepared effective defence measures. The main reason lay abroad.
Already in the first half of the sixties the US sent troops to Vietnam, and the war escalated quickly. Observers were correct in conjecturing that the US had largely paid for this war – as has often happened – via the money-printing press. This was the straight path to a permanent undermining of the partly gold-based monetary regime. Even other currencies were “wobbly” for similar reasons. France carried on a murderous war in Algeria for seven years. Great Britain was weakened after the Second World War and gradually lost almost all of its colonies. The country had to reinvent itself and devaluated the pound three times in the post-war period, to get out of financial distress. In addition, the proud Bank of England was nationalised, that is, it lost its independence and was to receive instructions from the Chancellor in the future. The English pound, worth 25 francs at the time of the Empire, began its descent. (Today the course is only 1.20 francs). These were all reasons that led some citizens to doubt the stability of the international monetary system. Those looking for a safe haven for their savings opened an account in Switzerland, or they bought securities or real estate. In addition, there were more and more “speculative funds”, which sought to capitalise short-term on the existing uncertainty. Quite a few people may have thought that if a country prescribes gold coverage in its constitution and even lets the people vote on it, you can really trust its currency. And you never know what will happen in the future. Contrary to the politicians’ different assurances, there were real reasons to doubt the stability of the monetary system.

The Vietnam War escalates

In 1971 – at the height of the Vietnam War – US President Nixon announced that he would close the “gold window”. In other words, the US would no longer trade their dollars against gold to foreign central banks, as they had done since the Second World War. The background was that the US had high foreign debts due to the war and was interested in repaying these with devalued dollars, which it would no longer have to exchange for gold. In this way, foreign countries were to co-finance the murderous war in the Far East. This process accelerated the end of the long boom after the Second World War, and a systemic correction in the monetary system was ushered in.
A real flood of dollars inundated Switzerland, and the banks took a whole series of further defensive measures. On
8 October 1971, the Federal Council submitted a further urgent federal decision to the Parliament, which would give the government new and far-reaching powers – even more than those of 1965. This time it was an emergency law which was immediately put into effect, with the people having the right to vote on it within a year, according to the ruling which they had established themselves in 1949. And again the politicians were amazed: On
4 June 1972, the people approved the politics of the Federal Council, the Parliament and the National Bank, with a rare 87.7 percent of “ayes”. So much support had probably never yet been received by the authorities.
As early as 1971, the Swiss franc had been officially revaluated by 7 per cent, which had had little effect.

The uncertainty remained and inflation began to rise threateningly.

At the beginning of the 1970s, it rose to over 7 per cent, in 1973 to 9 per cent and in 1974 to 10 per cent.
In 1972 the Federal Council passed an urgent federal decision on the surveillance of prices, limited to five years. Even this time people agreed again with about 60 per cent of “ayes”. At the same time, the Federal Council and the National Bank were weaving tighter the meshes of their defence network against the speculative billions. The negative interest rate of 1 per cent was significantly increased. The currency fluctuations were so massive, that the negative interest rate of 1 per cent had no effect, and therefore it was drastically increased. From 1972 on, it amounted to 2 per cent per quarter, in 1974 this had already been increased to 3 per cent, and the negative interest rate would continue to rise. The objective was clear: the negative interest rates were directed against funds that did not seek a long-term investment in Switzerland, but wanted to achieve short-term currency gains, so to speak over night (SNB Anniversary Report 1981, p. 230). The aim was not to hinder money transfers from normal business transactions, but as already mentioned, it was not always easy to distinguish between the two. Attacks on foreign currencies, as they would occur time and again later on, could be fended off in this way. In 1992 for example, George Soros attacked the (overvalued) English pound, thereby “earning“ billions. Other rigorous measures followed in those years. For example, the import of larger cash imports over the borders was prohibited. The investment in securities or the purchase of real estate by foreigners was made more difficult. With the end of the economic downturn in the mid-seventies, however, inflation declined again to almost 1 per cent, and rose to 4 per cent towards the end of the 1970s. It is interesting to see what the negative interest rates were used for at the time.
The funds did not remain in the cash register of the banks or of the national bank but were destined for the export risk guarantee. This is an insurance subsidised by the state which covers the export economy’s foreign risks to a certain extent, including currency risks. At the time this was even more vital than today.

Transition to flexible exchange rates: global change of system

On 23 January 1973, Switzerland was the first country to let its exchange rate float, and the SNB ceased to support the dollar rate with purchases. However, shortly after that the dollar exchange took a tumble again, and the National Bank resumed its support buyings. The situation remained uncertain. The SNB described these days and weeks as follows: “[…] even with favorable price developments, one never knew whether a revaluation boost was to be expected for the next day”. The urgent federal decision of 1972 was limited to three years. When the situation did not ease, Parliament and the Federal Council decided in 1975 to renew it. On 8 June 1975 the people also agreed to this decision with 85 per cent of “ayes”.
The situation remained tense. In 1977/78, the Swiss franc gained approximately 40 per cent in value versus the 15 most important trading countries in just two years (SNB report 1981, p. 375). The situation persisted in remaining difficult for the export industry and tourism – it was much more serious than today. The US dollar as world currency had collapsed from CHF 4.37 in 1971 to the extreme of CHF 1.45 in 1978.
In 1978 Parliament renewed the urgent federal decision of 1972 decision once more. This time, no popular vote took place, as the people had in the same year, with 68 per cent of votes in favour, agreed to a new economic article which now sufficed as a constitutional basis. It is striking to what extent voters supported the policy of the authorities and the National Bank throughout these difficult years.

Why did the Deutschmark collapse despite a stable economy?

Towards the end of the seventies, there were new difficulties. In the first half of the seventies, the US dollar in particular was targeted by speculators. In the second half of the seventies, a second important currency came to the center of attention – the Deutschmark. The German Bundesbank had always pursued a staid policy, and the D-Mark was regarded as stable in value. In the sixties It had even been upgraded twice because the FRG had a clear surplus in its balance of goods and services and therefore earned more dollars than it spent. Yet even this favourable situation was not enough to keep the DM stable in comparison with the Swiss franc. It also lost in value, and this downward trend just would not end. Originally the Deutschmark cost 1.20 Swiss francs in the Bretton Woods system. The course sank more and more to the extreme of 75 Swiss centimes. This development was once again dramatic for our domestic export industry and tourism, because the Federal Republic was Switzerland’s most important trading partner and now the holidays in Switzerland had become really expensive for German guests. The reasons for the decline of the D-Mark were, above all, psychological. No one knew whether the new system of flexible exchange rates would prove successful. In that same century, the citizens of the FRG had already twice experienced a currency reform, in which many citizens had lost all or almost all of their savings. This must not happen again, some might have thought and so they opened an account in Switzerland. This time, however, their caution was without a realistic cause. The D-Mark was really stable and became a symbol for the economic miracle of the post-war period, so that forty years later the population were very reluctant to abandon its marks for the euro. Most of them would not have agreed to this change, had they been allowed to vote. For the Swiss National Bank, the decline in value of the Deutschmark towards the end of the seventies was again a sign for alarm. Tourism and the export industry were already badly shaken by the dollar crisis and the massive slump in other currencies such as the English pound or the French franc. The weakness of the Deutschmark further aggravated the situation. In 1978, the National Bank reacted by introducing a new instrument. Similar to a short while ago today, it set a minimum exchange rate. The SNB announced that it would intervene i.e. buy Deutschmarks without restriction, should the DM rate fall below 0.80 francs. That was a clear signal.
After that, the situation on the currency front gradually calmed down, so that the Federal Council and the National Bank were able to begin reducing their defensive mechanisms. In 1981, the last of the measures, namely the ban on interest on foreign money, was completely abolished.

FED stops the money printing press

It was a controversial issue among experts what actually contributed to the normalisation of the Swiss Franc exchange rate – the long-standing defense dispositive, which was primarily directed against the speculative billions, or the minimum exchange rate for the Deutschmark? – But it was undisputed that an event in the United States was of significant impact.
Paul Volcker was elected Chairman of the US central bank, the FED, in 1978. He put a stop to the trendy money printing, or quantitative easing, as we would say today, and increased interest rates. Previously, the FED had – very similarly to today – tried to stimulate the stagnating economy with a flood of money and to devalue the Vietnam war debt by means of a controlled inflation – a process that we can also observe today. But it did not work. In the United States, inflation rose uncontrollable to around 15 per cent, and the unemployment rate rose to 10 per cent. Economists call this stagflation – a very difficult situation, where the economy stagnates, high unemployment dominates and yet, at the same time, the inflation accelerates. Paul Volcker did not only make friends when he raised interest rates in this situation, despite the unemployment, in order to get the severe inflation in the United States under control. This would only serve to strangle the economy completely, complained some politicians and economists. Volcker was not deterred. The dollar rose again and it was possible to normalise interest rates and exchange rates. Within a few years the economy was in tolerably normal channels again. This event was crucial in ensuring that the appreciation pressure on the Swiss Franc eased.

High gold reserves balance losses of the SNB

What was the financial situation of the Swiss National Bank in those years? Similar to today, the SNB intervened once and again and bought dollars and foreign currencies to support the exchange rate. And similar to today, it suffered large losses, mainly because the dollar and then also the Deutschmark were ever more on the decline. In 1978 the SNB’s large, proven reserves, which had been built up over many years, were completely exhausted, and francs instead of an equity, the SNB recorded a loss of about 2.6 billion – a negative equity one would say today. This was an uncomfortable situation, in which a normal stock company would be looked at as bankrupt. This situation lasted for two years. But as the SNB had silent, unaccounted gold reserves it was not all that bad: The SNB owned 2,600 tons of gold, which were recorded in their books at 4,595 Swiss Francs per kilogram. In 1978/79 – at the peak of the monetary turmoil – the dollar-exchange rate fell from initially 4.37 SFR to 1.40 SFR and the price of gold rose to an extreme of more than 70,000 SFR per kilogramme. This resulted in undisclosed reserves of approximately 65,000 francs per kilo and a total of 200 billion francs – a very large amount at that time and even today.
According to the accounting rules, one could cover losses with undisclosed, hidden reserves and balance the budget, without having to sell as much as one gram of gold. So the SNB was able to write in its 1981 report, “The losses were by far counterbalanced by the hidden gold reserves [...]” (report SNB 1981, p. 329). The people had decided in two referendums in 1949 and 1951 to rely on gold and not dollar, which became a blessing twenty years later. The dissolution of hidden reserves was not necessary.
The gold had proven itself as a last line of defence. In the following years the SNB again generated sufficient resources of its own to build up new reserves and come to a positive equity again. – As positive as this experience was, the gold and the associated hidden reserves should become a point of contention twenty years later.

Uniquely strong support by the people in the 1960s and 1970s

Looking back one can state: the defensive measures of the Swiss National Bank against excessive appreciation of the Swiss franc in the sixties and seventies consisted of four pillars:
1.    the negative interest rates, directly aimed against the “speculative billions”
2.    the minimum exchange rate for the German Mark
3.    the large gold reserves of 2,600 tons – associated with high hidden reserves
4.    the uniquely strong support of the people: The voters – and since 1971, also women had a right to vote – in referenda supported the policy of the authorities and of the National Bank again and again with more than 80 per cent of votes in favour. A healthy monetary system and a stable Swiss Franc was of great importance to the citizens.

Switzerland adheres to gold coverage

With the suspension of gold convertibility of the dollar in 1971, gold lost its central role in the currency system. Also with the transition to flexible exchange rates the link to gold was given up, that is, exchange rates were no longer defined in gold.
The provision to cover the banknotes in circulation to a large extent with gold, which had been included in the Federal Constitution since 1951, was still valid, so that nobody seriously considered selling the gold reserves at that time (as it later happened). On the contrary, a phenomenon that can still be observed today became evident: The stronger the turbulences in the currency system, the higher the price of gold. Until the beginning of the 21st century the SNB owned about 2,600 tons of gold, which were available in turbulent times as reserves – valued in the SNB’s books at 4,595 Francs per
This policy reflected the long tradition in many Swiss companies to very discreetly build hidden reserves for emergency situations by undervaluing assets. So the SNB was well able to cover its partly massive losses on foreign currency – especially on its dollar holdings – in the 1970s.

Gold as a guarantee of independence

In the seventies, gold functioned like a protective forest, which protects the mountain population from avalanches. For the state or the taxpayer there was never a danger that they would have to bail out their National Bank. Gold was no longer needed for the actual monetary policy. It had become a strategic reserve, and no politician came up with the idea of even touching it, just as in the mountains, no one would think of cutting down a protective forest.
This is clearly reflected in the 1981 SNB’s anniversary memorandum:
–    “Although gold had lost all its essential monetary functions, the National Bank regarded its gold holdings as a valuable asset; in the late seventies the rising market value of its gold holdings allowed it to absorb the high price losses on its dollar deposits.”
–    ”The SNB was concerned with safeguarding the role of gold [...] mainly for three reasons: Gold guaranteed fixed exchange rates; the association of the Swiss franc with gold – and not with dollars like so many other currencies – promised to ensure its political independence; and also gold was a symbol for the soundness of a currency.” (p. 237/238 of the German edition; [emphasis by Current Concerns])

Undeclared paradigm shift in the completely revised Federal Constitution of 1999

After the introduction of the new Federal Constitution in 1999, however, the attitude of the National Bank, the Federal Council and the majority in Parliament changed fundamentally. Already in the 1990s, the SNB had begun to speak of “surplus reserves” and more explicitly of “excess gold reserves”. It would be possible, it was said, to sell more than half of the gold and to dissolve the hidden reserves on it. And so it happened: 1,300 tons of gold were sold in a first step – after the legal obstacles had been eliminated by the new Federal Constitution. There was something new to be noted in this procedure, namely that the electorate was bypassed in the decision to sell. This had not been the practice in the decades before, when the federal authorities had observed the direct-democratic rules. It is true, that on the completely revised federal constitution with its about 200 newly formulated and redesigned articles, a vote had to be taken. However, three weeks before the vote, the people had been informed as follows: It was given out that new federal constitution was unchanged in content, and that it was only a formal and stylistic update. This was an example of crass misinformation and effectively “the Fall of Man” in the history of direct democracy, and it would have major aftereffects.
Without informing the citizens of the consequences, Article 39 of the old Federal Constitution was deleted, which in paragraph 7 contained the sentence: “The banknotes issued must be covered by gold and short-term credit.” It was replaced by Article 99 (3): “The Swiss National Bank provides sufficient currency reserves from its income; some of these reserves are held in gold.” This “small difference” changed the situation fundamentally. For the first time since its founding, the SNB had the full competence to decide more or less freely on its gold reserves. And what it wanted was to use this freedom for massive sales – in agreement with parliament as well as Federal Council. US attacks against the Swiss financial center and against the Swiss currency had preceded this. These attacks had been poorly apposite to the sprawling paper money world with its ever growing debts. The Swiss franc, which was so strongly anchored in the people, was in the way, as it showed the world that a different monetary policy was possible. – It would have been imperative to allow the sovereign to take a decision on the sale of 1,300 tons of gold, since it was the Swiss people who had in 1951 voted in a constitutional amendment stipulating the accumulation of gold reserves, and it was also they who had by means of their efforts in the following years accumulated the surpluses which were then largely converted into gold.
The Swiss National Bank was not the only bank to sell gold in the new millenium. It was a Washington-led action (Washington Agreement), involving 15 European countries. Other countries joined, such as Canada, and so did the IMF (but not the US).

SNB begins to sell off large portions of its gold stocks

In Switzerland it was not just a matter of gold sales. The hidden assets on the gold were also completely dissolved.
Instead of forming reserves, the SNB began to distribute billions of its high profits to the Confederation and the cantons. Without giving this too much thought, many a citizen will have felt that as the SNB provided the Confederation and the cantons with free money, this might contribute to lower taxes for the ordinary citizens. There were other new and no less curious elements in the SNB’s policy: As early as in the 1990s, it began to make money by lending gold to banks and to hedge funds speculating on a falling gold price. That is, they sold the gold that had been lent out and speculated that they would later be able to buy it back at a lower price and then return it to the SNB. In 1999, for example, 316 tonnes of gold were alienated for this purpose. The risk for speculators was not so great at that time because several issue banks were selling gold and therefore its price was falling. – It became increasingly clear that the SNB no longer regarded its gold as a strategic reserve, but rather as a kind of manipulation mass which could be used for various purposes. Thus, the increase of the price of gold was no longer used in a traditional way to create hidden reserves, but was used as a valuation gain to pay billions to the Confederation and the cantons.

Popular sentiment after the sale of the gold reserves and untenable accusations from the US

There followed a whole series of referendums, in which, however, the sale of the gold reserves was no longer in question; it was all about the use and distribution of the proceeds from the sale. It is striking that the attitude of the population towards Federal Council, Parliament and National Bank changed.
While in the sixties and seventies the people had provided ongoing support to authorities and National Bank several times in votes with more than 80 per cent of yeas, now followed a whole series of nays – no was said to the politics of the authorities, but also to individual national initiatives.
The voters had been passed over in the decision-making process over a central question in the monetary system, and their disappointment was great. So was the protest. There was much skepticism in regard of the authorities’ policies.
To be sure, there was more than one referendum, but only about the use of the proceeds of about 21 billion Swiss francs from the gold sale. Parliament proposed that this money be used by a third for the so-called Solidarity Foundation, the old age and survivors’ insurance (AHV) and the cantons. The idea of a Solidarity Foundation had been raised by federal councillor Koller in 1997. He imagined the contribution of seven billion francs to a foundation, the interest of which might then be used to give assistance of various kinds. This controversial proposal was an attempt by the Federal Council to counter the untenable reproaches issued by circles in the United States. They argued that there were dormant assets from the Second World War worth tens of billions of Swiss francs in the vaults of the Swiss banks, out of which Switzerland was making money. An international commission led by former FED chairman Paul
Volcker carefully clarified the accusations and was given insight into all bank records – a first breach of bank secrecy. This very expensive and complex action cost about one billion francs. The Commission found less than 100 million francs of dormant assets, of which at least 70% had no relation to Holocaust victims.

The Solidarity Foundation as a possible way out?

Federal Councillor Koller conceived his proposal of a Solidarity Foundation as an act of liberation in the quarrel with the US and the American organisations that were campaigning against Switzerland. But the first eulogies to generous Switzerland soon ceased, when it became clear that the seven billion would not flow into the US, but would be used to benefit people currently in need. Now the US suddenly understood the creation of the Solidarity Foundation as an admission of guilt, and intensified its attacks on Switzerland.
What was not known abroad: the Federal Council had made this “generous” promise under its own direction and responsibility, without being authorised to do so. Federal councillor Koller succeeded in convincing the majority in parliament of the Solidarity Foundation, but he did not convince the people.
The majority of the electorate saw all this as an unworthy caving-in and as inappropriate behaviour towards the assailants from the US, and the answer at the urn was a clear “No”. (This foundation is not to be confused with the Solidarity Foundation, which was intended for victims of the Holocaust in Eastern Europe, and the capital of which was built – not entirely voluntarily – by the banks. See also: Arbeitskreis Gelebte Geschichte (AGG). Erpresste Schweiz. (Living History Working Group (AGG). (Extorted Switzerland) 2002

Democracy works better with the people

At the same time, another national initiative proposed to use the 21 billion from the gold sales exclusively for old-age provision. The people rejected this bill, too, and thus in 2002 twice rejected proposals about what should be done with the proceeds from the sale of the gold reserves. Finally, the Federal Council and the SNB distributed the 21 billion out of the gold sale without a popular vote, by interpreting the Federal Constitution “generously”, and dividing the 21 billion according to the constitutional arrangement of how the SNB should normally distribute its profits: One third for the Confederation, and two thirds for the cantons. And so ended an unpleasant episode in the history of direct democracy.
There was one bright spot for Switzerland in these years with their many negative votes on money questions, and this should not be omitted here. In 2001, the people agreed in a constitutional vote to the so-called “Debt Brake” – with a high rate of 84.7 per cent, as it used to be in the past, and thus the voters once again set the course in the financial sector. This beneficial instrument has helped up to today to balance the revenue and expenditure in the Confederation and to remove the debt mountain to a certain extent.
These numerous votes put a considerable strain on Parliament and the Federal Council. This would not have been necessary if the people had been able to correctly decide right from the start on the sale of strategic gold reserves. In this case the gold reserves and the dormant reserves on the gold would very probably still be here today.
Ever since all these occurrences took place, the SNB’s policy has been observed attentively and with scepticism. Many people were vexed when the SNB sold more than half of the gold reserves piecemeal on the international gold market, at the low prices of the time, some of which were below $ 300 the ounce (now over $ 1,300). In 2012, a citizens’ committee launched the popular initiative “Save our Swiss gold!” The initiators wanted to stipulate that the SNB would have to stop further gold sales, to keep at least 20 percent of its currency reserves in gold and to store these in Switzerland. But in 2014, the people again voted no.

Situation today: Negative interest, but unlike before

More recently, difficulties have grown in the Eurozone and the euro has lost a lot of its value. As so often before, Switzerland is again regarded as a “safe haven”. Once again, the National Bank has responded with extremely low interest rates and a negative interest rate. Only: In the 1970s, everyone understood against whom the negative interest was directed – namely directly against the speculative billions. Today, only a few understand how the negative interest rate works.
Let us look at an example: A hedge fund moves 10 million euros to Switzerland to benefit from currency fluctuations. The Swiss bank exchanges this money into Swiss francs and redirects the euros to the SNB (where all banks have an account). The SNB credits the sum to the bank’s account in Swiss francs and charges a negative interest of 0.75 percent. Thus the hedge fund is not directly affected, and will not be deterred from its “deal”. Over the past few months, the SNB has earned a billion francs in interest in this way. The Swiss business banks, on the other hand, are faced with the problem of how to cover the costs of the negative interest that they – and not the hedge funds – have to pay!
In this way, the banking business becomes difficult, more complicated and confusing – and is hardly any longer comprehensible to the public. Banks and pension funds are increasingly running into problems. Citizens are kept from saving, which was once considered a virtue. They are beginning to worry about the numerous “peculiarities” in money-making. It is particularly serious that pension funds no longer manage to generate the income for the pensions they promised to pay.

Massive foreign exchange transactions and risky dealings

To support the exchange rate, the SNB now buys almost any foreign exchange (foreign currencies) – mostly the euro. It also acquires foreign government bonds and shares. For example, it bought US dollars for about 60 billion Swiss francs – an amount equivalent to the federal budget! These it used to buy shares of companies like Apple, Google, Amazon, and others, on Wallstreet. American bankers are describing this approach as “extraordinary”. So, with a few mouse clicks, the SNB reintroduced Swiss francs into circulation – in quantities for which the entire Swiss population has to work for one year! Accordingly, the amount of foreign exchange in its balance sheet rose to CHF 666 billion. The SNB hopes it will be able to sell its many euros and dollars for Swiss francs again in “better times”. The “Swiss francs would return” to the SNB, and the amout of circulating money would again be smaller. It is questionable whether this will be so easily possible without “stressing” the exchange rate.
There is also the risk that the exchange rates will crumble again and “system corrections” in the euro zone will be used to repay debts with depreciated euro, similar to what the US did in the 1970s with their debts from the Vietnam War. If the exchange rates crumble again, there will be losses that the SNB will have to cover with its reserves, which are now no longer all that large. A drop in value of only 12% of important currencies such as the euro and the dollar would suffice to fully use up SNB equity plus reserves. This already occurred at the peak of the currency crisis in 1978 and led to “negative equity” for two years. However, at that time the large, silent, undeclared reserves on the SNB’s gold served as a security – which is not the case today. The newspaper “Finanz und Wirtschaft” (finance and economy) of 30 July 2016 compares the current situation with a Damocles sword threatening us from the euro zone.

No suitable defensive mechanism

In contrast to the 1970s, the SNB has no defensive mechanism enjoying extensive popular support at its command, which might, for example, ward off an attack by George Soros on the Swiss franc. The SNB does, in effect, reserve the right to take such emergency measures. But, although it continues to enjoy a high level of confidence, its policy is understood only by a very few today. There is no last line of defense – as there was in 1978 – because gold reserves make up only about 7 percent of its foreign exchange investments and there are no more hidden reserves on gold available. It is therefore quite possible that the cantons as owners or the taxpayers will have to pick up the slack, so as to “recapitalise” or “refinance” the SNB as a stock corporation, i.e. to replenish its reserves. That can prove expensive because the SNB can not simply “print” the reserves that are intended to cover losses. It would then be shown that the billions distributed by the SNB to the Confederation and the cantons in recent years have not been free money.
Conclusion: The gold sales and the elimination of the hidden reserves on the gold were not only a “Fall” in the history of direct democracy but also a historical mistake.

Why the paradigm shift?

Many an observer is wondering today why, in the past two decades, the Swiss National Bank changed its policy in the manner described – so that we can speak of a paradigm shift in the proper sense. This question cannot be answered easily. The speech entitled “Geldpolitik ohne Grenzen” (No frontiers in monetary policy) presented by Jean-Pierre Roth, former Chairman of the Governing Board of the Swiss National Bank, at the Swiss Institute of International Studies on 6 May 2009 gives an indication. Roth mentioned several times that the international monetary system had become more stable. (This is questionable today.) Roth further pointed out that already in the 1980s and especially after the entry into force of the new Federal Constitution of 1999, the National Bank had “gradually incorporated international elements into its monetary policy strategy and its monetary policy instruments.” and thus “internationalised the SNB’s monetary policy”. He said that the National Bank had always accepted that the Swiss franc was traded globally. But in recent decades, the National Bank itself had become a “globally operating national bank”. [...] “It is normal for many banks of issue to limit their operations to their internal market – not so for the SNB.” This view explains many things: The structure of the National Bank as a state-controlled company, in which the majority of the cantons and also interested citizens are involved, the many popular votes about the monetary system, the strategic gold reserves formerly aimed at independence, the popular vote (which however did not take place ) on the sale of 1,300 tons of gold, a defense disposition directed outwardly against attackers and the speculative billions, the direct democratic way in which the SNB is embedded in the population, and the like – these are all elements of a more nationally oriented strategy, which has become less important to the Federal Council and the National Bank today. The current, artificial extension of the money supply far beyond the needs of the country and the population is not fitting for Switzerland but instead for the image of a “monetary policy without borders”. It creates risks that might overwhelm a small country.

Origins of today’s policy and its dangers

The SNB, along with its “international” policy, is getting in line – at least partly – with those banks of issue which artificially lower their interest rate over many years, which operate with negative interest rates, continually devaluating their currency and generating a “controlled” inflation in order to devaluate their mountains of debt. Debt worldwide continues to grow, and repayment of government debt is no longer an issue in many countries – especially in the US. There remains only the matter of preserving the ability to pay.
The underlying idea of this policy is based on Milton Friedman, who in the 1960s, together with Anna Schwartz, investigated the great economic depression of the thirties (“A Monetary History of the United States 1867–1960”). This investigation awarded high marks to Roosevelt and the American central bank, FED, because they made massive use of so-called deficit spending and the money-printing press. Only: They should have stuck with this policy – so Friedman – far more massively and longer. This is exactly what is happening today.

Public service must remain in the hands of the state

The experience of the past two decades teaches us that “internationalisation” is predominantly dangerous for originally strongly nationalised companies. It felled the Swissair, which had once been the pride of the nation, (when it started buying up one foreign airline after another). Swisscom has lost a lot of money in the course of its international adventures. The Alpiq electricity group (formerly Aare-Tessin AG für Elektrizität (Atel) and Energy Ouest Suisse (EOS)) is also treading a dangerous path. It is structured as a stock company. A significant majority of approximately 70 percent of the shares (which are traded on the stock market) belong to individual cantons and domestic cooperatives and companies. Alpiq’s power stations were initially designed to supply the Swiss population with electricity at cost-effective prices. The internationally focussed business policy of recent years, however, has led to massive setbacks, similar to those of Swissair, so that the stock price has fallen by 90 percent. Now Alpiq plans to sell its share of Grande Dixence, the largest hydroelectric power station in the Alps, as well as of other power plants – all linchpins of Swiss power supply – and if necessary, it will sell them abroad.
It is to be hoped that the Swiss National Bank will rethink its strategy and its approach. The necessary reserves have not been accumulated for a “policy without borders”. Swiss public service companies must not be sold out.

Too much power for banks of issue

The banks of issue have always had a lot of power – now they have more than ever. They also increasingly cooperate as a network – under leadership of the USA. The critical voices in the professional world are increasing. Professor Kurt Schild-knecht, for example, who helped shape the policy of the National Bank as a vice director in the 1970s, today argues – in an article titled “Zuviel Macht für die Nationalbank” (Too much power for the National Bank), which was published in the magazine “Weltwoche” of 23 June 2016 – that there are no studies that prove that the National Bank can influence the exchange rate with lowered or even negative interest rates. This policy should be stopped immediately because its side effects and risks for the country are too great. He sees the real cause of this Swiss problem in the policies of the major central banks, in particular the American central bank FED and the ECB, which have all for many years been clinging to the dangerous misconception that they could sustainably stimulate economy and growth by means of a glut of money – and this is quite similar to what happened in the seventies. They are only papering over the cracks, writes Schiltknecht. As long as the central banks stick to this policy, the exchange rate of the Swiss franc will remain a problem, whatever the SNB does. Kurt Schiltknecht comes to the conclusion that one can only hope somebody will succeed in curbing the “big banks of issue”.
Perhaps the question will arise whether the present structure and legal form of the SNB is adequate for coping with the dangers of a “monetary policy without borders”. Perhaps what is needed is a “pure state bank” with the federal state assuming comprehensive liability, such as was rejected by the electorate in 1897. The following scenario is conceivable and can not be completely ruled out: The Federal Council informs the population that the National Bank has already bought so many euros that this should be used to replace the Swiss franc. In this way losses could be avoided in the future, and export industry and tourism would be rid of their worries caused by the strong franc. – The shock would probably be far greater even than when Swissair went bankrupt. Yet the rule applies also here: this would be impossible without a referendum.

Retrospective and outlook

Since the Second World War, Switzerland has repeatedly had to struggle against the negative effects of a strong Swiss franc. All other currencies have lost much more of their value since that time. An end to this trend is not foreseeable. But do not forget the other side of the coin. A strong Swiss franc makes imports cheaper, which is important for a country without raw materials. In the long run, the country has not suffered any damage – on the contrary. It is true that individual years or periods were difficult – in former times even more than today.
In 1977/78, for example, in just two years, the Swiss franc gained almost 40% in value compared with 15 major trading partners (SNB report 1981, p. 376). But contrary to what some commentators sometimes claim, even this shock was not “the death blow” for the Swiss export economy and tourism. The appreciation of the Swiss franc’s value was also high viewed over the longer term. Over the past 60 years, the dollar lost 80 per cent of its value in relation to the franc and the English pound more than 90 per cent. Since 1998, the euro has lost about a third of its value.
There were certainly companies that had to give up because of this. Others have reoriented themselves, have reacted with innovations and improved production processes and have contributed to the success of the “Swiss model”. It is astonishing that exports are continuing to rise despite the difficult currency situation.
There are not only adverse effects when the Swiss franc is regarded as a safe haven in all major crises, and that it has to be protected against excessive revaluation. Behind this is a flexible and diverse economy with well-trained professionals, a healthy state budget and political stability.    •

–    Schweizerische Nationalbank 1907–1932. Bern 1932 (Swiss National Bank, 1907-1932. Berne, 1932)
–    Schweizerische Nationalbank, 75 Jahre Schweizerische Nationalbank – die Zeit von 1957–1982. Bern 1981 (Swiss National Bank, 75 years Swiss National Bank - the time from 1957 to 1982. Berne 1981)
–    Die Schweizerische Nationalbank 1907–2007. Zürich 2007 (The Swiss National Bank 1907-2007. Zurich, Switzerland, 2007)
–    Baltensberger, Ernst. Der Schweizer Franken. (The Swiss Franc) Zürich 2012
–    Roth, Jean-Pierre, Präsident des Direktoriums der SNB, Rede vom 6.5.2009: «Geldpolitik ohne Grenzen» (Roth, Jean-Pierre, President of the SNB’s Governing Board, speech of 6.5.2009: “Monetary policy without borders”)
–    Linder, W; Bolliger, Christian; Rielle, Yvan. Handbuch der eidgenössischen Volksabstimmungen von 1848 bis 2007. (Handbook of the Swiss National Referendums from 1848 to 2007). Bern 2010
–    Kölz, Alfred. Neuere Schweizerische Verfassungsgeschichte (mit Quellenbuch). (Recent Swiss constitutional history (with source book). Bern 2004
–    Rhinow, R.; Schmid, G.; Biaggini, G.; Uhlmann, F. Öffentliches Wirtschaftsrecht. (Public Economic Law) Basel 2011