By Ben Davies, CEO of Hinde Capital
In 1996 the Swiss National Bank (SNB) and Swiss government co-operated to divest themselves of a significant amount of their gold holdings. It was anchored in their constitution that gold should back the currency by 40%. This was one of the cornerstones of the Swiss banking sector, the other its neutrality.
The SNB had held the fourth largest gold reserves in the world, almost 8% of total official gold holdings. The near 2,600 tonnes was of similar size to Germany, a country some 10 times larger in terms of population or 22 times larger in terms of nominal GDP.
Why did they do his? For an in depth understanding look no further than Ferdinand Lip’s Gold Wars book. For simplicity I will state it is because they joined the IMF and according to IMF Articles of Agreement (2b, paragraph iv) prohibits one a member country from having an adherence to a gold-backed currency.
Under an international monetary system of the kind prevailing on January 1, 1976, exchange arrangements may include (i) the maintenance by a member of a value for its currency in terms of the special drawing right or another denominator, other than gold, selected by the member, or (ii) cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members, or (iii) other exchange arrangements of a member’s choice.
They not only ceased backing their currency to gold, they also took the step of actually selling their gold holdings down to 1040 tonnes.
The neutrality of the Swiss has been encroached year by year. Double Tax treaties, full disclosure on foreign accounts with EU and USA, have eroded their tradition of bank secrecy; all assisting in undermining their safe haven currency status. But the global financial crisis created a false swoon for the currency, as it strengthened abnormally - a near 10 sigma rise in the Swiss franc - an event unlikely to occur in any intergalactic lifetime – but it did, so bad were the risks considered for other currencies.
The SNB has been forced into accepting the role as custodian of a safe haven currency. By which I mean, as the world enters another slowdown and the Fed further tries to debase the dollar, the CHF and the Swiss economy must bear the burden of global rebalancing.
Measured against the long term average the CHF is currently 16.4% overvalued on a real effective basis, and while this is a historically high, deviations from a static average can persist for long periods. The Swiss are popping over the border into France and Italy to do their grocery shopping – a sure sign of PPP gone too far.
We accept that Switzerland has a very strong current account position made up mainly by a positive income balance and a strong services balance.
Notwithstanding a sharp drop during the 2008-09 panic following losses on foreign assets, the Swiss current account position has stormed north and is currently sitting at a healthy 14% of GDP.
The best reflection of this is the very strong net foreign asset position of the Swiss economy which has trended well with the appreciation of the CHF.
Logically this follows from the fact that as the currency appreciates foreign assets become cheaper. However, the game is up for the CHF as a safe haven trade and this will only fuel flows more and more into bonds, and then ultimately gold.
In response to the strength of the CHF the SNB has recently rolled out an impressive battery of measures in the attempt to shock and awe the market into reversing course on the CHF. Broadly speaking there has been three measures.
- •An expansion of the SNB’s balance sheet through the increase in banks’ sight deposits as well as open market FX
intervention.
• Negative short-term deposit rates
• Verbally signalling a possible peg or quantitative target for the EURCHF.
On a monthly basis, the SNB’s balance sheet has actually declined in the first half of 2011
However, the SNB has moved to increase its balance sheet sharply going into August, on two occasions raising the target for bank sight deposits held at the bank which represents a de facto increase in the money supply.
The SNB has (…) decided to expand again significantly the supply of liquidity to the Swiss franc money market. In so doing, it is increasing the downward pressure on money market interest rates with a view to further weakening the Swiss franc exchange rate. With immediate effect, it aims to expand banks’ sight deposits at the SNB further, from CHF 120
billion to CHF 200 billion. In order to achieve this new target level as quickly as possible, it will continue to repurchase outstanding SNB Bills and to employ foreign exchange swaps.
Source: SNB Press Release 17th of August
The Swiss front-end rates went negative, so desperate are they to deter currency strength. The Swiss are only hurting themselves. It was Ferdinand Lips who first lamented on Swiss gold sales. When he looks at the graph below he must despair for his country.
The ‘tragedy of the commons’ has crucially exposed the problem of this Bretton Woods II monetary system. Not all countries can eat at the trough. The Swiss have pushed back, but without the underlying stability of gold reserves the CHF is heading south along with all other fiat currencies.
SWISS M1 BACKED BY GOLD (IN USD)
There is always the yen, but don’t get me started on this topic; perhaps for another time. Calls for a gold-backed Swiss franc should be welcomed, but in the broader context of a debate on monetary reform. Until such time, gold is our preserve.
This latest pullback in the gold price is an opportunity to initiate a new investment or augment existing holdings.
Ben Davies
Director & CEO
Hinde Capital
In his new interview Ben covers the unprecedented demand for gold that he is seeing around the world, along with other key reasons why gold will continue higher and more. The KWN interview with Ben Davies is now available and you can listen to it by CLICKING HERE.
