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Setting monetary policy by popular vote: Full of holes

THE Swiss franc is a volatile currency that is fast becoming worthless. That, at least, is what some members of Switzerland’s right-wing People’s Party (SVP) would have you believe. Thanks to the SVP, Switzerland will vote on November 30th on a radical proposal to boost the central bank’s gold reserves. Bigger reserves, activists argue, will make the Swiss economy more stable and prosperous. In fact the opposite is true.

SVP activists forced the referendum by collecting the necessary 100,000 signatures. They are annoyed at the behaviour over the past few years of the Swiss National Bank (SNB), Switzerland’s central bank. In the late 1990s it came to the conclusion that it held far too much gold. Its reserves were worth 25% of annual imports, while Germany’s were worth just 6%. The tumbling gold price at the time also made the hoard seem less sensible. By 2005 the SNB had sold half its gold—1,300 tonnes.

The SNB then added insult to injury, by acquiring big reserves of a different sort. When the financial crisis hit, investors flocked to the Swiss franc, which is widely seen as a safe haven. That pushed it up in value: from 2010 to 2012 it appreciated by about 20% against the euro. The strong franc hurt Swiss exports, so the SNB bought foreign currencies in order to stop it appreciating. From 2010 to 2014 it acquired about $400 billion in foreign currencies (its total reserves are now $530 billion). Gold, which had accounted for about a third of its reserves in 1999, now makes up only 8%.

All this has alarmed many Swiss, who have a particularly soft spot for gold. The Swiss franc was explicitly backed by gold until 2000, long after most rich countries had switched to fiat currencies. Switzerland still has more gold reserves per person than any other country, according to the SNB. The reforms, if approved, would require the SNB to accord gold more respect, in three ways. First, it would have to hold 20% of its reserves in gold, which would involve the purchase of about 1,500 tonnes. Second, it would have to repatriate the 30% of its gold which is held in foreign central banks. Finally, it would never be allowed to sell any gold again.

Proponents of a Yes vote are woolly about how they arrived at the magic proportion of 20% of reserves. Campaigners probably picked it because it would return the SNB’s holdings to the level of the late 1990s in absolute terms. They speak vaguely of a “gold-backed franc”. Yet people in Switzerland would not be able to trade in their francs for gold bars, and there would be no relationship between gold reserves and the number of francs in circulation.

The franc probably would strengthen if the Swiss vote Yes, in that the SNB’s ability to influence the currency’s value would diminish. If it wanted to buy foreign currency to stem its rise, it would also have to buy yet more gold to keep to the 20% ratio. That would not only be expensive, but might also compound its problems. If the SNB wished at some point to offload foreign currency, perhaps to support a depreciating franc, the proportion of gold in its reserves would rise because selling it would be forbidden. “Gold could end up comprising 100% of Switzerland’s reserves,” says Robin Winkler of Deutsche Bank.

As the proportion of gold grew, the central bank’s profits would fall. Foreign-exchange reserves are typically held in the form of foreign bonds, which earn interest; gold does not. It would also become trickier for the central bank to control the domestic money supply, and thus inflation, says Mr Winkler. At present the SNB can reduce the money supply by selling reserves of any sort. It would have less flexibility if a big chunk of its assets were unsellable.

For the scheme to be approved, it must win both an overall majority and a majority in at least half of Switzerland’s cantons. Most observers assume that Swiss voters will side with the central bank over the SVP. Even if there is a Yes vote, disruption to financial markets would be minimal: the gold price is 10% lower than it was in the summer. How that could possibly be, given all the debased fiat currency sloshing around, the Yes camp has not explained.

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The Economist
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