by George Dorgan
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The famous Austrian economist Keith Weiner and implicitly the Wall-street Journal argue that the SNB must keep the euro over 1.20 in order to maintain stability in the Swiss banking system. A rapid appreciation of the franc would create losses caused by reckless lending of Swiss banks.
Via the Acting man Blog:
A Key Flaw
There is now a very interesting initiative on the Swiss ballot, which will require the Swiss National Bank (SNB) to hold 20 percent of its reserves in gold. The voters will decide on November 30. I won’t predict the vote, but I want to discuss the likely impact of a yes vote.
Much of the analysis of this initiative is about the price of gold. A typical prediction is that it will go up, as SNB buying will exceed supply. However Mike Shedlock notes that, “Nearly all of the gold ever mined is available…”
That’s because gold is not consumed. The SNB is small compared to worldwide gold inventories, so it won’t move the price much. Shedlock adds, “It is entirely possible that SNB purchases could significantly alter perceptions…” I agree sentiment is ripe for a change.
The price isn’t very interesting, unless you’re a gold trader. It’s much more important that the referendum brings the first positive monetary change in decades. It reintroduces a link between gold and banking, and imposes a barrier to currency debasement. For this, the Swiss are heroes.
There is a key flaw in our system of floating currencies. Every financial asset is someone’s liability. When a currency moves, it creates winners and losers. Big moves can harm banks with loan portfolios outside their home.
That’s why the SNB currently doesn’t allow the euro to fall below 1.2 francs. To maintain this currency peg, the central bank sells francs and buys euros. There is no limit to this deliberate franc devaluation, which robs Swiss savers, investors, and businesses.
Big exporters, like Swatch and Nestle, may have lobbied for a weaker franc, hoping to make their products more competitive, but that’s a sideshow.
After that “sideshow”, about which I often complained, for example in
Swiss Exports Rise Thanks to Higher Export Prices. Sorry, What ????
Keith continues:
The real purpose of franc devaluation is to shield the Swiss banks from euro devaluation.
They’re vulnerable, because they do a lot of lending outside the country. They have assets denominated in euros and liabilities denominated in francs. They suffer losses when the euro falls, or the franc rises.
Two examples help illustrate the problem. First, say Jens in Germany borrows a million euros from Credit Suisse. As the euro falls, Jens repays the bank in smaller and smaller euros. On the franc-denominated books of Credit Suisse, the value of the loan drops like a stone. Jens is happy but Credit Suisse is not.
Second, let’s look at Adriana in Italy who also borrows money, but not in euros. She gets a million francs from UBS. As the euro falls, Adriana experiences it as a rising franc. Her monthly payment goes up and up. UBS is happy, at least initially, because Adrian’s loan is in francs. However Adriana is getting squeezed. When she defaults, then UBS becomes unhappier than Credit Suisse.
The same opinion comes from the Wallstreet journal and we cited this risk in “The Risks of the Rising SNB Money Supply“.
It explained why M3 growth suddenly slowed down.
We wrote in our snbchf blog:
“The second risk does not directly concerns the Swiss economy and the euro, but the relationship between its banks and emerging markets and the risks of a strong franc for the balance sheets of Swiss banks”
From the Wallstreet Journal on Credit Suisse:
Much of this new money is from Asia and other emerging markets. One of the things attracting these clients is Credit Suisse’s willingness to make large loans to the ultrawealthy. Such loans have grown by CHF3.9 billion over the first nine months of this year versus CHF1 billion in the same part of 2013. They are often backed by the borrower’s illiquid wealth in the form of equity in their companies, for example, or warrants for future ownership.
Such lending can be hugely profitable. Yet any investor who has seen more than one cycle in countries such as Indonesia knows it can also be quite risky. (source WSJ)
We continue with Keith’ arguments:
A Better Option
Either way, the capital of the Swiss banks is eroding. If the euro falls enough, then the banks could go bust. Only they know where the line is, but it’s likely not too far below the current peg of 1.2 francs.
Depositors won’t feel the currency pain, at first. They are happy to own Swiss francs, especially if the franc is rising. Instead, they should worry about the unintended consequences of breaking the euro peg. Their strong francs will not be good in the case of bank insolvency.
Unfortunately the regime of paper money imposes a bitter dilemma on the Swiss people. They have a choice of slow losses by devaluation, or total losses by bankruptcy. They deserve a better option, a practical road map to the gold standard.
It’s great that the Swiss people are striving to move towards gold. I am a passionate advocate of the gold standard, and I want to cheer for my Swiss friends. Yet I must caution them today.
I realize they have spent a lot of money and political capital to come so far, but I don’t want to win this battle and lose the war. They need a new initiative, which takes into account the banks’ euro-denominated loans.
SNB headquarters in Bern. The trees are currently in mourning.(Photo credit: SNB)
Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.
4 comments
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kleingut
2014-11-26 at 11:20 (UTC 2) Link to this comment
Could someone perhaps answer a question about Swiss banking rules for me? In the countries which I am familiar with, banking regulations limit the extent of long/short FX positions which banks are allowed to have in their balance sheets. Exempt from that would be the Central Bank. Case in point: the SNB has probably has the greatest long position FX/local currency in the entire world. Obviously, one can make a lot of money with long/short positions just like one can lose a lot. This is why regulators limit banks in the extent of their long/short positions.
The author of this article suggests that the Swiss banks have enormous long positions in FX against CHF. Could he perhaps give some numbers? If I recall, IFRS accounting requires banks to publish details about their FX position. More importantly, could someone perhaps explain the regulatory stipulations for long/short FX positions for Swiss banks?
Thank you in advance.
GeorgeDorgan
2014-11-28 at 06:23 (UTC 2) Link to this comment
You find some balance sheet logic that explains the point on
https://snbchf.com/snb/history-of-snb-sight-deposits/
“By simple balance sheet
logic, the Swiss bank needs to book an asset for the obtained cash
liability to the client. The bank could decide to create a big cash
vault or it could lend the funds to somebody. But nowadays, the Swiss
bank does not want to take risks neither: it does like to lend neither
in CHF, for Swiss mortgages or to lend in foreign currency, e.g. to a
foreign bank in the weak euro members.
As opposed to lending, depositing these funds at the central bank
neither weaken the Basel 3 ratios nor require additional
counter-cyclical capital. ”
More details you find in my balance of payments article. in https://snbchf.com/chf/history-swiss-balance-of-payment/
I did some clarification on this after the comment from Stefan Wiesendanger on the lending part of BoP. I have not done the 2014 update yet, that should include the significant slowing of M3 in June 2014. I think that the size of BoP must shrink, because both current account surplus but also the financial outflows like this lending outflows should shrink.
kleingut
2014-11-28 at 08:33 (UTC 2) Link to this comment
GeorgeDorgan I refer to your first paragraph (in quotes).
I am definitely not an expert with monetary issues but it seems to me that one has to differentiate between money creation by the Central Bank and money creation by the commerical banks. If the SNB abstained from buying FX and paying for it with credits to the sight deposit accounts of the selling banks, there would be no CHF-creation on the part of the SNB. Its balance sheet total would not be affected. The CHF money supply in total would still go up but it would be in the banking system. If a commercial bank does not want to lend the CHF which it received from abroad (as proceeds of an FX sales by a customer) but, instead, transfers the CHF to its sight deposit account at the SNB, the SNBs balance sheet total would still not change because the sight deposit account of some other commercial bank would decline. Am I perhaps wrong?
It seems to me the real problem is Switzerland’s success. The people of other countries want to move there and the currencies of other countries want to exchange into CHF. Given these trends, there is no way to avoid population growth or money supply growth unless the Swiss cost of living becomes prohibitively high (or other people movement constraints) or the CHF becomes prohibitively expensive. In short: Switzerland seems a bit trapped by its own success.
GeorgeDorgan
2014-12-05 at 07:50 (UTC 2) Link to this comment
kleingut Austrians banks were borrowing and lending in Swiss francs. As the balance of payments shows, Swiss banks were less involved. Therefore Keith is probably wrong.
However, keeping the CHF weak until 2011 and let it not appreciate too quickly, was a question of stability for the European banking system.
The SNB losses in 2010 of over 10 billion CHF were effectively what the Swiss people had to pay for stability in Europe and the fact that Austrian banks were recklessly lending.
I think, that the part of this bill to the Swiss people will come in the future – not in form of central banks losses, but in form of overinvestments and inflation.