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  1. Stefan Wiesendanger

    You claim that 80% of the increase in SNB reserves was due to foreign capital streaming into the CHF, and that only 20% can be attributed to a refusal post 07/2011 by Swiss entities to reinvest the current account surplus abroad. This interpretation focuses on the flows but what about the investment stock abroad? More precisely, what are the effects of a reallocation of foreign holdings by Swiss entities into the CHF? Think of the asset heavyweights: pension funds (reassessment of risks in foreign currencies), insurance companies (same as pension funds) and banks (balance-sheet reductions, unwinding of investment banking positions). 

    A different interpretation of the \”foreign capital streaming into the CHF\” would therefore be \”repatriation of foreign holdings\” as a consequence of a disillusionment of domestic investors with foreign assets, wouldn\’t it? Add to this a sell-out by banks to shorten their balance sheets and reduce risk in what remains. In this view, the SNB is taking the risks that everybody else is shedding on its own books in the unwanted role of benevolent parent. After all, it needs to protect the export industry from a skyrocketing CHF which is the argument used in public. 

    Why does the SNB take the unwanted role of a risk dump? The catch-22 for the SNB is that if it as a regulator asks the big banks to reduce their risks, could it very well object to these same banks selling assets and exchanging the proceeds for CHF (which will then show up as sight-deposits on the liabilities side of the SNB balance sheet)? By the way, this is an argument for a clear separation of tasks between SNB and Finma.

    Additional thoughts1. The argument of the SNB to look at the current account is probably not to be taken as a full explanation for the increase of foreign currency reserves. But it is IMHO a good tool for proving to a wider audience that the current peg is unsustainable (something dangerously neglected by the current focus of the discussion on PPP), and prepare for a higher CHF and large losses at the SNB. If the current account surplus is 80bn (13% of GDP) and this capital is not reinvested abroad by the private sector, the SNB will ultimately have to call it quits and let the CHF appreciate.2. Following the thoughts above, it is also understandable that the SNB refuses to create a SWF. Why should the SNB with a handful of employees start up a SWF when there are thousands of underemployed investment professionals in the private sector? How could they do a better job? It is time for the private sector to start investing abroad again, preferably in the productive infrastructure. And it is time for the CHF to appreciate by which parts of the competitiveness of Swiss products and services are socialized. 3. The blame game pointing a finger at the SNB for the risk it is taking is not really fair. What real alternative is there? They are taking on the risks and later the inevitable losses in lieu of private sector actors like pension funds, insurances and banks. Of course one is entitled to question if such a private-to-public transfer of risk is right or not. I\’d personally favor mechanisms that would entice, even force, private actors to go out of their way to find profitable investments abroad, even now. But the real question is 4. 4. The key question is: how can a capital exporter like Switzerland safeguard the value of foreign investment? The answer is: sometimes not, often only partially and always with extreme difficulty in turbulent times. The history of Bank Leu is exemplary. Already in the 18th century, Zürich was a surplus economy at a loss for domestic investment opportunities. Bank Leu stepped in to invest this surplus abroad and through 2 and a half centuries sometimes won but several times almost lost all of it.

  2. Stefan Wiesendanger

    Nice chart, thanks. I withdraw my earlier suggestion that the growth of SNB reserves might be due to large-scale repatriation of portfolio investment abroad. It rather seems to be caused by the unwinding of the investment banking positions of CS and UBS. With their combined balance sheets worth 500% of Swiss GDP at their 2007 peak, they constitute by far the biggest part of the Swiss financial system and any change in their structure must have huge repercussions on Switzerland. In retrospect, it is not surprising and probably a good move that they hired a central banker to head UBS. Mssrs Weber, Rohner and Jordan must have a lot to talk about.

    In more detail: The chart shows clearly that up until 2008, the current-account surplus was reinvested abroad by companies in companies (direct investment component) and in securities (portfolio investment component), the latter mostly by pension funds and insurances. There are no signs of significant repatriation by pension funds and insurances after 2008, and there is sustained direct investment as you point out in your reply. In sum, we can safely say that the outflow of investment has slowed down and since 2008 contributes to the growth of SNB reserves since it does not balance the inflow due to the current account surplus. But the dominant effect by far is the large-scale reduction of bank loans. I’d hypothesize that this is due to a reduction of lending by CS and UBS to their investment banking subsidiaries. The Big Two have reduced their balance sheets by 900 bn CHF after their 2007 peak of 2.3 trn CHF (*). Surely, the unwinding of the investment banking positions must have enabled some head office loans to be repaid? Not that this is the precise mechanism but it seems altogether plausible that the investment banking party was backed by exported capital which is now partly coming home to the tune of a Western version of the Beresina…* , page A2 

  3. Can Sandikcioglu

    Hey George, thank you very much for your quite informative article. It is indeed quite helpful in trying to understand monetary system. I was just wondering about one more thing. How does inflow of foreign currency into local banks increase the M1 without any Central Bank intervention? I have one framework on my mind but I will understand it clearly and best if it is depicted by accounting entries. For example; when an american wants to buy swiss bonds, does he simply swap its holdings of USD deposits held with a US Bank for swiss francs from a swiss commercial bank? If so, this will increase the US Dollar nostro balances of the swiss commercial bank (asset item for Swiss banks) and it will also increase Swiss Bank’s swiss franc deposit liabilities to our American guy which just purchased swiss franc in Exchange for USD. Now this guy, will probably use this newly created M1 fund (deposit at Swiss Commercial Bank) to buy bonds from the financial markets. Is this accounting logic I described above correct? Is this how M1 is created whenever there is inflow of foreign currency into the country assuming no CB intervention? Does the same loic I described above also apply to trade surplus inflows as well? (I think it does) I would be pleased if you can help with the answer to that. Thank you in advance.

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