Comments on: Is Insanity Breaking out in Switzerland? Commentary on monetary policy in the spirit of R. G. Hawtrey Thu, 13 Nov 2014 06:21:36 +0000 hourly 1 By: Mikael Thu, 13 Nov 2014 06:21:36 +0000 David, I still don’t see how a gold cover requirement changes the Swiss central bank’s autonomy over monetary policy. Technically, the Swiss central bank cannot buy euros in unlimited quantities, but only sell francs in unlimited quantities. The central bank can equally sell francs in unlimited quantities to buy gold, or any other asset for that matter. All assets carry a risk of appreciation or depreciation. However this has no effect on central bank monetary autonomy but only affects who benefits from monetary seigniorage, which is a fairness argument not one of monetary autonomy. The same goes for an interest earning central bank balance sheet or cost associated with its acquisition, it has no effect on monetary autonomy but only effects who pays for monetary expansion (the entity paying interest) and who benefits (the owner of the central bank receiving interest profits).

Obviously if the gold cover requirement increases demand for Swiss franc, the policy will be deflationary. But that seems to be assuming the answer…

By: David Glasner Wed, 12 Nov 2014 20:06:44 +0000 In reply to Mikael.

Mikael, The Swiss central bank pegs (weakly) the franc to the euro. To do that, the bank has to be willing to buy euros in unlimited quantities at the pegged exchange rate. But they can costlessly create more francs with which to buy euros. If there is a 20% gold cover requirement, they will have to use the euros, which can be invested in interest-earning securities and buy gold, which generates no interest (but carries a risk of appreciation or depreciation) and involves some transportation and storage costs to bring into bank’s vaults, so it may be that the bank will be less willing to continue pegging the franc to the euro after it is legally obligated to keep buying gold as it creates more francs. Also if the gold cover requirement increases the demand for Swiss francs, the bank may have to buy more euros than it would otherwise have had to buy to maintain the peg/

By: Mikael Mon, 10 Nov 2014 04:53:39 +0000 David – I might have been too fast at commenting. If the question is about the composition of their balance sheet you’re absolutely right, they’ll just sell foreign exchange to buy gold. I assumed wrongly that it was purely about buying, and holding forever, 1500 tons of gold.

I nevertheless need help wrapping my head around the resemblance between a gold peg and a requirement to hold x% of outstanding base money in gold. Intuitively it seems like such a requirement should force the hand of the central bank to conduct monetary policy. To tighten, sell gold for money, when gold appreciates and vice versa when gold depreciates. But you’re absolute right in that they don’t have to increase and decrease the balance sheet when buying/selling gold, which should give them the same level of policy autonomy. What’s your thought? Why do you think this policy would be deflationary?

By: David Glasner Mon, 10 Nov 2014 03:52:59 +0000 Jim, You are right, the Swiss central bank is not bound by a fixed exchange rate between its currency and gold, so there is a basic difference between its position, even if the referendum passes, and the Bank of France. The post was mainly intended as a sendup of gold-buggism as a social-psychological phenomenon and only partly as a warning about the policy consequences should the referendum actually pass. However, I suspect that requiring 20% gold cover will make it more costly for Swiss National Bank to maintain a peg against the euro, and will therefore increase the deflationary pressure on the Swiss franc.

Tom, Thanks.

Don, Thanks. There is a like button by the way, but you are free to keep ignoring it.

Andrew, I am not worried about the Swiss balance of payments, and I don’t think anyone else needs to worry about it either, but I take your point about the consequences on the asset portfolio of the central bank.

Elsa, Imply? I thought that I was being pretty unequivocal. People don’t have to hold euros. They can use their euros to buy all kinds of assets that are likely to appreciate or generate pecuniary returns that will provide their owners with a much higher return than gold. Same goes for holding sterling or any other currency. Gold, thank God, is not the only inflation hedge.

Mike, I don’t say that a central bank should not hold any gold, but gold is certainly not the only asset with the property that its value is not highly correlated with the value of the currency issued by the central bank.

Maynard, A gold bug is a gold bug regardless of nationality.

elwailly, QE is about the total size of the central banks’s balance sheet. The referendum is not about the size of the balance sheet but about its composition.

Shahid, I agree.

Benjamin, Well they haven’t voted yet, so don’t assume that they have gone nuts.

Mikael, Why do you assume it’s a helicopter drop? They will convert their foreign exchange to gold. They don’t have to increase their outstanding liabilities.

Jim, Thanks for the link. Interesting.

Scott, As I pointed out in my initial response to Jim, I was mostly responding to gold-buggery as social-psychology, not to the policy implications. However, although you may be right that the Swiss may be able to continue with a reasonable policy even if the referendum passes, I do think that the referendum would increase the risks of deflation in Switzerland, which would not be a good thing.

By: sumnerbentley Sun, 09 Nov 2014 16:04:04 +0000 David, Good post and this would be a bad idea. Hopefully it won’t pass. One small quibble; this mistake is unrelated to the mistake of pegging a currency to gold. The Swiss traditionally have pretty good monetary policy, and that would not change.

By: jlcaton Sat, 08 Nov 2014 21:15:39 +0000 Some thoughts on a fixed reserve ratio under a commodity standard. The Swiss are headed in the right direction, but should abandon their predilection for gold.

By: Mike Sproul Sat, 08 Nov 2014 15:14:23 +0000 In reply to Max.


Suppose a bank has issued $100 in bank notes, against which it holds assets of 20 oz of silver, plus $80 worth of bonds (denominated in dollars). Define E as the exchange value of a dollar (oz./$). Setting assets (20 oz plus bonds worth 80E oz) equal to liabilities (dollars worth 100E oz) yields

20+80E=100E, or E=1 oz/$

The value of the dollar is no different than if the bank had held 100 oz as backing for $100, so as you say, dollar-denominated assets are not a problem, at least not so far.

But suppose the bank is robbed of 10 oz (10% of its assets). The same equation becomes:

10+80E=100E, or E=0.5 oz/$

This is inflationary feedback at work. A 10% loss of assets caused the dollar to lose half its value. Note that if the bank had held 100 oz as backing for $100, the same loss would have caused the dollar to lose only 10% of its value. There would be no inflationary feedback in this case.

So overall: While holding dollar-denominated assets does not necessarily affect the value of the dollar, it raises the potential volatility of the dollar.

By: Mikael Sat, 08 Nov 2014 12:23:25 +0000 I agree that this is intellectually an absolutely idiotic proposition. However, the results might not be so bad, albeit unfair. If the Swiss central bank are required to hold the additional gold reserves in perpetuity, this ridicolous policy will effectively be a one time helicopter drop, which arguably is just what they need right now.

By: Max Sat, 08 Nov 2014 06:12:26 +0000 Mike, “The trouble with most central banks is that their assets are denominated in the same currency that they issue.”

I’m surprised you think this is a problem. For a CB with a truly floating currency, like the Fed or ECB, safe own-currency loans are the safest assets. Gold or foreign currency is much more risky. So are stocks, or land, for that matter (see Japan).

If the CB can shrink its balance sheet to zero whenever it wants, without taking losses, why would it need a pile of gold?

The only argument for gold is one of diversification. In certain doomsday scenarios, gold may do relatively well.

By: Benjamin Cole Sat, 08 Nov 2014 06:08:21 +0000 Obviously the Swiss have gone nuts. They should be buying silver, and go back to a silver standard. Asthe Chinese thought for 1000 years, gold was a trinket/jewelry metal while silver was money.
Silver also wears better than gold.