Tag Archives: Swiss Franc

Gold’s Price Performance: Beyond the US Dollar

With the first half of 2018 now drawn to a close, much of the financial medias’ headlines and commentary relating to the gold market has been focusing on the fact that the US dollar gold price has moved lower year-to-date. Specifically, from a US dollar price of $1302.50 at close on 31 December 2017, the price of gold in US dollar terms has slipped by approximately 3.8% over the last six months to around $1252.50, a drop of US $50.

Since the world’s major gold price discovery hubs of London and New York trade gold in US dollars (or more correctly predominantly trade synthetic gold and derivatives), and since much of the mainstream financial media tends to be very US-centric, the media’s fixation with the US dollar price of gold is probably not surprising. However, it’s not the full story, because in some major national currencies as well as in cryptocurrencies, the price of gold has actually moved higher year-to-date.

From the perspective of an investment bank forex trading desk, where gold is traded as a currency in ‘pairs trades’ against a set of major fiat currencies, the varied movements of gold prices across a range of currencies will not be surprising. Currency prices (including the price of gold) are constantly moving against one another, creating these exchange rates. What’s important to these forex traders is the ‘relative strength‘ of currencies and of gold (and increasingly of cryptocurrencies).

Since the US dollar has had a relatively strong performance year-to-date 2018 against many other fiat currencies, this means on the flip side that many national currencies have weakened vis-a-vis the US dollar. By definition, this also means that the gold price performance year-to-date, measured in any currency which has weakened more in percentage terms against the US dollar than the US dollar gold price has weakened, will actually now be higher in those currencies.

For those with a base currency other than US dollars, or whose wealth or earning power is denominated in currencies other than US dollars, it’s important to keep track of the relative strength / weakness of one’s base currency, and at the same time look beyond the financial media’s headlines, and keep an eye on the gold price in that base currency / home currency.

Brazilian Real

Let’s look at some examples. Some of the worst relative performances of fiat currencies over the first 6 months of this year have been the Brazilian Real, the Swedish Krona, the Russian Rouble, the South African Rand, and the Indian Rupee, i.e. a mix of developed and emerging market currencies, and a mix of commodity and non-commodity currencies.

Given the very strong performances of cryptocurrencies late last year (especially in December 2017), and their subsequent price reversals since January, the gold price when measured in cryptocurrencies, such as Bitcoin, is also higher over the first half of 2018.

Year-to-date, the Brazilian Real (BRL) has lost more than 17% of its value against the US dollar. However, over the same time, the price of gold in Brazilian Real has gone up by more than 12.5%, rising from BRL 4315 per troy ounce at the start of January to BRL 4858 per ounce at the end of June.

The explanation for this is as follows. At the start of 2018, the US dollar gold price was trading at US $1302.50 per troy ounce, which at the USD / BRL exchange rate of USD 1 = BRL 3.31 at that time translated into BRL 4315 per troy ounce of gold. Fast forward six months and the US dollar gold price ended June $50 lower at US$ 1252.50 per ounce.

Gold Price in Brazilian Real, January – June 2018, Source

Over the same 6 month time period, the Brazilian Real weakened against the US dollar, falling from 1 dollar = BRL 3.31 at the start of January to  1 dollar = BRL 3.88 at the end of June. In Brazilian Real terms, that end of June gold price of US$ 1252.50 per ounce price now  translates into BRL 4858 (1252.5 * 3.88). In this case, the rise in the local currency (BRL) price of gold is attributable to the fall in the value of the Brazilian Real. This is a classic example of the gold price adjusting to reflect the weakness in a local currency.

Brazilian Real per US  Dollar, January – June 2018. Source 

Swedish Krona

Taking another example, year-to-date, the Swedish Krona has also had a relatively poor performance, falling by more than 11.5% against the US dollar over the first 6 months of 2018. However, during the same time period, the gold price in Swedish Krona has rallied strongly from SEK 10685 per troy ounce to approximately SEK 11210 per troy ounce.

Gold Price in Swedish Krona, H1 2018. Source

Again, even though the US dollar gold price fell from US$ 1302.50 to US$ 1252.50 during the first half of 2018, the SEK gold price has risen. Why? Because the Swedish Krona has weakened from 1 USD = SEK 8.023 at the start of January to 1 USD = SEK 8.950 at the end of June, meaning that the US$ 1252.50 gold price now translates into SEK  11,210 (1252.50 * 8.95).

Swedish Krona per US  Dollar, January – June 2018

Russian Rouble

During the year-to-date to end of June 2018, the gold price in Russian Rouble (RUB) has risen from RUB 75110 per troy ounce to RUB 78690, an increase of approximately 4.75%. Over this time, the value of the Rouble has fallen from approximately 1 USD = 57.7 RUB at the start of January to 1 USD =  62.8. Again this means that even though the US dollar price of gold has ebbed from US$ 1302.5 to US$ 1252.2 over the first 6 months of 2018, the RUB value of an ounce of gold has increased on the back of the depreciating RUB exchange rate (1302.50 * 62.8).

Gold Price in Russian Rouble, H1 2018. Source

Indian Rupee

The story is similar in Indian Rupee. Over the year-to-date 2018, the gold price in Indian Rupee (INR) has risen 3.19% in local currency terms, from INR 83130 per troy ounce to approximately INR 85780 per troy ounce. In this case, over the first half of 2018, the US dollar strengthened from 1 USD = 63.85 INR to 1 USD = 68.45, with the higher Rupee gold price reflecting the US dollar gold price of 1252.50 translated into Rupee at a 68.45 to 1 exchange rate.

Gold Price in Swedish Krona, H1 2018. Source

Bitcoin

The upward price movements of the gold price denominated in Bitcoin are even more startling. From an opening price of approximately US$ 14,110 on 1st January 2018, the price of Bitcoin in US dollars fell dramatically over the first 6 months of the year, to around US$ 6400, i.e. a 55% drop in 6 months.

Gold Price in Bitcoin, January – June 2018. Source

However, the gold price denominated in Bitcoin more than doubled over the same time frame, rising from 0.09 to 0.20 for the year-to-date. This would mean, for example, that had you traded out of Bitcoin and into gold at the start of 2018, your Bitcoin at that time would have had more than twice as much purchasing power in terms of purchasing gold as it had at the end of June.

A Better Way of Thinking

Given the constant fluctuations in fiat currencies, fixating on the gold price in US dollars, or indeed in any fiat currency, may not be the best way to think about your gold holdings. After all, many savers and investors in physical gold move their wealth and investments into physical gold precisely because it is not linked to fiat currencies and is a gateway out of government induced financial repression.

Remember that physical gold has no counterparty risk, and is not issued by any central bank, government or monetary authority. Physical gold is a mined tangible asset with inherent value and a limited supply.

A better way to think about an investment or holding in gold is perhaps by how much of it you hold. For example, I if had US$ 13,000, which I used to buy ten 1 troy ounce gold Maple Leaf coins, whatever then happens with the gyrations of fiat currencies, I still have those 10 gold maple Leafs and I can think of my holdings of physical gold as 10 gold Maple Leafs, weighing a combined 10 troy ounces.

The US Dollar has lost more than 98% of its value since 1913, while gold has retained its value.

Savers and investors move into physical gold precisely because it’s a monetary store of value that maintains its purchasing power over time and as such offers an exit from the debasement of fiat currencies such as the US dollar. Buying physical gold and then constantly trying to value it in terms of a fiat base currency is in some ways illogical. Surely a more logical approach is to say, I had x amount of dollars, but now I own X ounces of gold.

The same applies to gold’s role as a safe haven and as a form of financial insurance, i.e. physical gold is a form of wealth preservation in times of monetary and economic crisis. People make an allocation and use the safe harbor of physical gold precisely because it is ring-fenced from the turmoil of fiat currencies and associated central bank and government meddling. Again, surely a better way of thinking would be to say, I had x amount of fiat currency, I used this to buy gold, and now I have X ounces or X kilograms of gold. At a minimum, thinking in this way is a liberation from the constant barrage of mainstream media commentary about the US dollar gold price.

Sovereign Money Referendum: A Swiss Awakening to Fractional-Reserve Banking?

On Sunday 10 June 2018, Switzerland’s electorate voted on a referendum calling for the country’s commercial banks to be banned from creating money. In a country world-famous for its banking industry, this was quite an interesting turn of events.

Known as the Sovereign Money Initiative or ‘Vollgeld’, the referendum was brought to the Swiss electorate in the form of a ‘Popular Initiative‘. The Sovereign Money referendum proposed that commercial banks in Switzerland should no longer be allowed to create money out of thin air as they currently do, and that in future only the Swiss central bank should have the power to create money. Sovereign money as a concept refers to money issued or created by a State or central bank.

Popular Initiatives

The initiative was launched and advocated by Swiss group called Monetäre Modernisierung (MoMo) which was established  with the goal of bringing monetary reform to Switzerland in the form of a sovereign money proposal.  According to the proponents of the proposal, the initiative was launched as a reaction to the financial crisis of 2008 and 2009, and the increasing levels of commercial bank debt creation that has taken place since then.

Vollgeld Initiative

Based on the official results of the Vollgeld referendum announced on Sunday afternoon, 24.3% of the turnout voted in favour of the initiative, with 75.7% of voters against. As opinion polls in advance of the referendum had suggested such an outcome, a majority endorsement of the Sovereign Money proposal had not been expected. However, with 1,821,835 valid votes cast in the referendum, 442,387 Swiss citizens did endorse the proposal, which is a sizeable number, and shows that at least in Switzerland, there is increasing unease about how money out of thin air is created in today’s fractional reserve banking systems.

With one of the most effective systems of direct democracy in the world, Switzerland is known for its frequent referenda on diverse aspects of Swiss law, and Swiss Popular Initiatives allow petitions to be activated by Swiss citizens to propose law changes. While there can be cantonal and communal popular initiatives in Switzerland, the Sovereign Money referendum was an initiative at the federal level, aiming to change wording in the Swiss Federal Constitution.

For a Federal popular initiative in Switzerland to get to the referendum stage, the initiative’s proponents must collect 100,000 valid supporting signatures from the Swiss electorate within an 18 month period. In the case of the sovereign money initiative, this signature collection exercise was completed in December 2015 when over 111,000 valid signatures were collected and submitted to the Federal Government enabling the proposal to move forward. Many Swiss popular initiatives never get beyond the signature collection stage as they do not attain sufficient support among the electorate. Therefore, the success of the sovereign money initiative in gaining strong initial support also shows that there was an appetite among the Swiss population to raise the commercial bank issue in the form of an official referendum.

As it was essentially proposing a ban on fractional-reserve banking by commercial banks and a return to a more sound money system, the sovereign money Initiative had garnered significant attention in the Swiss financial media in the run-up to the vote, and brings to mind a Swiss referendum which was held in 2014 on the subject of Switzerland’s gold reserves and its storage locations, which also gained similar widespread public attention at the time.

However, as the Swiss Federal Council (Government), the Swiss Parliament and Switzerland’s central bank, the Swiss National Bank (SNB), had come out against the sovereign money proposal, much like they did in the Swiss gold referendum in 2014, the positions of the establishment institutions of State undoubtedly helped sway Swiss public opinion away from voting in favour of the sovereign money proposal. Other vested interests such as the Swiss bankers Association, also, predictably, rejected the initiative.

Out of Thin Air

Although most people aren’t aware of it, the majority of money in today’s global financial system is created not by central banks, but by commercial banks. These commercial banks create money in essentially unlimited amounts when they lend money into existence, in other words, when they provide credit and create debt, which they then call an ‘asset’ on the asset side of their balance sheets.

When commercial banks create money via lending on the asset sides of their balance sheets, they also create deposits. As liabilities of a commercial bank, these deposits are only fractionally backed by the bank’s assets, hence the term fractional-reserve banking.

UBS Switzerland

According to sovereign money advocates, electronic money or ‘book money’ created by commercial banks and recorded in commercial bank accounts comprises about 90% of Switzerland’s money supply, with only about 10% of the Swiss money supply made up of legal tender issued by the Swiss central bank. They also maintain that commercial bank creation of money is not constitutional, since Article 99 of the Swiss Constitution states that “The Confederation is responsible for money and currency“.

In summary, the Vollgeld Initiative called for the following:

  • Swiss commercial banks should no longer be able to create their own fiat currency out of thin air, i.e. be unable to create deposits through lending money created out of thin air.
  • Only the Swiss central bank should be able to issue electronic money to back deposits. This would mean that the SNB would have exclusive responsibility for all money creation in Switzerland, both cash in circulation and electronic money in commercial bank accounts.
  • Commercial banks should only be able to lend money that is already in existence, for example money long-term savings accounts, money market funds or funds sourced directly from the SNB.
  • The central bank should be allowed to issue new money debt-free into circulation by issuing it to the Swiss Confederation, cantons, local authorities and citizens.

According to the Sovereign money advocates, commercial bank money creation leads to a number of problems that affect the real economy, such as credit bubbles which accentuate credit boom and bust cycles, and also excessive inflation. Commercial banks also profit both from their ability to create loans out of thin air and from their ability to create money for their own financing needs. This gives the banking sector an unfair advantage (i.e. a privilege) vis-a-vis other sectors of the economy.

A return to a fully sovereign money creation process, would, according to the initiative’s adherents, lead to a more stable banking system, would prevent asset bubbles, would prevent commercial bank runs, bailouts, and bank collapses, and would prevent the need for deposit insurance protection, since all money would be central bank issued money and deposits would not be fractionally-backed.  The Vollgeld backer’s also said that if the SNB had a monopoly on money creation, it would profit from seigniorage, i.e. the ability to create valuable money at a very low-cost. Currently by not creating most of the money in the Swiss economy, the SNB foregoes these profits of seigniorage.

The Swiss central bank responded to the Vollgeld initiative in typical central bank fashion, citing heightened risk, more uncertainty, tightened credit conditions, increased inefficiencies from a sovereign money system, and a reduction of monetary policy tools and flexability. Some of these concerns may have some validity, some may not.

If the Vollgeld motion had been passed, it would undoubtedly have led to short-term volatility in the Swiss banking system and in broader currency markets, and longer term unease in other country’s banking sectors, out of fear that there would be a growing call for similar changes elsewhere. But as no country has yet tried a return to a sovereign money system, its unclear how much of a risk such a change would entail.

It is probably true that if all money was created by a central bank, then that central bank would be less effective in using interest rates to regulate inflation (via the level of bank lending), and would have to concentrate on targeting the quantity of money in circulation (monetary targeting). That, says the SNB, would be a regressive step.

Credit Suisse

The Results of the Referendum

Swiss federal popular initiative referendas are based on the concept of a ‘double majority’, where for a referendum to pass, a majority of votes overall have to be in favour of the proposal, and the voting in a majority of Swiss Cantons has to also be in favour of the proposal. Although there are 26 cantons in Switzerland, due to historical splits, six of these cantons are considered half cantons in terms of electoral power, so there are 20 full cantons, and the equivalent of a further 3 full cantons, making 23 cantons in total.

According to the referendum results on the Swiss Confederation website, out of 1,821,835 valid votes cast in the referendum, a total of 442,387 votes (24.3%) were in favour of the sovereign money initiative, while 1,379, 448 votes (75.7%) were against. Overall, all 26 cantons (and 23 equivalent cantons) voted against the initiative, with nearly all cantons defeating the motion by a 3 to 1 majority, in other words between 70% to 80% of voters voted ‘No’ to the proposal. By the same token, approximately 20% – 30% of voters in nearly all cantons voted ‘yes’ to the proposal.

The turnout for the vote was quite low, at only 33.8% of the electorate across Switzerland. For these popular initiative votes, many in the Swiss electorate cast their votes in advance by postal vote, so the results are usually known rapidly soon after voting has closed.

Reaction

In response to the referendum results, the Swiss National Bank (SNB), which had come against the referendum’s proposal, released a short statement saying that:

“The adoption of the sovereign money initiative would have made it considerably more difficult for the SNB to fulfill its mandate. With conditions now unchanged, the SNB will be able to maintain its monetary policy on ensuring price stability”.

Switzerland’s central bank

It was not surprising also that the Swiss Bankers Association also welcomed the outcome of the referendum, calling the sovereign money plan a ‘radical alteration of the monetary system‘:

“The Swiss electorate has clearly rejected a radical alteration of the monetary system. The existing monetary and financial system functions well and is stable. The Swiss Bankers Association (SBA) welcomes the decision of the people and the cantons.

In reaction, the Sovereign Money Initiative’s backers remained resilient saying that:

“Despite the campaign of confusion and fear run by our opponents and the misinformation provided by the Federal Council and the Swiss National Bank…[the result] is a respectable outcome and shows that many Swiss people have realised that the creation of money by private commercial banks leads to numerous problems.”

“It is not acceptable that private commercial banks continue to jeopardise our prosperity by creating money out of nothing. In addition, technological developments such as crypto currencies will pose major challenges to the Swiss monetary system and the global economies.”

“Many of those voting ‘No’ did not vote on the Sovereign Money Initiative, but on the distorted picture of it that was conveyed to them by the authorities and the banking lobby. The result of the referendum cannot therefore be interpreted as approval of the privatisation of Switzerland’s money creation.”

Vollgeld Campaigning

Conclusion

Although the average person on the street knows little or nothing about how money is created in contemporary financial systems and mistakenly presumes that all money is central bank money, the Swiss sovereign money initiative is fascinating in that it has raised awareness, at least in Switzerland, as to how fractional reserve banking systems really operate, and how commercial banks create most money in the financial system out of thin air.

In 2016, ‘Monetäre Modernisierung (MoMo)’, the backers of the Vollgeld initiative, highlighted that a survey in Switzerland had found that 73% of the Swiss population mistakenly thought that the Swiss State or Swiss central bank was the creator of the majority of Swiss money and not, as is really the case, the Swiss commercial banking sector.

However, in a country with a total electorate of approximately 5.3 million, the ability to gain 110,000 signatures to advance the sovereign money proposal to referendum stage shows that the Swiss are presumably now becoming more informed about how the money creation system actually works. By the same token, a sizeable 440,000 Swiss voters backed the Sovereign Money proposal, which will no doubt cause concern in the upper echelons of the Swiss National Bank, and Swiss Bankers Association.

Since the sovereign money initiative would have fully centralised the money creation process with the SNB, it lies at the opposite end of the scale to fully decentralised forms of money such as cryptocurrencies. But what sovereign money and cryptocurrencies do have in common is that they both cut commercial banks out of the money creation process, and commercial banks could now in theory find themselves fighting on a number of fronts.  With decentralised crytpocurrencies also aiming to cut central banks out of the equation, and with some central banks responding by alluding to the issue of their own cryptocurrencies, these central bank cryptos could be another form of sovereign money that the commercial banks may in future need to take account of.

Discussions of fractionally-backed banking systems also bring to mind the fractionally-backed system of trading which operates in the London Gold Market, where vast amounts of synthetic gold which do not exist are traded and cleared each day in unallocated accounts maintained by the bullion bank members of the London Bullion Market Association (LBMA). But unfortunately, the London Gold Market remains a protected enclave, protected from the disruptive scrutiny of direct democracy, and with little hope even that the financial media would dare to investigate why a gold market runs a leveraged fractionally-backed gold trading system.