Switzerland, Negative Interest Rates, and Gold Money

 “Central banks are treading in uncharted waters. Sidney Homer and Richard Sylla, the authors of A History of Interest Rates found no instance of negative rates in 5,000 years.  Now there are $11.7 trillion invested in negative-yield sovereign debt, including $7.9 trillion in Japanese government bonds and over $1 trillion in both French and German sovereign debt.”  —Jim Grant 

A quick search finds that Switzerland had negative interest rates in the 70s.  The first edition of A History of Interest Rates was published in 1963, so there is no omission of fact in Grant’s statement. The question is why did tiny Switzerland become the one time outlier with negative interest rates in the 70s?

Switzerland has always been a hard money country which explains their dominance as a financial center.  When Bretton Woods ended in 1971, Switzerland kept the CHF linked to gold.  With the rest of the world floating and devaluing, Switzerland became the only country where international contracts could be written without having to worry about inflation or deflation.  Switzerland was producing the best “accounting unit” in the world.  Anyone who trades goods across time will demand that accounting unit.  Why risk discounted future returns to the unknown of a devaluing currency when the known stability of a value currency is readily available?  Money from around the world flowed into the Swiss franc.  Swiss banks could increase the price they charged for them.  The demand for Swiss franc stability amid currency chaos resulted in negative rates.

The stability of the CHF linked to gold benefitted Swiss banking at the expense of Swiss exporters.  The problem for Swiss exporters was the high demand for the Swiss franc.  Swiss exporters could not compete with their devaluing European neighbors who gained temporary advantage from distortion in the terms of trade due to changing currency values.  Demand for Swiss banking drove up their share price, attracting capital.  Higher capital attracts labor.  This caused a shift in labor from declining exporters to banking and put tremendous pressure on Switzerland.  If Switzerland maintained their link with gold and held out, theoretically at some point, all Swiss would be working for banks and no one exporting.  The political strain was too much, forcing the Swiss to float the CHF along with other European currencies.  The CHF remained a store of value amid increasing U.S. dollar reserve currency chaos.  Negative interest rates persisted in Switzerland until 1978.

The lesson is that a very small entity cannot effectively maintain a link with gold in a floating world.  This is the challenge for the rise in parallel currencies.  Gold based, digital, and crypto currencies are increasingly popular as an alternative to central bank mismanagement of government mandated fiat currency.  Their limitations remain similar to Switzerland’s attempt at value in the 70s.  As a tiny subset within the floating world, government fiat distortion overwhelms gold-linked currency.  Digital and crypto currencies based on time, such as bitcoin, fit into this category, though they are not expressly linked to gold.  It is an economy of scale problem.  Total digital currency market capitalization is less than $10 billion.  This is less than .01% of the $150 trillion annual cross-border payments volume.

Like the CHF that became a store of value within the floating world, gold, digital, and crypto currencies act as speculative hedges against fiat.  Yet, it is not a level playing field.  Parallel currencies are taxed as commodities, or collectibles, and subject to arbitrary regulation.  This remains a major obstacle to parallel currencies obtaining the economy of scale to effectively challenge government fiat.

The political world is changing rapidly.  Revolt against the established order is evident in Brexit and the Trump phenomena.  The alternative gold and crypto based currency tide continues to rise.  The challenge to government mandated fiat increases in proportion with central bank incompetence, now at the 45 year point.  Technology and innovation enable new ways to bypass the fiat monopoly.  We are coming full circle from the Switzerland lesson.  Gold based, digital, and crypto currencies combined with states’ rights and a groundswell of public discontent are challenging the fiat regime.  Parallel currencies are natural constituents of the rising challenge to the political order.  Gold is once again entering the political realm.  Judy Shelton, a long-time proponent of gold based money is an advisor to the Trump campaign.  As yet named “Shelton bonds”, government bonds backed by gold, are another potential threat to the tenuous fiat status quo. 

Nixon ended the Bretton Woods international monetary system, based on gold, overnight by executive order.  There was no congressional debate in advance of Nixon’s act or public discontent with Bretton Woods.  Bretton Woods, when operated properly, resulted in two decades of stability and growth that today seems unimaginable.  The economic thought responsible for today’s malaise has defaulted to “secular stagnation”.  As George Gilder wrote in Knowledge and Power, “An economy is a “noosphere” (a mind-based system), and it can revive as quickly as minds and policies can change.”  When the political environment is ripe, a return to a stable gold based system can be re-established just as quickly as Nixon ended it. 

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