The Swiss Franc is perceived as a safe haven currency due to its long tradition of practicing sound monetary policy. Even today, the Swiss National Bank (SNB) is notable for being the only major central bank which have not conducted massive monetary accommodation except for the defense of the minimum exchange rate of Swiss Franc (CHF) 1.20 to the euro. Although GDP growth in Switzerland has remained stagnant at 0% as it is surrounded by struggling European countries, its unemployment remains low at 3.1%. The economic comparison between Switzerland and Europe can be seen in the charts below.
The Swiss growth rate is represented by the dotted lines and the column in blue on the right. It is currently at 0% while Europe grew at 0.2%. This is the nominal growth rates but if you were to take into consideration inflation of 0% in Switzerland and 0.4% in Europe, one may even conclude that Europe is shrinking in real terms while Switzerland is at least keeping its place in these difficult circumstances.
Switzerland is represented on the solid line and left column for its unemployment conditions. The left and right columns themselves show a wide of difference between unemployment between Switzerland and Europe. Unemployment in Switzerland range from 2.8% to 3.6% and is currently at 3.1% while unemployment in Europe range from 11.4% to 12.2% and is currently at 11.5% over these past 2 years.
Hence we can see the reasons behind the global demand for the CHF. The SNB sees that without intervention, the CHF would be massively overvalued and this would weigh on the export driven economy of Switzerland. From year 2000, the SNB expanded its balance sheet from 100 Billion CHF to more than 500 Billion CHF to defend the peg of 1.2 EURCHF. However a recent Swiss Gold Referendum, initiated by Luzi Stamm of the influential Swiss People's Party (SVP) aims to put a stop to this intervention.
The referendum requires the SNB to hold 20% of its assets in gold, prohibit it from selling gold and requires it to repatriate the gold held on foreign lands.If the referendum is successful, the SNB would need to purchase 1500 tonnes of gold for at least 5 years to meet the requirement. That represents at least 70% of world production of gold.
This will also mean that the SNB is unable to defend the minimum exchange of CHF 1.2 to one euro. The CHF will rise as investors will rush in as the CHF would have a double safe haven status. Its reputation of being a sound money will be enhanced on both measures of a sound economy and a partial gold standard. Currently due to the safe haven status of the CHF, the interbank rate is at -0.15%. In other words, banks are willing to pay 0.15% to lend money to Swiss Banks. This is only logical when investors think that their money is safer in Switzerland than in Europe or their place of origin.
Inflation is at 0% now and any breach of the peg would result in deflation. Deflation would make it harder for Switzerland to repay its external debt of 84441 Million CHF given that the SNB is now restrained by the referendum. It would also discourage discretionary consumption as items are cheaper tomorrow and restrain investments as businesses worry about sales. This will be a grand experiment on the current orthodox monetary policy assumption that a mild inflation of 2% is essential for economic growth.
Not surprising, the SNB is dead set against the referendum. I quote the Chairman of the SNB, Thomas J. Jordan in a speech translated from German in Ustertag on 23 November 2014 in his attempt to dissuade the public from the referendum:
"The initiative is dangerous because it would weaken the SNB. The connection between a minimum share and a ban on selling which it embraces would very greatly restrict our monetary policy room for manoeuvre, since the SNB only retains its full capacity to act when it is in a position to adjust its balance sheet to monetary policy requirements - in other words, if the SNB can expand or shrink it - without any restrictions."
"Second, it combated the massive overvaluation of the Swiss franc by introducing a minimum exchange rate of CHF1.20 to the euro. With the minimum share of gold and the selling ban demanded by the initiative, enforcement of measures like these would have been very much more difficult."
The market has detected the weakness of the SNB at the moment and it has gathered around the 1.20 floor of the EURCHF as seen in the chart below.
In April 2012, during intense worry about the Europe sovereign debt crisis, the EURCHF went at 1.1990 as investors flee the euro. The SNB spent 1 Billion euro to defend the 1.2 floor but this time round the market will only test the floor only after a 'yes' vote on the referendum. You can be sure that large institutional investors have their sights on being the next George Soros to break a major central bank.
Although the referendum would require a double majority of the approval of the cantons and a majority of the people to become law, a 'yes' referendum would point to cracks in the dam. This is especially so if there is a large voter turnout for the referendum. It will stay in public conscious for a while and the likelihood of a second and more organized attempt are more likely.
The CurrencyShares Swiss Franc Trust ETF (NYSEARCA:FXF) tracks the performance of the CHF net of expenses and it is listed on the New York Stock Exchange in USD. The chart above shows that the FXF has shown consistent strength this week as the gold referendum draws near. This would imply that the market thinks that there is a fair chance that the referendum would pass.
If the referendum is passed, this would have a profound impact on Switzerland itself as analyzed above. In addition, there will also be international implications. If Switzerland survives this partial gold standard without major structural economic issues, it is likely that the partial gold standard will gain support worldwide. Zurich is also likely to overtake Frankfurt as the economic center of Europe.
In addition, the Federal Reserve might be influenced to rise rates earlier than the consensus of mid 2015 if they perceive that the reserve currency status of the USD is under threat. We have to remember that when Nixon closed the gold window in 1971, the US persuaded the Arab oil producing regions to price their oil in USD in exchange for military protection. OPEC is currently facing both internal and external pressures from falling oil prices and faces risk of fragmentation. The CHF is a recognized major currency without the serious issues. Although it does not have the liquidity of the USD, it could be the tip of the sword to break the USD reserve status in the environment where the Chinese Yuan is trying to overtake it with bilateral agreements around the world to settle international trade in their currency.
Hence the current world economic order would depend a lot on the result of the Swiss Gold Referendum on 30 November 2014. There is a possibility that the conventional wisdom as we know today would start to change next week and investors would be wise to pay attention to it. If it fails by a large margin with a low turnout, we can safely put it at the back of our mind. If not, we should be aware of that this could be the start of a economic paradigm and position ourselves accordingly. For very short term traders, they can also ride on the strength of the CHF before the weekend.
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