Swiss Vote To End Fractional Reserve Banking Matters Even Though It Won't Pass

by: Austrolib

On Sunday, June 10th, Switzerland is voting on an initiative that would end fractional reserve banking in the country.

The vote will almost certainly fail, but not by nearly as much as the 2014 Swiss Gold Initiative, a similar initiative that would have hamstrung the Swiss National Bank, failed.

A close vote could rock Swiss bank stocks, CS and UBS, as it would signal that after the next bust, the initiative could be resurrected and passed.

Nevertheless, the initiative as currently structured would not stop the boom bust cycle since it still allows the SNB to create money at will.

Switzerland is voting on Sunday in a referendum that could end fractional reserve bank lending in the country. Let me get this out of the way quickly and say I do not believe it will pass. I don't think it will even be close. Further, even if by some miracle it does pass, it would not tame or even temper central bank-induced boom bust cycles, which are caused by tampering with the money supply. All the initiative does is leave the authority to create money entirely in the hands of the Swiss National Bank (OTCPK:SWZNF) rather than Swiss commercial banks. Despite the probability of its failure though, this does not take away from the vote's significance. The question isn't whether it will pass or fail. The real question is how close the vote will be.

What Is the Initiative?

First, the initiative itself. It is essentially a rehash of early 20th century economist Irving Fisher's Chicago Plan, which advocated for a 100% reserve banking system with the money supply controlled entirely by the Federal Reserve. The system we have today, fractional reserve, allows commercial banks to create money by loaning out demand deposits, which make all banks structurally vulnerable to bank runs. The Fed can also create money itself through direct purchases, mostly bonds, which means that most of the money that exists today is owed back to the Fed. It came into existence by purchasing debt, so ultimately it must go back to the Fed when that debt is repaid. This is known as debt-based money, and Chicago Plan advocates are obsessed with this singular aspect of our current fiat monetary system, which they believe is the single worst feature about it.

For those interested, I wrote a post debunking this obsession three years ago, explaining that debt-based money, though certainly not a good thing, is only an accidental feature of our current global monetary feature, and not the core problem with it.

The supporters of the Swiss initiative then, just like the Chicago Plan proponents, want to replace debt-based money with sovereign money, just created and handed over directly to the government and the banks for their own purposes. The money supply would keep expanding as it has in the past, just through a different mechanism. The boom/bust cycle would continue, perhaps even worse than before.

Neither Fisher nor the modern day Swiss supporters of his plan understand this at all. Evidence that he did not understand this comes from Fisher's broadcasted announcement on October 24th, 1929, that the US economy was basically sound and that the cause of the stock market crash was borrowing on margin. Once this stopped, he said, everything would quickly stabilize.

So much for that. The cause was, and will always be, the cessation of monetary expansion after a long period of monetary growth. Fisher said not a word about this.

Opponents of the initiative, the main one being the Swiss National Bank itself, claim that its monetary policy is responsible now and the SNB has a handle on the economy. Another bank run won't happen and the initiative would collapse commercial Swiss banks. The latter part may be true, but the SNB's monetary policy is nowhere near responsible and another bust is absolutely on its way at some point. In order to see the utter silliness of the SNB's claim that its monetary policy is responsible now, just consider the fact that its overnight right, the Swiss equivalent of the effective federal funds rate, is -0.75%. If this is responsible, then there is no such thing as reckless.

Also, consider these two interesting charts. First, the SNB balance sheet:

Second, SNB stock price over the same time frame:

If you want to drink straight from the inflationary well before prices actually rise, it seems the best way to do it is to own the bank that actually does the inflating. Anyway…

Why The Vote Still Matters

Despite the fact that even if it does pass, it wouldn't stop business cycles from occurring and might even make them worse; the vote is still very important because it will gauge sentiment regarding how much the average voter is aware at least that there are serious problems inherent in allowing banks to create money through fractional reserve.

A little under four years ago, Swiss voters roundly rejected a different referendum, the Swiss Gold Initiative. Even that one would not have completely eliminated the business cycle, but it would have come closer to doing so. Had that one passed, it would have required the Swiss National Bank to keep 20% of its assets in gold. This would have, in effect, created a de facto gold standard in Switzerland since the SNB would not have been able to go below the 20% threshold of gold to total Swiss franc supply. It would have stopped the central bank from printing money, and by extension bailing out the banks the next time a bust hit, ending the next boom/bust before it got a chance to start again.

That referendum was rejected by an overwhelming margin of 77%. This current referendum, which is certainly different but has themes in common with the 2014 gold initiative, is a lot closer. In a poll conducted on May 30th, 54% of Swiss voters were either strongly or leaned against, and 34% were either strongly or leaned in favor. That's still a blowout in favor of the status quo, but it's a clear gain for those whose sentiments are on the other side of the monetary debate. Again, not that the initiative itself actually stands for hard money banking, but the sentiments of those who favor it do tend to lean in that direction.

If polls are slightly off and the vote fails by single digits only, it would create a huge tailwind for those who stand against fractional reserve banking. If this happens, then after the next Swiss banking bust - and there will certainly be one - the initiative could be resurrected for another go, and next time it could pass.

That's why, even though the vote probably won't pass, a close vote could rock Swiss bank stocks pretty badly. UBS (UBS) and Credit Suisse (CS) are already right near all-time lows, and I believe they will go even lower as I see the Italian debt situation unraveling sometime in late summer when the European Central Bank's bond buying program finally comes to an end around September. These Swiss Bank stocks can only be hurt by this referendum. They cannot be helped by it.

And if by some miracle the initiative actually passes, all hell could break loose in the Swiss financial sector. If you want to play the short game, the time to go short Swiss banks is by the end of this week.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in CS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.