Switzerland seems to be in the eye of a storm lately, as several indications have resulted in a code red situation. The Swiss Franc is trading at its highest level versus the Euro since 2011 when the central bank had to intervene in the forex market to safeguard its purchasing power.
The EUR/CHF exchange rate is vital for the Swiss economy, and the Swiss National Bank needs to keep a very close eye on this exchange rate as (unfortunately for Switzerland), the CHF is still widely being considered as a safe haven. Back in 2011 the fear for the collapse of the Eurozone was absolutely real and investors were scrambling to get their hands on Swiss Francs in a flight to safety.
Source: Yahoo Finance
This obviously resulted in a sharp increase of the value of the Swiss Franc and in just six weeks time, the currency appreciation was roughly 10% which has led to the Swiss National Bank’s extraordinary measures as it pledged it would do everything it could to defend the EUR/CHF exchange rate of 1.20. And indeed, even though several market parties continued to attack this fixed exchange rate, the central bank didn’t move its stance and poured billions and billions of newly printed Swiss Francs into the system. Why? Because it desperately needed to protect its exports as the more expensive goods such as Swiss watches were becoming pricier at a very fast pace.
Just to give you an idea of how important this exchange rate is for the Swiss National Bank, in 2012 the country had to buy $188B worth of foreign currency [11] to support the targeted exchange ratio, which is roughly 1/3rd of the GDP that year. A quick look at the balance sheet of the SNB shows that the central bank is indeed doing everything it can to protect the exchange rate. As of at the end of 2010, the total value of the balance sheet was ‘just’ 270 billion Swiss Francs [12] but by the end of 2012 this had already grown to 500 billion Swiss Francs. If you’d have thought that once the Eurozone was ‘saved’ the pressure on the CHF would go down is terribly wrong. The SNB’s balance sheet continued to expand, and as of at the end of September the total value of the balance sheet was 522 billion CHF. This means that the pressure on the Swiss National Bank is ongoing.
And that’s exactly the reason why the SNB is attacking the gold proposal in the upcoming referendum. The situation of the balance sheet was quite alarming as of at the end of September, as the ratio gold/total balance sheet was just 7.66%. The proposal calls for a minimum of 20% of the reserves being held in gold, which would mean that the SNB would have to purchase 55 million ounces (!!) of physical gold in the market.
But that’s not the only problem. As soon as the Swiss Franc would move to be a gold-backed currency, the demand for CHF as a safe haven currency would increase even further. This means that the balance sheet would continue to expand and it would definitely reasonable to see the balance sheet double once again (because let’s be honest, who wouldn’t want to gain exposure to a currency being backed by gold). And that’s the big problem. If we’d assume a further balance sheet expansion, the balance sheet of the SNB would be much larger than the GDP of the entire country. And if 20% of a 1000B USD balance sheet would have to be backed by gold, the Swiss National Bank would have to buy an amazing amount of 129 million ounces of gold. Good luck finding that amount of physical gold.
And that’s exactly why our financial system is sick. And it’s not just the flu, it’s an ebola-like disease. The Swiss National Bank is against the gold proposal, but not just because it would undermine the flexibility of the SNB, but because it would be a total disaster for the country. The Dutch Central Bank has announced it repatriated its gold to increase the confidence in the central bank once again [13], but if the Swiss Franc would become a gold-backed currency, the Swiss economy would take a deep nosedive. That’s why the SNB doesn’t want its currency to become more attractive and why it’s opposed to the re-introduce the gold standard. The financial system has passed its point of no return.
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