Cracks in the Fiat Money System: The Swiss Gold Referendum and Currency Pegging

On November 30, Swiss voters will go to the polls to vote on what is being called the “Save Our Swiss Gold” referendum.

A vote of yes would mean that the Swiss National Bank (SNB) would have to refrain from selling any more gold and increase its gold holdings to 20%, which is up from current levels of 7%, where it will remain indefinitely. It would also require the SNB to repatriate all Swiss gold holdings currently held outside of Switzerland.

A fifth of Switzerland’s 1,040 tons of gold reserves are held with The Bank of England and nearly a third with the Canadian Central Bank. This vote needs more than 50% of Switzerland’s 5 million plus population to vote yes to pass.

If the Swiss vote yes on Monday, the SNB would be required to buy 1,500 tonnes of gold over the next five years, the equivalent of almost 70% of the global gold mined every year. Obviously this would send the price of gold much higher. Currently, it only has the support of 20-30% of the population and is highly unlikely to pass.

However, even with a no vote there is much to take away from this. There are cracks forming in the current fiat system that are becoming more and more visible.

Why is this important?

While this is the first vote by the population of a country for fiscal responsibility and a repatriation of gold, some European countries have already begun doing this. The Dutch have just recently repatriated 122 tons of gold and Germany has announced it will be bringing most of its gold home as well.

France has also started grumbling to this effect as well. We also know that the BRIC countries have been purchasing large quantities of gold (particularly China and Russia). These moves by European countries should be looked at with scrutiny particularly at a time when Europe is entering another recession and the ECB has launched another round of quantitative easing and asset purchases. As for the BRIC countries it can be assumed this is being done to diversify out of dollars and protection against slowing global growth.

While a picture is being painted in Switzerland of a bunch of right wingers (the lunatic fringe) wanting this vote (20-30% is not a fringe), it actually stems out of yet another failed policy from a central bank: currency pegging.

Switzerland has pegged its currency to the Euro at approximately 1.20 EUR/CHF.

Before the Swiss case is discussed it is important to talk about what a currency peg is and the pros and cons of doing it. Currency pegging is a method of stabilizing country’s currency by fixing it to the exchange rate of another country. This is mainly done for purposes of export and trade.

If a country is able to control its domestic currency it can and will in effect keep its exchange rate low. This helps support the competitiveness of the country’s exports sold abroad. These low exchange rates help boost profitability from domestic companies selling goods internationally by keeping the costs of production low and selling to countries with stronger currencies (think China, the U.S. and Eurozone).

By pegging your currency, you are ensuring that your currency can’t strengthen to a point where it hurts the domestic economy and placing a tight band so as to smooth out volatile currency swings and reduce the likelihood of a currency crisis. If your currency experiences a sharp appreciation, it makes your products and services more expensive and less competitive in the market, which is recessionary.

However, this does come with a cost. When a country fixes (pegs) its exchange rate, it must be maintained within the band that is set. This requires a large amount of reserves because the country’s government and central bank have to constantly buy and sell its domestic currency. The problem with this is it can have really bad inflationary side effects. In order to maintain this reserve a country has to increase its money supply, since you need to hold more currency reserves in order to take action as necessary.

This will cause rising domestic prices and increase domestic instability, which is the exact opposite of what a currency peg is designed to do i.e to support a rising standard of living for the population and protect the domestic economy from price spikes. Below is an example of what the peg looks like.

The Swiss decided to peg their curren