The SNB Must Align its Investments Strictly With Monetary Policy Instruments
The Swiss National Bank’s disastrous result has little to do with its monetary policy but is a consequence of its investment strategy. It must create transparency in this regard and draw organizational consequences.
The goal of the Swiss National Bank (SNB) is not profit maximization, but monetary stability: it must keep inflation in check for the good of the Swiss economy. To begin with, it has achieved this amazingly well for years. Since the end of 2011 until September 2022, cumulative consumer price inflation was only 3,1% (annual inflation in September 2022 alone was 3,3%).
However, the SNB’s enormous losses during the current year can only be partly explained by monetary policy measures. In the author’s view, the SNB has neglected its balance sheet risks too much and thus gambled away future room for maneuver.
Whether this is acceptable or not is a political question. In any case, it must be clarified whether the SNB wants to expose itself in the future to market risks that do not contribute to monetary policy.
Retrospect
Let’s look back: When the Swiss franc appreciated massively during the course of the European debt crisis in 2011, the SNB pulled the emergency brake for the good of the Swiss economy and intervened in the foreign exchange market. It set the Swiss franc’s minimum exchange rate against the Euro at 1.20. This protected exporters and limited deflation thanks to more expensive imports.
One of the side effects of these interventions: The SNB’s total assets rose from around 200 billion in 2009 to 560 billion Swiss francs at the end of 2014. In January 2015, the minimum exchange rate was lifted, and a negative interest rate was introduced at the same time. Although this negative interest rate continued to ensure price stability in the consumer price index, the consequences for the real estate market were price increases of an unusual magnitude. Attempts were made to cushion this with further measures (e.g. imputed interest rate of 5% for calculating the affordability of mortgages), but the patchwork took its course: at the end of 2016, the SNB’s balance sheet total exceeded the Swiss gross domestic product (GDP).
Interventions in the foreign exchange market did not stop. By the end of 2021, the balance sheet total was over one trillion (one million million) Swiss francs, 144% of GDP. Even the consolidated balance sheet of the expansionary ECB is only 70% of GDP in the Euro area, well below the SNB’s figure.
Largest hedge fund in the world?
The SNB had to invest these accumulated assets in foreign currency. Nota bene assets, which it had acquired too expensively – otherwise the interventions would not have been necessary. Historically without significant asset management expertise, the SNB not only bought bonds in foreign currency, but also invested in foreign equities. For example, in 2018 it was discussed in the press that the SNB was one of the largest institutional investors in Meta (then Facebook) shares. Of course, they countered that they were investing close to the index and globally, which was indeed the case. But is this really compatible with the SNB’s objectives?
If the welfare of the Swiss economy is the goal, it might have been worth considering whether the risk portion of the investments should have been invested in foreign core infrastructures (keyword: security of supply/protection against inflation), which could have improved Switzerland’s position also from a monetary policy perspective. China has set an example on how this could be done.
The SNB, however, decided to map the market in its breadth; of course, such an approach requires neither special skill nor expertise, because one goes with the market.
Together with the negative interest rates, the equity capital of the SNB was thus strengthened from 53 billion to over 200 billion Swiss francs thanks to the investment income. In view of these figures, no one could seriously criticize: «The world’s largest hedge fund?» You would get a weary smile for that. Politicians were not interested anyways: The special profit distributions aroused new desires.
SNB driven by ECB policy?
It is fair to say that the SNB was driven by the ECB’s expansionary policy. That may be so. But the key figures clearly show that the net monetary expansion of the SNB was equal to the ECB (Euro 19 zone consolidated). Let’s compare a few key figures:
- M2 money supply grew cumulatively by 41% in Switzerland since the end of 2011 until September 2022, and by 77% in the Euro area.
- The cumulative inflation in the same period: Switzerland 3,1%, Euro area: 28,4%.
- Thus, the difference between inflation and money supply since 2011 is 37,3% in Switzerland, while it is 38,2% in the Euro area. The expansion difference is marginal in real terms.
This is relevant insofar as Milton Friedman proved that inflation is always and everywhere a monetary phenomenon. To be sure, he later clarified that he was referring to periods of sustained inflation. In the short run, supply shocks can affect the price level. But we are looking at a longer time horizon here.
Of course, Nobel Prize winner Friedmann is criticized in literature, but historically the link has been relevant for over 100 years.
The consequences have been evident since the end of 2021: Inflation is an issue again. As briefly shown here, this was clearly foreseeable well in advance, especially for the SNB’s economists.
The SNB has fought inflation in Switzerland relatively well since the beginning of 2022 by no longer intervening substantially in the foreign exchange market and giving the Swiss franc room to strengthen. This made inflated imported goods cheaper. Negative interest rates, which were driving up real estate prices, were also lifted. The result: 3.3% instead of 10% inflation in the Euro area. So far, so good.
So, did the Swiss National Bank do everything right?
Unfortunately, no. The conclusion must be much more:
- The SNB has expanded the real money supply to the same extent as the ECB, thereby creating the same inflation potential in Switzerland as in Europe. The fact that it can mitigate this with a strengthening of the Swiss franc is relevant in the short term, but it masks the cumulative potential.
- The SNB management had to know that inflation would be an issue. The main response option for all national banks is to pursue a restrictive monetary policy and raise interest rates.
- The SNB management failed to prepare its balance sheet for this situation: It had to be clear to it that imported inflation would have to be reined in with a strengthening of the Swiss franc. This devalues its foreign currency holdings, which, as explained above, were purchased at too high a price to start with and account for over 90% of the balance sheet total. Consequently, significant losses were to be expected here. These losses are acceptable because they are a result of the monetary policy instruments.
- All the more reason why the logical consequence for foreign investments should have been: Reduction of market risks. Duration risks (i.e. the risk of interest rate changes) on foreign bonds would have had to be reduced. The same applies to equity risks, because there is no doubt in macroeconomic terms that equity valuations come under pressure in an environment of rising interest rates. Anyone who is a little more familiar with inflation (the SNB’s core topic) should, for example, have read and understood Warren Buffett’s essay (How inflation swindles the equity investor, Fortune, Vol. XCV, No. 5, May 1977, 250-267) on equity valuations in inflation scenarios. Consequence: Hands off equity risks before an imminent burst of inflation!
The SNB loss in the amount of the Swiss government debt was unnecessary in terms of monetary policy
The SNB has wiped out 75% of its equity within nine months. The loss exceeds the entire debt of the Swiss Confederation. In any other company, all alarm bells would be ringing. Not so at the SNB.
In terms of monetary policy, a fraction of the loss would probably have been necessary. Mainly currency losses: at the end of 2021, 38% each of the SNB’s 966 billion foreign exchange assets were invested in dollars and euro, another 8% in Japanese yen, 7% in pound sterling, the rest in other currencies. If the foreign exchange investments reported at the end of 2021 are converted at the balance sheet rates of Q3 2022, we arrive at a currency loss in the region of 31 billion Swiss francs. The reported 9-month loss, however, is 143 billion. Where does the difference of 112 billion come from?
Did the SNB have to take foreign equity risks from a monetary policy perspective? Did it have to take duration risks on foreign bonds? The answer is clearly and unequivocally no.
A strong SNB balance sheet is important
There are always those who claim that a central bank cannot go bankrupt because it can print unlimited amounts of money. The consequence of printing money is inflation, the prevention of inflation is the main goal of every central bank. In this respect, this thesis contradicts itself.
For a credible and stable policy, a national bank needs a good equity cushion.
Speculating away such an equity cushion in a short period of time for the wrong reasons therefore damages the SNB’s reputation and restricts its monetary policy leeway.
Unlike a sovereign wealth fund, the SNB’s assets from foreign exchange investments are a direct consequence of its monetary policy measures. To put it bluntly: Consequently, expectations of special distributions and political demands for investments of any kind are out of place. Rather, it calls into question the extent to which an index-based investment of such foreign exchange assets in the broad market serves the SNB’s own monetary policy objectives, which are to be implemented independently.
Therefore, the SNB should firstly create transparency with regard to its losses (what was necessary in terms of monetary policy and what is the result of speculative investments). Furthermore, organizational consequences must be drawn: The Bank Council as the top management must be professionalized, as also called for by the SNB Observatory. The management competence of the governing body must be questioned. And the SNB should align its investments in foreign currencies strictly with its monetary policy instruments.
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