# 11 / 2016

The Empty Promises of the «Sovereign Money Initiative»

Empty promises mean greater uncertainty

Risk of loss of confidence in the Swiss franc

Instead of comparing the Louisiana case and coinage with sovereign money – i.e. apples with pears – apples should be compared with apples in order to be able to at least roughly sketch the uncertain outcome of the sovereign money experiment with the aid of various scenarios. Here, one indicator would be the apparently strongest argument put forward by the initiators: the security of the Swiss franc.

Because payment transaction accounts are managed outside the balance sheet, sovereign money is no longer affected by banking crises. Issued Swiss francs would always be available on the clients’ own account and could therefore be withdrawn at any time. Even if all clients decided to withdraw their money simultaneously, this would not give rise to any difficulties for the bank.

While this means that bank runs would be eliminated, a significantly greater risk would arise, namely that of a run on the currency. At present, the SNB books central bank money under liabilities and a mix of forex investments, securities, gold and bonds under assets. Although the SNB is currently being criticised to some extent for maintaining securities denominated in euros on its books, the situation under sovereign money conditions would be a great deal worse. In a sovereign money system the central bank no longer books any assets on its balance sheet. Sovereign money would be defined as an asset and subsequently given away to the government and the population. This means that no assets are acquired in order to put sovereign money into circulation. Instead, sovereign money is simply defined as an asset.

This practice could shatter confidence in the Swiss franc. As Voltaire pointed out, paper money eventually returns to its intrinsic value – zero. Sovereign money would sooner or later suffer the same fate if the SNB were to no longer possess any foreign currencies, securities, gold and bonds on the assets side. Confidence in the Swiss franc could rapidly diminish and culminate in a frantic flight from the currency. Based on historical comparisons, this is unfortunately a realistic scenario.

The historical balance of «asset-based money» with no intrinsic value

All over the world, the devaluation of coins was always a popular means of supposedly generating revenue at no cost. The intrinsic value of a coin was reduced with the aid of various methods and thus resulted in the creation of seigniorage. In the Byzantine Empire, silver was added to coins originally made of pure gold while the nominal value was retained. The proportion of silver was constantly increased until in the end the coin consisted entirely of silver, which resulted in a loss of confidence in the currency and ultimately caused it to collapse. In Japan, the weight of coins was periodically reduced until they were worth only a fraction of their original value. The Japanese population then used rice as a means of payment.

Unlike coins, sovereign money – which is also an asset-based concept – does not possess any intrinsic value at all. In view of this it is likely that the loss of confidence in such a currency would be at least as drastic as was the case in the above historical examples.

A currency crisis would have far-reaching consequences for the Swiss population. The purchasing power of the Swiss franc – and thus the country’s prosperity – would be eroded. This would mean that all the advantages that Switzerland has built up since the nineteenth century thanks to its stable currency would practically vanish overnight.

While the risk of bank runs would be eliminated through the introduction of a sovereign money system, Switzerland would merely be exchanging that risk for the much greater risk of a flight from the Swiss franc.

Sovereign money cannot protect savings

It is an undisputed fact that bank runs and banking crises can cause a great deal of harm to the economy. But the sovereign money system only prevents the former. A bank run occurs when a large number of clients simultaneously decide to withdraw their money from their bank. Due to the money multiplier, the bank is not able to cover all the withdrawals at the same time. This means it becomes illiquid and could drag down other banks in the resulting turmoil, thus potentially jeopardising the entire banking system. This kind of bank run cannot occur in the sovereign money system. By contrast, a bank can become bankrupt if its borrowers are no longer able to repay their debts. Because only payment accounts are secured in the sovereign money system, if the bank becomes bankrupt, savers would lose their money as in the past. But the existing deposit protection ensures that a client’s deposits at the domestic and foreign branches of a bank are secured up to the amount of 100,000 Swiss francs.