# 11 / 2016

The Empty Promises of the «Sovereign Money Initiative»

A radical experiment with an uncertain outcome

Switzerland as guinea pig

The advantages the initiators attribute to the sovereign money system are by no means a foregone conclusion, and the initiative largely ignores the risks and drawbacks associated with the proposed changeover. If the initiative were to be accepted, Switzerland would effectively become a large-scale test laboratory in which the population would collectively function as test subject. The consequences of the changeover to the sovereign money system are difficult to predict and threaten both growth and prosperity in Switzerland. No other country has introduced this system and it has never been trialled anywhere to date. As guinea pig, Switzerland would face a highly uncertain future.

Inappropriate comparison between Louisiana and coinage

The initiators cite Louisiana and coinage in Switzerland as evidence that sovereign money functions very well. But this comparison is unable to withstand close scrutiny: it is tantamount to comparing apples with pears. Following the US banking crisis of 1837, Washington delegated banking regulation to the individual states. While Texas and Iowa prohibited banks altogether, other states – and in particular New York – favoured «free banking», i.e. a system without any banking regulation at all. With the adoption of its Free Banking Act in 1853, Louisiana also favoured a market economy solution, but had already imposed an obligation on banks in 1842 to cover their deposits and banknotes with cash (one-third) and short-term securities (two-thirds). The system adopted in New York proved highly successful, and the Louisiana solution was also relatively successful and stable from the 1850s onwards.

But the example of Louisiana is not suitable for making a genuine comparison. At that time there was no central bank that brought money into circulation as monopolist: banks issued banknotes in competition with one another. That system essentially is a combination of the free banking period in Switzerland in the 19th century and the Chicago Plan, and thus functioned in an entirely different way to the sovereign money concept proposed by the initiators.

Coinage, too, is an unsuitable example for comparison purposes. At the time of its inception in 1851/52, the composition of the Swiss franc was defined as five grams of silver 900 per thousandth, fine. The five franc coin was currency money, i.e. its intrinsic value was equivalent to its nominal value. Banknotes were not widely distributed until the 1870s, and at that time book money was also not as widely used as it is today. Swiss franc coins were widely distributed alongside foreign coins and were used intensively. However, the first Swiss franc coins were not sovereign money: with the exception of coins with a nominal value below 20 cents, their intrinsic value was equivalent to their nominal value. Thus seigniorage resulting from the minting of coins was only possible to a very limited extent.

Today, the metal value of Swiss coins is only a fraction of their nominal value. This means that the federal government is able to obtain seigniorage from the minting of coins. However, a comparison with the sovereign money system is not appropriate. On the one hand, the federal government forms reserves equivalent to 65 percent of the coins in circulation. Because experience has shown that a shrinkage rate of 35 percent has to be anticipated, even in the case of a full return flow of the coins the government is able to exchange them on a profit-neutral basis for banknotes or book money by drawing on its reserves. And on the other hand, coins meanwhile account for less than one percent of the overall money supply. Consumers have largely substituted coins with banknotes and book money.

Two major risks due to lack of comparisons

It is therefore clear that the Sovereign Money Initiative aims to introduce a fundamentally new monetary system that has never existed anywhere to date in the proposed form. Although other monetary systems indicate certain similarities with the sovereign money concept, it is not possible to draw direct comparisons. This gives rise to two major risks: firstly, it is by no means certain that the transition from the existing system to the proposed sovereign money concept will take place without severely harming the Swiss economy. And secondly, it is not at all clear whether in the sovereign money system the desired effects can be achieved and at the same time the negative effects will not outweigh the positive ones. In view of this, the proposed sovereign money system has to be regarded as an economic experiment with a highly uncertain outcome.

Transition to banknote issuance monopoly

The handover of the banknote issuance monopoly to the newly established Swiss National Bank (SNB) meant that around three dozen private and cantonal banks had to cede their issuing rights. In 1907, the proportion of notes in circulation to the balance sheet total was around twelve percent on average. In order to give the banks sufficient time to create the necessary liquidity, a three-year transitional period was specified. By the end of June 1910, the banks had to deliver a minimum of 40 percent of the equivalent value of their issued banknotes to the SNB in legal tender and the remainder in the form of cash, bills of exchange or securities. Because the banknotes were covered to around 50 percent by coinage and the option was available to hand over securities – an option that some banks utilised to a very great extent – the transition took place relatively smoothly.

For some banks, however, this move resulted in far-reaching consequences. Private issuing banks were either liquidated or merged with other banks because their business activity was now prohibited. And for the cantonal and other private banks the loss of a financing option had a negative effect on profitability. The elimination of banknotes meant that they had to replace non-interest-bearing resources, which in most cases was implemented via share capital increases. This accelerated the process of consolidation in Switzerland’s banking sector.