Jun 11, 2018

Brian Blackstone on the ECB and the Swiss Referendum on Sovereign Money

Should the SNB be the only national entity in control of money creation?
David Beckworth Senior Research Fellow , Brian Blackstone

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Brian Blackstone is a Switzerland Bureau Chief for the Wall Street Journal. Previously, he covered the European Central Bank from the Wall Street journal’s Frankfurt office. Brian also covered the Federal Reserve during the financial crisis. Brian joins the Macro Musings podcast to talk about the Swiss Referendum on sovereign money as well as his insights on the European Central Bank.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu

David Beckworth: Brian, welcome to the show.

Brian Blackstone: Thank you David.

Beckworth: Well, it's a real treat to have you on. I've been reading some of your articles with interest particularly the ones on the Swiss Referendum and the developments in the Swiss economy but as I do with all my guests, I would love to hear how did you get into financial journalism and how did you go from the Fed to the ECB to Switzerland.

Blackstone: Well, I started in financial journalism 20 years ago and I had been living and working in Washington D.C. doing research work for Think Tanks Trade Associations and I got interested in journalism and started writing op-eds and trying to get those published. That led me to decide that I really wanted to do journalism and I moved to New York City and got a job with Dow Jones and started off writing about the government bond market. That, in the late 90s, got me into covering the Federal Reserve. My career has taken me to a few different places since then and different beats, but I've come back to central banking and that's been a real ... It's just ended up being a real core area of my career as a journalist.

Blackstone: I was covering, after being in the Paris Bureau I moved to Washington D.C. in the mid 2000s and started covering the Federal Reserve in 2006 when Ben Bernanke became the chairman. It's kind of funny, I remember this was during the time that they called the Great Moderation and covering central banking was quarter point rate hikes, predictable and I even remember around 2007 thinking that there wasn't a whole lot going on in central banking. Then the financial crisis started with first little things like these Bear Stearns related hedge funds in the summer of 2007 collapsing. Then that just kind of became a tidal wave by the middle of 2008 and then that led to some very exciting times. Then in 2009, the opportunity came to cover the European Central Bank and I went to do that. A few months after I arrived in Frankfurt, the debt crisis in Greece began.

Beckworth: You tend to follow the crisis along where they go, huh?

Blackstone: Exactly and that's what led me to Switzerland. Not on purpose, but maybe there was a little something in my subconscious that after covering the ECB during the really biggest days of the crisis right up through the QE launch through the end of 2015, I did what all investors do which is seeking safety, safe haven in Switzerland and I've been here for the last two and a half years. I'm not sure how happy the Swiss were to have me come but I've been here two and a half years and there hasn't been a crisis following me here, yet.

Beckworth: Yes, no crisis, but some interesting developments.

Blackstone: Exactly.

Beckworth: Maybe we can call you the Blackstone Indicator. Wherever you move something interesting is going to happen.

Blackstone: Exactly.

Beckworth: Your financially prophetic gift is something we all must follow closely. Okay, well, let's move on to some of the observations you have about the ECB. I want to chat with you because you come from a unique perspective in that you've covered the Federal Reserve during the crisis and you were covering the ECB during its key crisis time as well. There are a lot of differences between these two banks. For some Fed observers like myself, I'm sitting here across the Atlantic and I see the ECB not hitting this inflation target. I hear about the wars between the Hawks and the Doves over there. For some of us, like myself, we want to say, "Just hit your inflation target already." Tell us about the reality on the ground there. I know there's big differences culturally, dynamics, what are the differences between the Fed and the ECB?

Blackstone: Well, one of the most striking ones was just covering the Feb during the Lehman collapse and the housing crisis was how quickly the US responded, how quickly the Fed responded with, whether it was the tarp, even though I remember covering Ben Bernanke and Henry Paulson in the Congressional hearing and they kind of got pummeled by member of Congress but they got their money. The Fed would create these maiden lane-type instruments to deal with the crisis and its aftermath. Some of them worked, some of them didn't work but if something didn't work, they tried something else. There was a lot more agony in the eurozone on trying to do these things. I remember when the ECB started buying government bonds of Greece and Ireland and Portugal in the spring of 2010, it was so controversial even though we were not talking about huge sums of money. It was kind of the same with the Greek debt crisis. Greece is a tiny economy. The amounts of money, obviously these sums grew quite vast as time went on but sometimes there would be a lot of anxiety of the future of the eurozone, Greece would have a debt payment to make and that the amount, compared to what I would see in the US, weren't really that big.

Blackstone: But the big difference was, there's no central fiscal authority for the eurozone. There wasn't a eurozone bond. You had however many countries in the eurozone, now it's 18 or 19, you'd have that many different bond markets. You would have issues of countries in the stronger north want to be lending money to southern Europe or giving money to southern Europe. Then you'd have the question of Greece borrowing money when most people agree that they wouldn't be able to pay it back. There was just a lot more angst when it came to the institutions of Europe trying to do these things. All the late night meetings in Brussels from the Euro group, from these European, eurozone finance ministers. It was the reaction in the US was so much faster and like I said, not that they necessarily were getting everything right but there was a sense that if something didn't work, you try something different the next day. Whereas in the eurozone, there was just a lot more debate and controversy because again, these were not problems that the eurozone and the European Central Bank were necessarily set up to do. It meant it took that much longer for things like QE to be launched with a lot more controversy because it's a central bank that's set up without a common finance ministry. That's just a really unique situation for Europe and it's something that they're still trying to figure out.

Beckworth: Yeah, so Mario Draghi must be a really sharp political operator to have to navigate those other finance ministers. You know, in the US, we read about Bernanke having to navigate the regional Fed presidents but what you're suggesting is that Mario Draghi has an even tougher course ahead of him.

Blackstone: Well, for Mario Draghi, one of the challenges was on the one hand, being kind of the main crisis responder, which isn't necessarily the case in the US, where you have the Central Bank and the Treasury Department responding to the US crisis. In dealing with an imperfect setup, to deal with the eurozone crisis and then he also just had the challenge of operating the European Central Bank given that a lot of the traditions behind the ECB were the Bundesbank, Germany Central Bank, which had a much different vision when it comes to things like buying government bonds or tolerance for inflation being below a 2% target. There's been a lot of controversy in Germany over the ECB's policies in a way that Ben Bernanke and Janet Yellen didn't have to deal with.

Beckworth: Yes. It's far more complicated than many of us observers here in the US make it out to be.

Blackstone: Exactly. That's why the ECB didn't launch its quantitative easing program until January 2015, several years after the Fed and it's why the ECB is still tapering at a time when the Fed has completed that. It's why you still have negative interest rates in the eurozone at a time when the Fed is steadily raising interest rates. The ECB is lagging behind the US. Obviously different economies, different crises that they were dealing with, different economic and inflation environment but it took the ECB and Draghi longer to do the kinds of things that Ben Bernanke was able to do.

Beckworth: Now, you mentioned the ECB inherited the Bundesbank's German culture. Do you think Mario Draghi is left a change upon the institution? I mean, when he leaves, will it revert back to the old Bundesbank culture more or will Mario Draghi's actions forever leave a mark, a path that they can tread in the future?

Blackstone: I mean, I think it will leave a lasting legacy because I mean, my own view is that's just the nature of central banking now. Things like quantitative easing are seen as kind of a normal part of the Central Bank's toolkit. It was really controversial when the European Central Bank did it but the eurozone economy is recovering. Inflation is getting closer to the ECB's target and so I think in that way, the policies were very controversial and there was a lot of anxiety but in the end, I think a lot of these ... The ECB has adopted the same toolkit that other central banks have adopted. It's probably less controversial now than it was a few years ago.

Beckworth: Okay. Well, let's move onto Switzerland because I want to spend most of our time talking about the Swiss Referendum, which you've covered quite a bit.

Blackstone: Mm-hmm (affirmative).

Beckworth: To help paint the picture, kind of set the context for that discussion, I want to touch on the Swiss economy in general. You had a really fascinating article not too long ago that was titled, How Switzerland Lost the Currency Battle But Won the War. Tell us about that as a way to help paint the picture of the Swiss economy.

Blackstone: Well, Switzerland is one of the economies in Europe that are really kind of fascinating cases because they're not part of the euro and yet their economies are highly dependent on what ECB does because the eurozone is a huge export market for them. They import a lot from the eurozone so that has a big effect on inflation. Switzerland has the added challenge or complication of having one of the world's preeminent, if not the most preeminent safe haven currencies. When the eurozone is in trouble during the crisis in 2010, 2011 especially, in the really dark days of the euro crisis, the Swiss franc was strengthening a lot. That was making the Swiss National Bank's job really difficult because their economy and their inflation is so dependent on the exchange rate, in a way that the US economy is not so dependent on the dollar's value because most of the economy is internally generated. The same with the eurozone. But in Switzerland, that's different. In 2011, I'm going to step back a few years, the Swiss National Bank tried something pretty radical which was to set a floor on the euro's value against the Swiss franc. Meaning, the euro could only weaken up to a certain level and then the Swiss National Bank by intervening in the markets, selling francs and buying euro and other foreign currency assets. They did this for about three and a half years and accumulated a lot of reserves in the process.

Blackstone: But then, at some point, that just became an untenable situation. The SNB decided, at the beginning of 2015, they couldn't do that anymore. Without any warning, because again when you are setting an exchange rate target, it's not like moving interest rates, where you can kind of give hints to the market. You can't really say, "Well, we have this exchange rate target and maybe we'll drop it." They just did it by surprise on January 15th, 2015. They said they're not going to maintain this limit on how strong the franc can be against the euro. As you can imagine, at the same time they dropped their deposit rate to minus 0.75% in an effort to weaken the franc. The Swiss National Bank, for the last several years, their biggest problem is that their currency is too strong. When they dropped that exchange rate target with the euro, the franc went through the roof and at one point was basically at parity against the euro. That really put the Swiss economy at risk. After that, the SNB was in this really uncomfortable situation because they were having to intervene a lot in the markets to just try to keep the franc from just strengthening so far above and beyond what was healthy for the economy.

Blackstone: Basically for the next couple of years, they were able to keep the franc to where the euro franc rate was something in a 1.05 to 1.10 range. Not to get too specific with numbers but this was a level that was really, really strong for the Swiss franc, too strong for the SNB but not to strong that it was going to just cripple the economy. So, in the process, the economy adjusted, the manufacturers adjusted. They found ways to become more competitive. It's a very high cost economy in terms of labor costs but it's an efficient economy. The labor markets are very flexible, it's relatively easy to hire and to lay people off. The economy adjusted. In that sense, it was kind of a success story because despite this, they call it the Franc Shock, when the franc just went really, really strong at the beginning of 2015. The economy buckled and I think there might have been one negative quarter on GDP. But the economy didn't go into recession, unemployment didn't go up. There were certain sectors in the economy that struggled, watches struggled, tourism struggled because if you want to go skiing in the Alps, yeah you can come to Switzerland but you can also go to Austria, you can also go to Italy, you can also go to France where it was a lot cheaper.

Blackstone: But, by and large, big sectors of the economy, like pharmaceuticals that aren't very price sensitive, did okay. They were able to weather the storm. In the end, here we are in 2018, the economy is growing at about 2%, unemployment is around 3% and inflation is still quite low. But the economy adjusted. The one byproduct is that now the SNB is sitting and something like 750 billion francs, that's about 750 billion dollars worth of foreign exchange reserves. That's going to be really complicated when they have to do something with those someday because that's an amount equal to even more than Switzerland's entire GDP.

Beckworth: Yeah, this is a very fascinating story on several levels. The Central Bank dimension but also the recovery. I want to focus on that latter point. The story you're telling is that despite there being a strong currency, the Swiss economy adapted. You mentioned in the piece they had nimble labor markets, productivity growth, and a number of ways they adjusted to deal with the higher currency values. You think in economics there's the interna price, there's the foreign price, your competitor and then there's the exchange rate. They effectively did devaluation internally, is that right?

Blackstone: Exactly. You can compete through the exchange rate or you can compete through efficiency, productivity and they had no choice. The SNB couldn't weaken the Swiss franc. It wasn't a, they had to make this adjustment, they couldn't. Swiss industry couldn't wait for the Swiss franc to devalue, who knows when that's going to happen. Now, in the last year the euro has strengthened against the franc, which has helped the economy, which is probably why the economy has gone from growing at a 1 to 1.5% range now to closer to the 2% range, a little bit higher. The economy adjusted. They did, in kind of an economics jargon, devaluation and were able to improve efficiency, improve competitiveness. Like I said, they don't necessarily have a clean bill of health. There's still someday maybe an aftereffect of having a negative interest rate for so long. You've got a really strong housing market here in places like Zurich and Geneva. Very low mortgage rates, very high house prices. Like I said before, you've still got Central Bank sitting on foreign reserves that exceed the size of their economy. It's difficult to give Switzerland a complete, all clear on the economic and central banking front. But I think that given what happened at the beginning of 2015, they have to be pretty happy with how things are looking in the middle of 2018.

Beckworth: This is instructive because the discussion about the eurozone, particularly the periphery is that they have lost the ability to devalue through the exchange rate, right? They are forced to internally devalue, Greece has been doing this, maybe Italy to some extent. That's been painful for them. And other words, Swiss is able to do what the Greeks have not been able to do without much suffering and pain. It kind of fits the hopes, maybe the aspirations of what the Germans want the rest of the euro to do but no one else has been able to do it quite like them. I know Greg Ip had a piece on Spain in the Wall Street Journal recently that suggested Spain had done some structural changes and was doing better. But for many of the countries in the periphery of the eurozone, the critique has been because of this fixed exchange rate regime, the euro, their hands are tied. Effectively the Swiss were the same way, even if they worked through it. It's an example of where internal structural reforms can make a difference. I guess the question is, can other countries replicate what Swiss has done? Swiss may be unique in that it's small, maybe there's more coalitions that work together. I mean, can you comment on that?

Blackstone: Well, I mean this was kind of a debate in the eurozone. Can you have each country in the eurozone kind of elevate to a German-style economy in terms of efficiency, in terms of manufacturing, in terms of being able to run trade surpluses. In a sense, Switzerland is an example that competitiveness is not all about the exchange rate but at the same time, it's hard to make a case that Greece or Italy or some of the other countries that have struggled in southern Europe are going to be able to kind of adopt a Swiss economic model. Switzerland is used to having a strong currency. It's not lik during the euro crisis, Switzerland all of a sudden went from having a really weak currency to a really strong one. They went from having a strong currency to having an even stronger one. In a sense, it was an extreme case of something that they're pretty used to dealing with already. It wasn't quite the shock that countries like Greece had. Also, in the end, they did have what Greece and Italy didn't have, which is their own national central bank. Now, obviously, the ECB would disagree. They would say that the National Bank of Italy is the European Central Bank. The Greece is the European Central Bank.

Beckworth: Sure.

Blackstone: But it is different when you have a-

Beckworth: It is.

Blackstone: ... a central bank that is designing their monetary policy to fit the unique circumstances of their country. In the end, Switzerland did have that.

Beckworth: Yes. Just in general, my sense is that Switzerland has better institutions, the quality of the rule of law, the governance in general makes it easier to implement structural change. Is that fair?

Blackstone: Well, it's an interesting political system because it's very much run in a kind of consensus driven way.

Beckworth: Okay.

Blackstone: You don't have a lot of volatility when it comes to the political atmosphere, except for the referendums, which I know we're going to get to, which we're going to get to later. But it's a very decentralized political system, too. It's not like you would necessarily have a Swiss federal competitiveness idea or something to make the labor market or make the economy more reactive and competitive. It's basically a system where each of the states, known as cantons, have a lot of autonomy in terms of setting their own corporate tax rate, in terms of having their own labor market structure. It's more a political system that's built for an economy that can be reactive.

Beckworth: Okay. One other point on this discussion about the Swiss experience over the past few years, this goes back to the Central Bank's balance sheets. You mentioned the SNB, which is Swiss National Bank and the concern they had was that it's balance sheet was getting so large they could take a loss at some point because they're holding all these assets on the balance sheet. You mentioned 750 billion, is that right?

Blackstone: Something in that ballpark, it changes every quarter depending on what the franc rate is but around there.

Beckworth: Now, my question is, does the Swiss National Bank have some kind of inflation target? Are they aiming to get higher inflation then they've had

Blackstone: Well, they haven't gone to this magical 2% rate that other central banks have in terms of defining inflation right at 2% as the best rate for the economy.

Beckworth: Okay.

Blackstone: They basically have an inflation goal of under 2%, positive, but under 2%. Basically 0 to 2%.

Beckworth: Okay.

Blackstone: Typically Switzerland has lower inflation then the eurozone. That's kind of just something that's been the way it's been for the last decade I think.

Beckworth: Yeah.

Blackstone: Right now, the Swiss inflation rate is something around 0.8% annual inflation. It's still quite low but it doesn't necessarily trigger the kind of urgency that it would at the ECB or the Federal Reserve because their objective is not to get inflation back to 2%. If they are closer to 1 than to 2, it's not necessarily a credibility problem for the SNB because their mandate isn't to get 2% inflation.

Beckworth: They have an inflation range they go after, 0 to 2%. The reason I bring this up is because the concern they had about their balance sheet taking a hit is exactly the kind of thing you would use to create inflation. If there was a hole in their balance sheet, if they had more liabilities, more money created, more monetary base than they had assets, that in itself should create some inflation. In fact, some people suggest you grow the balance sheet big enough, it makes higher inflation a credible threat. It's a bit, maybe, puzzling as an outsider to see them get concerned about a hole in their balance sheet on one hand and at the same time, worrying about a strong currency on the other hand. Those two concerns seem to be at crossroads.

Blackstone: Well, the challenge here is that, I mean you can almost look at it as the Fed, the ECB, the Bank of Japan, other central banks, are doing quantitative easing. The SNB was also doing quantitative easing with other countries assets. They weren't buying Swiss bonds the way the Fed was buying US bonds, the eurozone is buying eurozone bonds. The SNB, again it makes it a fascinating central bank because it's limited. There isn't a huge pool of debt in Switzerland. The government debt to GDP ratio is very small compared to what you see in the US or the eurozone. There isn't a big pool of Swiss bonds for them to even buy if they wanted to somehow credibly show that they were going to get inflation back to 2%. That basically for them leaves the negative interest rate and foreign exchange intervention. But if you're doing foreign exchange intervention, you're loading up your balance sheet with eurozone assets, US assets, stocks, bonds and I forget what the latest data were but the SNB owns a pretty good chunk of Apple stock, for example.

Blackstone: That puts the balance sheet of the SNB at risk because it's not only sensitive to what happens in Switzerland, it's sensitive to what happens in the United States. It's sensitive to what happens in the eurozone. It means a very risky balance sheet that's somewhat outside of the control of what the SNB can do. Another example would be look at what happened in Italy in the last couple of weeks. Because of the political uncertainty in Italy, you had the franc rise about, I don't know, 4 to 5% against the euro. Well, think about the hundreds of billions of eurozone assets that the SNB holds on its balance sheet. If you get the franc strengthening just a few percentage points, that's a lot of money. Now, it's money that's in the same way that the Fed, it's not like the SNB has to run profits or if they run a loss it's not like they have to go to the taxpayer for money.

Beckworth: Right.

Blackstone: It just shows how unique their situation is in terms of being dependent on things that happen outside of their own borders.

Beckworth: No, I get that. I understand maybe that they don't like the volatility but that is exactly how you generate inflation, right? That's how you weaken a currency. If your balance sheet takes a hit, the concern here, to be clear, is that as the franc goes up in value, those assets will lose their value, right?

Blackstone: Those foreign-

Beckworth: Those foreign assets.

Blackstone: ... currency assets will lose their, exactly.

Beckworth: Right. Which would then mean there's more francs outstanding than there are assets. If they wanted to go buy up those francs, for example, they need some assets of comparable value but suddenly those assets have lost value so now they can't buy up as many francs. Oh no, what happens now? There's more inflation now, the franc loses value. I guess that's where I'm a little puzzled. I can understand maybe the magnitude of the volatility can be so huge, they want to avoid that but in terms of the direction, if they have a balance sheet that's getting some risks, maybe some holes in it on the capital side, then that would generate inflation and you would think, take the edge off the strong currency. But maybe I'm missing something here.

Blackstone: Well, there's two sides to it. You take on risks with such a big balance sheet but then can also make a lot of money. Last year, the Swiss National Bank ran a profit of 54 billion francs. That's 54, 55 billion dollars. That's about, I don't know, probably 8% of GDP or something like that.

Beckworth: Wow.

Blackstone: When the franc weakens, as it did last year, they can run huge, again these are paper profits. These are paper losses.

Beckworth: Sure.

Blackstone: Because they're not selling their assets. But I think the big challenge for them is the SNB can try to do a lot but in the end, it's a small, as economists like to say, a small open economy. It's a small open economy with a safe haven currency. That just leads to the question of, the SNB can try really hard to weaken their currency but sometimes the force is going in the opposite direction whether it's what the ECB does or what the Federal Reserve does can somehow outweigh what the SNB is trying to do.

Beckworth: It's very interesting. We talk about resource curses for countries who have oil or other great resources. It comes back to haunt them, they rely too much on it. In this case, you can apply the resource currency to Switzerland and the curse of having a safe haven currency. It really comes back to haunt them. Well, let's move onto the Swiss Referendum on sovereign money really fast and any development, you've been covering that. Just a note to our listeners, this show is coming out on June 11th, on a Monday. The vote will be on June 10th, a Sunday. This show will come out the day after the referendum is voted on. You will know the outcome. We don't know the outcome yet, although Brian knows the polls and has a good sense of where it's going. But Brian, tell us about this referendum and why it is so radical.

Blackstone: Well, first of all, just to kind of step back to explain the referendum system because it's kind of a contrast to what I said before about the political system being very much a consensus driven one that doesn't really change very much. Switzerland has a very strong, kind of direct democracy tradition. A lot of things come up to a public referendum. Corporate tax reform comes up to a public referendum. There was one a couple of months ago on whether to have public television fees continue or whether to eliminate them. They'll have a referendum on nuclear power plants. What can happen though, is basically if you can get 100,000 signatures, there's obviously a more complicated process that goes along with it but you also have to propose a constitutional change but you can get something on a referendum. It takes several years but what that ends up happening in Switzerland is you can get something interesting economic ideas that come to a vote by Swiss people. A recent example, I think it was two years ago was they had a referendum on basic income. This is the idea that every resident, no matter your wealth or status, gets a minimum level of income from the government.

Blackstone: Now, it failed by a pretty wide margin but it got a thorough public debate in a way that sometimes these economic ideas don't if it's just something that economists are talking about. There's working papers about them, conferences. There's really no substitute to having a campaign, a political campaign for some of these ideas. This is what's happening now with this idea of sovereign money. This referendum really goes back to the financial crisis. What they're trying to do is basically change money creation system. Right now, commercial banks in Switzerland and around the world, create money every day. If they're extending a housing loan, they create the reserves. The money that's created that you might see on your mortgage statement or your bank statements isn't necessarily the same as the money that pops out from the ATM machine. What the sovereign money initiative would do would say that only the Central Bank can create money. This would lead to just a huge change in what banks are able to do.

Blackstone: The banks are lined up against it, the Central Bank is lined up against it. They say it would lead to less lending, higher borrowing costs, that it would overburden the Central Bank. What the sovereign money supporters say is that it would prevent kind of the booms and the busts that we've seen over the last 20 years because the Central Bank would have more control over the money supply and that you wouldn't have bank runs because all the money would be Central Bank money. They think this would lead to a more stable economic system, but like I said, the Central Bank and the banks and the government are lined up against it.

Beckworth: It's very fascinating because this has been a discussion among some economists since the crisis. As you mention in your pieces and as part of this conversation, this idea goes back to the 1930s, the Chicago plan. Irving Fisher was a big proponent of it. That banks would no longer do fractional reserve banking. Just, again to repeat what you've said, when I go get a car loan, the bank creates money out of thin air, puts it in my checking account, I go buy the car with it. That becomes money. You mentioned the statistics. In Switzerland, in your article you note that there's 645 billion Swiss francs and only 85 billion are notes and coins. What they're calling for is the elimination of banks opportunity to create that kind of money. To be precise, banks would no longer function as they do now. They would no longer create money through deposit creation.

Blackstone: Exactly. In a sense they kind of become asset managers. They would still, obviously because the assets would exist, they're not creating them anymore. The sovereign money in German is called Vollgeld. Sometimes I lapse and call it Vollgeld. They say that this kind of restores banks to their proper role. They would still provide services, you'd still go to a commercial bank for a mortgage loan. They would still provide services. The difference would be that the banks would have to have the reserves either their own reserves, borrow money from other banks, issue debt or get the money from the Central Bank in order to grant the loans. It would really change the nature of banking here. It would put Switzerland, whether it's a good idea or a bad idea, it would put Switzerland on a completely different playing field than the rest of the world.

Beckworth: Very fascinating. In some ways, Switzerland is a great place to try this because it's a small country, if things go bad. On the other hand, it's not a great place to try because the banks in Switzerland are these big, international banks that really cater more to an international audience than the domestic ones. I read one place that even if this experiment were to pass and it doesn't work out, great. It may not harm the big banks so bad because most of their business is overseas but I want to go back to the mechanics of this because I think it's important. I followed the proposal. I wanted to just read the actual proposal or the referendum statement. It says, "Do you accept the popular initiative for crisis saved money, money creation by the National Bank only!" And they have sovereign money initiative. I followed this to the Federal Council website and the Federal Council is the federal government in Switzerland. I just want to read a few excerpts when they go into this detail about this proposal.

Beckworth: It says, "The aim of this initiative is to give the Swiss National Bank, the SNB, sole responsibility for creating all money, both cash and book money in bank accounts. This means that commercial banks will no longer be able to create money by granting loans. In addition, the SNB should bring newly created money into circulation free of any debt without receiving any consideration in return by distributing it directly to the federal government, the cantons or ordinary people." That's where I guess I wanted to maybe flesh this out a little bit. I can understand how one might have a checking account in Central Bank. The question is, how does Central Bank create new money and how does it do it in a smart way. How does the Central Bank know when there is an increased demand for funds. I mean, it could look at maybe an inflation target, something like that but have they fleshed out how this would work operationally?

Blackstone: You know, not really. One of the problems and one of the reasons that the Central Bank is so opposed to it is that operationally it would be really difficult for them. This is not a huge central bank with thousands of people. How does a central bank decide what's the appropriate level of money in the economy at any given time? Or are there too many housing loans or in an extreme case, should you or me qualify for a loan? The Central Bank is saying that the way the system works now, where they influence the amount of money in the economy through interest rates, they can act as a break on the amount of credit creation in the economy by raising interest rates and raising the costs of lending and borrowing. They want that system to be continued. I don't think the Central Bank has a really good idea of what they would do if they kind of had to go into this new regime. That's one of the reasons that they've been ... It's rare for the Central Bank to kind of publicly weigh in on referendums because in the end, this is a political decision, not a central bank decision. It's one of the reasons that they've kind of come out and been pretty strong in saying what they see as the risks to this initiative.

Beckworth: Yeah. I understand the motivation, they want to avoid bank runs and this idea has come up again and again. Again, 1930s, there were some other folks who recently proposed this after 2008. It's an idea that kind of comes and goes in waves of popularity. But one of the key principles is they want to separate money creation from credit creation, or as the proposal detail said, debt-free money. I think that's just more complicated and harder to do in practice than they might imagine. I want to go through a thought experiment here. I often hear people tell me the Federal Reserve's monetary base is no longer a liability of the Federal Reserve or the government because it's no longer backed by gold. The idea for the Swiss proposal is, you'd have Central Bank money and it would somehow be increased. Maybe they would just add money to people's checking accounts. Maybe everyone would see increases in their balances if there's a recession for example. You increase it until inflation goes to a certain level or you could even do money supply targeting.

Beckworth: One fascinating implication of this is that Milton Freedman's monetarism could actually be implemented under this proposal. But one of the things I think is not true is that the money would not be completely debt free. People say the Federal Reserve's monetary base is no longer a liability of the government but it is implicitly if you care about price stability. In other words, if a government cares about low inflation, it is implicitly committing future resources to make sure that that happens. So, if they need to increase taxes in the future, if they need to cut government spending, there's real resources dedicated to that. Even in the case of the sovereign money, it implies that the government is willing to do whatever it takes to keep inflation low. That may require real resources in the future. Implicitly it is still a liability of the government. It's, I think, a lot more complicated in practice than on paper.

Blackstone: That's one of the arguments against it that's been advanced here is that it would potentially undermine the independence of the Swiss National Bank by putting a lot of pressure on it, potentially, to print money, to create money. That it would complicate the SNB's task, which is right now to keep inflation below 2%. That it would potentially put them under political influence. One thing that the people in favor of sovereign money have said is that the one advantage would be that it would create more money in seigniorage. This is the fees that central banks charge for creating notes and coins, for creating legal tender money. The sovereign money people have said, "Well if we're converting site deposits to Central Bank money, that's going to create billions of francs every year in additional seigniorage fees. This can be used to cut taxes, this can be used for public spending." Again, the SNB has countered that this is something that would potentially undermine their independence.

Beckworth: Yeah, you can see why they're not excited about it. One last question on the details of this plan and maybe it's not clear to you, either because this is just an idea being thrown out there but commercial banks could no longer create money like they do, but they still could exist, right?

Blackstone: Absolutely, yeah.

Beckworth: Okay. But they could not issue loans unless they had 100% reserve backing. Right?

Blackstone: Exactly, yeah.

Beckworth: Okay.

Blackstone: I think the sense would be that for example, Swiss banks here have, they are obviously major wealth manager. You could potentially still be a wealth manager even under a sovereign money regime. You're managing the assets for your clients. I think that in terms of the supporters of the sovereign money initiative trying to limit some of concerns that this would just completely lead to a complete undermining of the banking system. I think their point is, well, banks will still exist. They would just be performing a different function and that they would be performing the function that they're supposed to have been performing all along. Obviously the opponents have a much different view about it.

Beckworth: Okay. That's the idea behind the proposal, the referendum. What is the likelihood that it will actually pass? What do the polls tell us?

Blackstone: It looks unlikely that it would pass. The latest polls I've seen have about a 20 point spread with something around a third of the people that are polled being in support and somewhere maybe in the mid 50s of people being opposed to the initiative and then the rest of the people being undecided. Typically, you know, Switzerland has these referendums which create a lot of interest and potentially could create a lot of volatility but you don't get a lot of Brexit type surprises out of Swiss referendums. This is, like I said, the basic income referendum was something in the 75 to 25% in terms of the spread or 80 to 20. Right now, typically the initiatives tend to lose support as the campaign goes on. I think it's pretty unlikely that this sovereign money initiative will pass. I think what's going to be really interesting would just be the spread. If it's something where it's, again I don't have a great sense to pinpoint what the spread would, what would be considered good news or bad news but I think if it's a fairly close race, this referendum could come back. If this referendum were taking place in the middle of a crisis, if this were happening in the middle of Lehman or something like that, it might have more support. I think if it's a case where the margin is relatively close, then this argument would live to fight another day.

Beckworth: Now, you mentioned there's been several referendums that have come up that might seem like radical ideas and then they're ultimately voted down but along with them come a campaign. There's a campaign that follows, a national conversation. How do they have that? Is that just through the press? Through the media? How do these campaigns evolve? You mentioned as the date draws near for the vote, people get more engaged. Is this the kind of conversation you don't see in the United States on issues?

Blackstone: You know, you don't see so much just flooding of the airwaves on something like this. It's maybe a little bit more old fashioned in terms of, I don't know, retail politics. You'll see people in the train station with the old fashioned kind of sandwich boards-

Beckworth: Really? Huh.

Blackstone: ... passing out flyers. They had a giant piggy bank touring different Swiss cities because this isn't a big country. It's not like you have to buy million of dollars of television airtime. It's a country of a little over eight million people. You've got some large cities by Swiss standards. It's been an interesting campaign though, because it's a difficult campaign for the people who are against the sovereign money initiative. For example, it's hard for the bank CEOs to come out and really denounce it because there's still probably a little bit of a backlash against bank CEOs. It's a tricky position for the opponents to come out and to really strongly campaign against it. It's not like you're seeing CEOs of the big Swiss banks at rallies or anything, giving speeches where they're really being critical of it. The Central Bank, the bank chairman, Thomas Jordan, gave a speech a few weeks ago where he laid out, in pretty strong terms by Swiss standards, the case against it. But I think it's a little bit more difficult of a task for the opponents of this sovereign money initiative because they have to be careful not to come out too strongly against it because again, there's always that little bit of a skepticism of bank CEOs.

Beckworth: Right. That makes sense. Well, this is very fascinating. I look forward to next week, seeing the outcome of this referendum. Well, our time is up. Our guest today has been Brian Blackstone. Brian, thank you for coming on the show.

Blackstone: Thanks for having me.

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