Speech
Embargo
8 October 2020, 11.30 am
What constitutes sound money?
Economic Conference, Progress Foundation
Thomas J. Jordan
Chairman of the Governing Board∗
Swiss National Bank
Zurich, 8 October 2020
© Swiss National Bank, Zurich, 2020 (speech given in German)
Ladies and gentlemen
As the title of today's event clearly states: supplying the economy with sound money is a
constant challenge. I am therefore particularly pleased to have the opportunity to examine the
issue of 'What constitutes sound money?' with you in more detail here. After all, as Chairman
of the Governing Board of the Swiss National Bank, I represent an institution that is
responsible for providing our country with sound money, a task we have performed since our
foundation 113 years ago. Sound money is crucial in a society that is shaped by the division
of labour and the exchange of goods and services - as has been demonstrated not least by the
experience gained with a wide range of monetary orders over many centuries. Today, money
is used in virtually all economic transactions. A sound monetary system is an essential
prerequisite for a modern economy, for efficient trade and for social stability.
Given how significant the monetary system is, it is only right and proper that the associated
developments are also the subject of regular public debate. With this conference dedicated
exclusively to the issue of sound money, you are making an important contribution in this
regard. Sound money is a fragile accomplishment, and is thus essentially always at threat.
However, against the backdrop of the global financial crisis, concerns that our good money
could turn bad have increased markedly across broad sections of society in recent years. On
the one hand, this is understandable. Central banks' crisis management has led to an
extraordinary expansion in money supply and interest rates are at record lows - in the past,
these phenomena have often been indications of imminent inflation and thus currency
depreciation. On the other hand, it is a demonstrable fact that the value of money has never
been as stable as it has been in the past 20 years (cf. chart 1). Viewed from this perspective,
central banks' expansionary monetary policies have simply satisfied the enormous demand for
central bank money. The strength of this demand is actually testament to a high level of trust
in central banks.
The fact that inflation has been held in check for so long may also explain the increasing
popularity of ideas from an entirely different perspective. The proponents of modern
monetary theory would like to see central banks being put at the service of state financing.
Their take is that independent central banks are merely a troublesome relict and that monetary
policy should largely be determined by the government's financing needs. But experience
from throughout history shows that this would, sooner or later, end in an economic policy
fiasco.
As you can see, the positions are far apart, with diametrically opposed interpretations of facts.
The aim of my speech is to provide some clarity from the perspective of Switzerland's central
bank. To this end, I will set out some fundamental thoughts on the properties of sound money
and the various types of money. I will then address the question as to whether, against the
backdrop of our current monetary policy, the Swiss franc can still be described as sound
money.
Sound money is stable money
But let us first take a step back and look at money as a concept. Money is a generally accepted
medium of exchange, and performs two other important functions, namely as a unit of
account and as a store of value.
As a unit of account, money serves to make economic transactions comparable. In this
function, it is also used for representing the nominal value of all kinds of claims and
liabilities. As a unit of account for determining value, money plays a prominent role in
virtually all walks of life - from the workplace to healthcare and pension provision.
For money to be a generally accepted medium of exchange, it must be possible to use it to
buy goods or services not only today, but also tomorrow, and the day after, and so on. Money
can therefore also be used as a store of value. However, money is not the only means of
holding and growing wealth, and it is often not the most profitable. Although it does offer
security and flexibility, unlike risky financial investments it generates little or no return.
So what constitutes sound money? My answer is unlikely to come as a surprise: money is
sound if it fulfils its functions as well as possible. And this depends on its value being stable.
Only if this is the case will it be broadly accepted as a medium of exchange over the long
term. Furthermore, as a unit of account, money that is stable in value makes it possible and
easier to plan and calculate, and it is also suitable as a store of value. However, the
importance of money that retains its value goes far beyond these three narrowly defined
functions. Sound money contributes to preserving the real value of financial claims with fixed
nominal amounts, such as savings deposits, bonds, employment contracts and pensions. It
thus creates security and trust, which in turn promotes social harmony and cohesion.
Money is therefore sound if it neither depreciates nor appreciates, i.e. if there is neither
inflation nor deflation. But how can we measure the development of the value of money over
time? To do so, we have to take as our basis the development of its purchasing power. It thus
makes sense to measure the value of money using a basket of goods and services that is as
representative as possible of consumer spending, as Switzerland does with the consumer price
index.1 The value of money thus depends on the transaction prices of goods and services, and
its development over time can be measured using the price of the basket.
Central bank money and bank deposits
Having looked at what constitutes sound money, let us now turn to the two types of money
that are circulating in parallel in the current monetary system and that can be exchanged for
each other: central bank money and bank deposits, that is to say book money of banks.2 In
Switzerland, central bank money comprises the banknotes issued by the SNB and the sight
deposits held at the SNB by financial market participants, primarily banks.
The Federal Act on Currency and Payment Instruments stipulates that the money issued by
the SNB is legal tender in Switzerland and that the Swiss franc, which is divided into 100
centimes, is the Swiss currency unit.3 Central bank money and its unit of account thus form
the anchor of our monetary system. The SNB's money defines the value and characteristics of
our currency and thus also provides the basis for bank money.
Bank deposits are not legal tender, however. They are instead much more a private claim
against a bank. On demand, these claims can be exchanged one-to-one for central bank
money, i.e. banknotes in the case of non-banks. Economic agents are prepared to hold bank
deposits instead of central bank money as long as they have confidence in the bank's ability to
pay and as long as the bank deposits offer them added value compared with central bank
money. For instance, bank deposits facilitate the settlement of transactions - most of us would
probably find it highly impracticable if wages and rent had to be settled in cash, for example.
Bank deposits also offer protection against theft and are often a better means of preserving
value than central bank money in that they normally generate a return. However, they do
entail a certain degree of credit risk.
In Switzerland, bank deposits account for more than 90% of the money held in Swiss francs
by households and companies, with less than 10% being held in banknotes. It is therefore not
enough for just central bank money to be sound money; bank deposits must be sound as well.
When is central bank money sound money?
But let us first consider the money that serves as the anchor of our monetary system. These
days, central bank money is paper money:4 there is no defined obligation as regards
convertibility into gold, which makes the issuing of money completely flexible.5 This brings
considerable advantages. It allows central banks to adjust supply in line with demand and thus
to keep the value of money stable over time.6 Thanks to this flexibility, in crisis situations a
central bank can make an important contribution to damage limitation by supplying additional
2
Just over two years ago, the Swiss electorate rejected the sovereign money initiative and its proposed change to a system based purely on
central bank money. Prior to the vote, the SNB had also highlighted the disadvantages of such a move. Cf. inter alia Jordan, Thomas J.
(2018), How money is created by the central bank and the banking system, speech at Zürcher Volkswirtschaftliche Gesellschaft, Zurich,
16 January, and Jordan, Thomas J. (2018), Why sovereign money would hurt Switzerland, speech at the Swiss Institute of Banking and
Finance at the University of St. Gallen, St Gallen, 3 May.
3
In addition to central bank money, the coins issued by the Confederation are also legal tender.
4
Paper money is used here in the traditional sense as a synonym for fiat money, i.e. the opposite of money backed by precious metals
(metallic money) or other commodities. These days it exists not only in paper form, but also as coins, book money and as digital tokens.
5
A remnant of Swiss franc convertibility to gold can still be found in the Federal Constitution, which obliges the SNB to hold part of its
currency reserves in gold.
6
The approach was already advocated in Hayek von, Friedrich A. (1931), Prices and Production, London: Routledge, p. 123 et seq.: "Such
a change in the 'velocity of circulation' has rightly always been considered as equivalent to a change in the amount of money in
circulation... it will serve as sufficient justification of the general statement that any change in the velocity of circulation would have to be
compensated by a reciprocal change in the amount of money in circulation if money is to remain neutral toward prices".
money and thus avoiding a shortage of liquidity in the financial system. This was scarcely
possible under the Gold Standard. Owing to the convertibility into gold, the monetary base
was largely static, which greatly exacerbated the recurring bank crises.7 Despite the glitter of
gold, the currency system then was anything but stable, and many people lost their savings
during banking crises.
However, there are also many examples from history where paper money proved to be
decidedly bad, as high inflation led to a rapid erosion of value with disastrous consequences
in some instances for the economy, society and politics. The flexibility that is the defining
feature of the paper money system is both its strength and its Achilles heel. Used properly, i.e.
with the focus on the goal of value retention, this flexibility can contribute to the stability of
economic development and the solidity of the banking system. However, things start to get
dangerous when it is misused to solve political or structural problems by issuing central bank
money - as advocated by the proponents of the aforementioned modern monetary theory, for
example. The temptation to fulfil such wishes via the printing presses, by creating money out
of thin air, is of course all the greater the more politicised monetary policy becomes.8 The
solidity of a paper money system therefore lies in three mainstays: a clear mandate for the
central bank, setting as its target the preservation of price stability and thus ensuring sound
money; protection from political influence by enshrining the independence of the central bank
in law and actually putting this into practice; and healthy state finances. After all, experience
shows that high government deficits mean increased political pressure on the central bank,
and in cases where monetary policy has been politicised, there is a clear risk of significant
currency depreciation sooner or later.
When are bank deposits sound money?
We can thus now also answer the question as to when bank deposits constitute sound money.
Having central bank money that retains its value is a key prerequisite for sound bank money.
Since bank deposits in Switzerland are denominated in Swiss francs, their value is largely
determined by SNB money.
Sound bank money therefore hinges on sound central bank money, but that in itself is not
enough. Bank deposits are only sound money if the bank in question is also solvent and
liquid, in other words, if the depositors can rely on being able to exchange their deposits into
banknotes or into deposits at another bank at any time without any problems.
For this to be ensured in turbulent times as well, banks need to have a strong capital base and
sufficient liquidity. They must be able to meet their obligations at all times, and therefore
must not take on any excessive risks. This is the case if banks structure their business
strategies accordingly and if regulation is focused on stability. This also reduces the
likelihood of the central bank having to step in as lender of last resort, that is to say providing
solvent banks with liquidity in crisis situations if they can no longer raise funds on the market.
Is the Swiss franc sound money?
And so we come to today's key question: is the Swiss franc sound money or not? The fact is
that the level of prices in Switzerland has never been more stable - and the Swiss franc's
ability to retain value thus never higher - than in the past twenty years. And also over a
longer-term perspective, the Swiss franc displays an exceptional ability to retain value by
international comparison (cf. chart 2).
What are the reasons for this? The solidity of the Swiss franc is attributable on the one hand to
the strength of the Swiss economy, and on the other hand to the stability of Switzerland's
state institutions. The SNB is one of these institutions. Swiss central bank money has retained
its value because the law guarantees the SNB's independence and gives it an unequivocal
mandate to ensure price stability while taking due account of economic developments. Added
to this, public finances are in good shape as far as debt is concerned, which reduces the
political pressure on the SNB.
The value of bank deposits in Switzerland is stable because the value of its central bank
money is stable, because the banks are operating prudently, and because the regulation of the
banking system is centred on stability. The strong capital base and high liquidity of the banks
in Switzerland increase the resilience of the system in times of crisis and promote confidence
among depositors. Both of these factors contribute to bank deposits retaining their value.
Current monetary policy and the role of central bank balance sheets
Our findings are therefore rather reassuring. In Switzerland, central bank money and bank
deposits are essentially sound money. However, there is no guarantee that this will always be
the case. Or, to put it in somewhat more pointed terms: will the expansionary monetary policy
that the SNB has been following for some years jeopardise the solidity of the Swiss franc in
the future? Issuing too much central bank money can indeed undermine the foundations of
sound money, especially if the money is created to solve political or structural problems.
However, the unprecedented expansion in the monetary base in recent years does not pose a
particular threat to the stability of the Swiss franc's value. With the increase in money supply,
the SNB has simply reacted to rising demand, and its focus in doing so has been firmly on its
mandate to ensure the stability of the Swiss franc and thus the supply of sound money. It is
worth noting here that bank deposits, which are also relevant for the development of inflation,
have grown at a comparatively moderate rate. Growth in the monetary aggregates referred to
by economists as M2 and M3 has been much less strong than would have been expected on
the basis of the increase in the monetary base or base money (M0) alone (cf. chart 3). In other
words, there has been a marked decline in the money multiplier.9
The increase in base money reflects the rise in demand for the Swiss franc, which is seen
worldwide as a safe haven in times of crisis. Without an expansion in the monetary base,
money would have been excessively scarce and its price would have risen massively. This
would in turn have led to a marked drop in the level of prices, our currency would have
appreciated even more, and economic activity would have declined.
Can this strong expansion be reversed when necessary? Yes, it can. If the demand for Swiss
francs weakens, the supply of money can be reduced at any time, thus ensuring that the
currency retains its value. The SNB has a wide range of ways and means at its disposal for
absorbing liquidity. However, one important condition for a successful reduction in money
supply is that the SNB must have unrestricted control over its balance sheet. And in
particular, it must, if necessary, be able to sell foreign currency for Swiss francs, in the same
way as it has been able to make foreign currency purchases in recent years. We therefore must
also firmly reject any ideas aimed at channelling our assets into a sovereign wealth fund, even
though we may be highly sympathetic to the matters in question, such as securing pension
provision.10
Summary and outlook
In conclusion, allow me to stress once again how valuable it is to have a dialogue on the core
issue of sound money. In my remarks, I referred to the crucial importance of the three
mainstays of a robust paper money system: a central bank mandate focused on price stability,
the independence of the central bank in setting monetary policy, and solid state finances. As
we have seen, sound money is always subject to latent threats. It is essential that we remain on
our guard if we are to identify these threats in good time and ward them off.
What are the biggest threats to sound money at present? In my view, there are two
developments in particular that we need to be watchful of. On the one hand, any move to
make central banks an instrument of state financing would undermine the second mainstay,
namely central bank independence.
On the other hand, the consequences of the coronavirus crisis could also impact on the
soundness of money. Overall, state financing needs and thus government debt have increased
considerably as a result, and this could undermine the third mainstay if countermeasures are
not taken over the medium term. In addition to this, many central banks have themselves
bought exceptionally high amounts of their country's own sovereign debt. In a crisis, that may
be the right thing to do in terms of monetary policy, but it must not be done for reasons of
state financing. The challenge lies in safeguarding the clear separation of responsibility for
monetary policy and fiscal policy even in this crisis situation, and thus ensuring that central
banks remain independent in practice and not just on paper. It is particularly important to
avoid scenarios where excessive government debt means that a central bank is de facto forced
into making its decisions dependent on their impact on public finances. This would result in
monetary policy no longer being centred on price stability and thus on sound money.11
Switzerland has been able to manage the additional debt well thus far thanks to the fact that its
public finances were in good order when the crisis hit. That said, the coronavirus crisis has
fuelled aspirations here, too. There have been mounting calls for the SNB to make massive
additional profit distributions. However, there are two things to bear in mind here. On the one
hand, the size of any distribution depends on the earnings potential of our investments. And
on the other hand, a central bank's equity must be sufficiently high to cover the risks in its
balance sheet.12
Ladies and gentlemen, a monetary system has to take account of the changing needs of the
economy and society over time, and the evolving environment in which it exists. However, it
is also important to note that it is an order that has developed over the course of history and
any ill-considered interventions could entail serious consequences for our country and the
population as a whole. Swiss monetary history has been characterised by a wide range of
changes, but the desire for sound money has been a constant throughout. Today's paper
money system with central bank money and banks' book money has stood the test of time.
But if we want to be able to benefit from the advantages of this system in our national
interests going forward, we must make sure now that the three mainstays of sound money can
continue to perform their roles and provide support.
What constitutes sound money?
Thomas J. Jordan
Chairman of the Governing Board
Swiss National Bank
Economic Conference, Progress Foundation
Zurich, 8 October 2020
Chart 1
2 08.10.2020 What constitutes sound money? | Thomas J. Jordan | © Swiss National Bank
Chart 2
3 08.10.2020 What constitutes sound money? | Thomas J. Jordan | © Swiss National Bank
Chart 3
4 08.10.2020 What constitutes sound money? | Thomas J. Jordan | © Swiss National Bank