EP 55: The Swiss Franc, 1798 to 2055 (with Costa Vayenas)

[Music] Welcome to the Library of Mistakes, changing the world, one mistake is a time. This podcast is presented by Professor Russell Napier, keeper of the Library of Mistakes. To find out more about the library, our events, our course, and much more, simply visit libraryofmistakes.com. Welcome everybody to the Library of Mistakes podcast. And today we are delighted to have with us Costa Viennes, who is author of a new book, The Swiss Frank 1798, 2005. We'll come back to why it ends in 2015. It's fascinating to read a book on the Swiss Frank because it's something that's always there. We kind of know as investors anyway some of its properties. But no one really has invested it over the very long term where those properties come from. Most interestingly of course it's ability to sustain its purchasing part better than other currencies. So where does that come from? Where does it all start? Costa's book tries to cover this with some tremendous data, some wonderful charts. But the book begins in 1798. So that's just briefly covered what was going on before 1798. Why a book on the Swiss Frank starts in 1798? I think the Switzerland and the first defense alliance of the Cantons is 1291. So what changed in 1798 to start a book on the Swiss Frank in 1798? Yeah, thank you very much for the invitation. So 1798, you have Napoleon invading the country. And this is radical because over centuries Switzerland has had this alliance of perpetual peace with the great neighbor, the kingdom of France. And there were 13,000 plus Swiss soldiers protecting the king. So they were on the wrong side of history. Napoleon comes in and he decides to invade the country. He invades it because there's treasure Adam Smith has told us about this in the wealth of nations. That there was the equivalent of a sovereign wealth fund. So there's a lot of gold assets. And Switzerland allows Napoleon to travel to the east faster. So it's kind of, you know, radical upheaval in the country. And what he discovers is that there are all these cantons and they have their own currencies. And he's like, no, you should be like France. You know, have one capital city. You should have one currency. You can call it the Frank. And so that's kind of the origins of the Swiss Frank story. And the Swiss obviously have no option but to accept this while the Napoleon is around. When he's not around, what happens next? There's a period where maybe there's a seems to be a sort of a gap between 1798 and 1850. What's going on in that period in terms of there being a Swiss francor numerous Swiss folks. Yes. So as a result of the invasion, all France's enemies decide that they need to take him on. And so from, you know, Austria, Britain, Russia. They, they go to war against Napoleon and, and he loses that little battle. And as part of the deal, he has to pull his he has to pull these troops out of Switzerland. And what that does is, you know, suddenly he weakens his influence. And the moment the moment that the forces are gone, which is 1803. So just a few years. The Swiss immediately cancel this new currency. This was Frank. They hate the central state. They hate centralized money. And so what then happens is that the canton's continued to pursue there. They can't know currencies. But this was Frank remains as an accounting unit among sort of 19 or so canton's. And continues to be an important reference. Up until around 1850 when there's a new constitution, a new currency introduced. But, but the key. The key contribution, I'd say. As a result of what how Pauline's invasion 1815 Congress of Vienna. Europe decides what has to be neutral. Don't go there. Don't attack it. And as a result of that protection. And these are treaty signed from, you know, Britain to Russia. Country prosperous. And. You know, before 1850. Which actually most, most very most Swiss people don't know. Because most Swiss people begin the story in around 1850. Yeah. So it's really interesting. This Congress of Vienna and that treaty we, we, we, you know, blame men looking at Switzerland and say word as disability to be neutral come from. What is actually enshrined in international treaty in 1815. And when we look at one of the reasons why the Frank has been successful. And the reality is it's not the whole story. We'll come on to that. But part of the story and it goods there in law for 1815, which is obviously incredibly helpful. The currencies of the canton's up until 1850. Do we know whether they are accepted sort of one for one with the unit of account, which is the Swiss Frank or all canton's coins created equal. We should of course say that this is a metallic standard being run. Yes, exactly. So what. The trigger for the book, which relates to your question is that. I struggled to find data before 1850. So I approached the central bank. They said that open their archives and they discovered there was nothing in the archives that would answer the question. And this caused me to kind of, you know, search. A little deeper. And what I discovered was. Instead of looking for the data at the central bank. The data that I found related to, to FX trading between hubs, FX hub cities. So what I discovered was like. Paris Basel or Hamburg Basel. The data is in Hamburg, the data is in Paris. And what this shows you is. That there was, you know, Basel was a strong FX hub. And so the data appears to suggest that if you, you know, if you were trading locally. Okay, you had your coins. But if you wanted to trade with Paris, there was a way to do it. And that was. For a very specific unity in Basel. If you wanted to trade with Hamburg, there was a way to do it. And it was why a very specific unity in. In Basel. So this is kind of what the. The show is FX hubs. It's also consistent with what I found. I mean, the data shows the same for many other European cities. City states cities were very important. So usually a monetary reform comes because there's been a problem. So it's 1850. Is it a problem that finally. Creates what we might call the Swiss Frank that we, we know today that the Canton seed. The US reauthority to the center. What is it that I mean, as you say, there's a lot of them by this stage. I think there are. Two. I think there's 25 canton's at this stage and they all decide to seed. Manage reauthority. So what is it that drives them to that decision? Yes, so they're surrounded by countries that have. One. One currency per country. They did have. They have this reference unit amongst themselves. And pressure just grows to become more efficient because. As you can imagine, trading between these different. Cantons was just not. Efficiently done by all these different currencies. So that was the. The background was that this was the trend. And there had been several attempts to read launch. This was franking to create a single currency and. They kind of all failed. And finally. The time had come. And then the question was, OK, so, so. Who do we, who do we follow? What do we do? And there was a split in the country. There was a. Basel. And a few other cities wanted to follow the French Frank, which was a new strong currency. And well known. And Zurich and a few other country. Cantons want to follow Southern Germany. The very area, Munich. And that almost led to a civil war. But in the end, they chose the French Frank, which. Horns after have been a good decision. Because the French Frank was strong for for quite a while. And it was probably a fairly easier decision because France has unified country at this stage. Germany is still. forming into the Germany we know today. Is that exactly what you're saying? Exactly. So one of the counter-arguments was, OK, so everybody knows who France is. Everybody knows the Frank. And what is Germany? It's not a unified country. It has several currencies. But that just shows you, you know, typically the Kentons were just looking out for themselves. We're not thinking about, you know, bigger alliances. And that inefficiency was a sort of effect then in their money. So the currencies are linked. And it's a metallic standard. The coin of circulation would be denominated in silver. I think it's right to say that French coins moved pretty freely in Switzerland. That was pretty fungible in Switzerland, wasn't this Swiss franc? Or they say the French franc? Yes. So what is interesting is, as you said, the original Swiss franc began as a silver coin. And there was no paper money at the time. And next door in France, they had already started introducing paper money after the revolution. And this led very quickly to hyperinflation. So many of the neighbors ended up in sort of inflationary phases, whereas Switzerland was its metallic coins did not have the same degree of inflation. And these cantones ended up being firewalls. So what happens if one canton doesn't spread over to the rest? Whereas in France, you make a mistake in parasitic effects of the whole country. So this focus on the metallic nature of the unit of exchange helped for quite a while. And we can see from the data that they have, Switzerland just had lower. The price level was lower. Inflation was lower than the next door. Throughout this period, we have the developmental banking system. Switzerland obviously ends up as a very famous center for banking and for international banking. But at this stage, banking is not that dominant in Switzerland. When did we begin to say that Switzerland is famous for banking as a poet? Because there is sometimes a conflict between having banks and having a signed currency, given how much money banks can create. So when do we begin to think that banking begins to influence the monetary policy of Switzerland or interact with it in a way that's important? So what is interesting, the data shows-- there were four banks in the 1800. And this increases to around 450 by the 1870s. And then you have probably sideways movement until the all-time peak, which is close to 500 around 1960. So that was the all-time high. I'd say. It's interesting that obviously you had banks before you had a central bank, a central bank, only came in existence around 1907. And the banks opposed a central bank and the banks who were issuing paper money eventually also didn't like the idea that a central bank would be issuing currency. So the banks were quite powerful. But not in the way that we would consider banks powerful today, they were local businesses. They were not super international. So these are local banks, as it would be in any other country. Nothing like at this stage, the sort of Swiss banks we come to know today. And the Swiss franc at that stage is not an international store of value. It's not as if foreigners are beginning to hold Swiss franc deposits in the 19th century. Or is that really something that comes after the link to the French franc ends? When is it to begin to see it? I know by 1929 there's a lot of foreign money on deposit in Swiss francs. But when we begin to see this recognition that there's something about the Swiss franc that would entice foreigners to own it. So what I would say is going back to this after 1815, you have a situation where the country's kind of an island. It's not part of these wars going on next door. It's kind of left alone. Whenever you have refugees, immigrants, they tend to move over to Switzerland. And so it does appear as a place where you can store treasure. Not necessarily in Swiss francs, but it tends to be a kind of viewed relative to what's happening next door. It tends to be a safer place. So you have that little bit of that aura of stability. We can also see who were the asylum seekers. Lenin, for example, was there for several years. So it was a place where you were tended to leave you alone. And I think that was a significant thing because if you don't have these ongoing disruptions, you can keep building your little shop, and your business, and whatever. The big knocks to the French francs and the neighboring currencies really come after the First World War. First World War is very damaging to France and its currency. And we see a very substantial decline in its value. And a similar thing happens in most of the natives. And the second big knock is 1948, so after the Second World War. So the Swiss managed to disentangle the Swiss francs from the French francs around the First World War. And so the French currency falls. Swiss francs doesn't. And that's really where things begin, where you can clearly highlight that across the continent, here's a currency that didn't have to be re-denominated. It maintained its value relative to silver and/or the biometallic system. And it gains a reputation as just being a safe currency. I'll give you one example quickly. Friend of Mayan said, from Italy, he said his father had told him. Had they invested, or they converted their Italian lira to Swiss francs, they would have been rich. So I decided to look up, so what were those values? 1861, one Italian lira buys you once was franc. By 1946, it's around 460 Italian lira. So I lost of 99.8%. And then by the time the Italian lira joins the euro, it's 1,200. So this is kind of the picture in an neighborhood. And people presumably take note of this. No, there's many things in the book that I didn't know. But I just wanted to read a little bit on about defense spending, because sometimes when you ask people about this, it's fri-ing less, I will. Obviously, one of the reasons is the government was much. More stable, fiscal aid didn't have a large army, et cetera. So I'd have-- let me read this passage on this period that we're now talking about. Swiss defense spending increased from below 10% of total federal government expenditure in the mid-1950s, to 25% in the 1860s, above 40% in the 1890s. And above 45% before the outbreak of the First World War. And at the point you make in the book is a low Switzerland doesn't end up at war. This didn't mean it didn't have to spend a lot of money on defense in preparation for the possibility that there could be another Napoleon of 1798. So yeah, so this seems surprising to know that Switzerland was spending so much money on defense. But that didn't at least-- we're going to come on to the First World War, but up until the First World War. This wasn't really causing any major inflationary issues with this Swiss currency, despite the rapid ramp up in defense spending. Yeah, so I think what does numbers show you is a fear. They didn't think they were safe from the Alps. They responded to the news headlines. And if there's war breaking out across the continent and refugees, then they were getting ready for war and spending more, preparing. So that's kind of what the data shows. And now there was one episode when the war spending did result in inflation and it was the First World War. So the First World War-- so remember, French Frank is collapsing, all these currencies are collapsing. And then the first one. World War, you have government expenditure increases 200%, most of it is linked to defense. And they issue these bonds and the public can't buy these bonds. Who buys the bonds? This new young central bank buys them and gives the government freshly issued Swiss francs. And this results in an inflation rate in the year 1917 on 25%. At the all time high, I could find in the data. So in one year, quarter of the Swiss francs purchasing power is lost. And this kind of shows you that war is not good for business in general. And places fiscal monetary policy under severe constraints. What is interesting though is the following two years, you have this very strong deflation, minus 15, minus 12. So that after that period, the Swiss franc is again back in terms of its purchasing power. Whereas the next two neighbors had far higher inflation and didn't reset it. So the point appears to be, yes, there's increased defense spending. Yes, it can result in inflation. But relative to what was happening next door, it wasn't that bad. And the rule of law stays intact as well. And we Switzerland, at this stage, doesn't lurch into any form of totalitarianism, property rights are respected. And that is also a contrast to some of the other bits of Europe. Is that correct? Or is there any significant change in the nature of the Confederation at war in wartime? So what do you, what you do have in wartime is the government chooses a commanding chief, chief of the army in general. So that police people know who's in charge. Because as you know, Switzerland doesn't have a prime minister or a former head of state. They have this council. But you're right. The nature of the system is such that because you don't have this Churchill figure, this powerful person, who needs to lead, it's just harder for the country to make radical moves one way or another. Because the people at the top don't have the power, don't have the authority. There's this little councilor, seven, and they're supposed to agree. So I think that helps. And then you also have these 26 Cantons that also have some say. And the fact, so the fact that you have this very distributed, our system and structure is what prevents the country lurching towards tyranny in hard times. Or has so far. The willingness and ability to deflate after the war is impressive. Other countries try it, other countries try maybe to get back onto the goals standard or pre-war levels. One thing's particularly of the United Kingdom attempting that with significant failure. Because it's a difficult and painful policy deflation. It's usually not good for, sorry, not good for debtors, probably not good for labor. Do you think there's something about Switzerland that enabled it to accept this form of deflation? And the second part of that is sometimes when you've got a large banking system, it's particularly difficult to live with a deflation, given that it tends to produce private sector cash flows and trigger credit defaults. So I'm sure we're accumulating all the positives for the Swiss franc here. I'm sure one of them must have been the ability to bring the franc back to its pre-war war one parody to squeeze that inflation out of the system. Is it something special that allowed Switzerland to achieve that? And so many others, Germany being the obvious example which lurks in the hyperinflation, really failed to achieve it? That's a good question. The only thing I can think of is the central bank was new. And perhaps it was doing what it thought, if we are pegged to gold, then this is what it means. That could be. So what is obvious and you're right, and I didn't investigate in detail that episode. What the data shows is, after the First World War, that was the country's weakest point. You had this 25% inflation, then you had deflation. You had the first national strike, what do we call those big strikes when the whole country closes down. Usually a general strike. A general strike, I guess. You had this the first ever general strike. There is this fear, the data shows that there's this fear of communism. And you see this, for example, in that the new Soviet ambassador is expelled and diplomatic relations are cut. And the reason is that the Soviets were causing trouble at the embassy. What were they doing? Ishing out pamphlets or the workers to unite. So you can see that this is a nervous time and this would fit with your view that it must have been very tough doing that deflation thing. So they stick it out. And this is really the period. This is my conclusion from reading your book where foreigners, sometime in the 1920s, come to really see the Swiss franc as a safe haven store of value. Is this where the real international reputation for the currency comes from? Or would you do that to a different period? I'm data dependent and what I find is that around 1923, 24 I think the data shows that it is the world's third largest reserve currency. So you have sterling. You have the dollar just about to surpass sterling. Those are the two big ones. And then you have this tiny third currency, the Swiss franc. And I don't think this was any policy by the authorities, but it was just the fact that this piece of paper was tied to gold and was as good as gold and survived the first world war. And that's probably what kind of help build its reputation as something strong. It's building a reputation amongst reserve managers, but also the foreign private sector. And this is when they seem to start to begin to accumulate Swiss francs. Yeah, so it would appear that around this time, this was quite a recognition internationally. And it's reinforced, and you may come to this, but it's reinforced by evidence of contracts in the second world war. And for example, a Romania borders, I don't know, coal or office to supply coal to Germany in the second world war. And it doesn't want to be paid in gold. It wants to be paid in Swiss francs. And so that's because it's lighter to transport, but is as good as gold. So I'd say the post-first world war and the second world war really enhances the currency's international reputation. Okay. Without any Swiss government strategy to do so. Yeah, once again, as your book stresses, it's really because of the chaos elsewhere. I mean, we have that peak of the Weimar high-primulation, 1923. Pretty soon we're heading towards the Great Depression. And Switzerland stays on that gold standard much longer than others, partially because francs does. You think that's why or is there something uniquely Swiss about it being able to hold on? So we'll come up with some dates. I think America leaves in Britain leaves in '32. I think America leaves in '33. France I think cleans on the '36 or '37. So Switzerland is able, in terms of its currency, to keep that gold backing from much longer than most people during this period, attracts capital inflows because of that. Yes. So it's the right. It's the link to France. They followed France. 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Imagine being the finance minister of a country, and you were faced with an enormous fiscal burden. These are super difficult choices. And as you say, they had more options because they had less relative debt. No, the interesting thing is the reputation of Swiss-Frank is high. People want to own the Swiss-Frank. But it's not easy for them to get it, because other countries have foreign exchange controls. But it gets there anyway. And then the Swiss, and you document this in the book, have to try and repel this capital, this willingness of foreigners to put money into Swiss-Frank deposit. So, what do they do to try and repel people from wanting to own their currency? So, we have to bear in mind, this is an economy with companies trying to export things. And it's always very damaging if your currency moves, appreciates too rapidly. And you may wipe out these companies, you may cause unemployment, all the things that you alluded to earlier. And so, the authorities try and prevent too rapid an appreciation. And so, we have these examples in history, in the 1970s when the gold standard collapsed. You have this massive inflow of dollars, also petro-dollars in Switzerland. And the authorities try and make the country less attractive. And so, what they do on these dollars, they're like, OK, so if you bring dollars to the country, there will be a commission or a negative interest rate of 2% per quarter. This seems to have no effect. And eventually, it's increased to 10% per quarter. So, a negative rate of 40%. And at minus 40, the dollars kind of stop flowing in. But what that shows you is, you know, what it takes when the world absolutely wants to have their assets there, there's a price they willing to take, or accept. And it appears that it appeared in the 1970s, it was minus 40. Wow. So, I didn't know. I didn't know what it got to that state. I mean, there are lots of things that can undermine a currency. One of them is that your banking system becomes far too big relative to the state. The banking system gets in trouble. The state has to be like the banks that involves issuing you money in one shape or form. But the striking thing about this West Frank is, it's not happened twice in just over 20 years. Initially, 2009, 10, it would have been UBS that was in trouble. Obviously, more famously. In the last few years, credit swiss. And the swiss of this dealt with two huge banking problems. And yet, still the swiss for it has remained a strong currency. What was it or is it about the ability to deal with problems or that magnitude that still doesn't undermine faith in the willingness of the authorities to put price stability ahead of other things? I think I'm in traveling around a little bit and hearing what people say. It's always interesting to bear in mind, these are relative to what is happening elsewhere. So for example, the data shows that during the global financial crisis, despite the issue that UBS had at the time, the data shows Americans are transferring cash to Switzerland. Why do they do that? Because they assume that there's less subprime in Switzerland. So I was in New York at the time and there were some weekends where you didn't know whether the ATMs would operate on Monday. So there was fear. And so I say, it's a relative bet. And then when you have a situation like credit swiss, which is obviously very negative, and you speak to people further afield, they were like, yeah, but nothing happened. We got our deposits, the bank open on Monday, everything was fine. And so there's this perception that even in a serious crisis, you guys appear to fix it on one weekend. And so even in bad times, it's still a relative story. What is happening elsewhere and what is likely that we'll get our deposits back? We have to finish on the title of your book, The Swiss Frank 1798 to 2055. So why does the book end in 2055 and not 2026? Yes. So the reason the reason is, okay, the book was published a few months ago in the 2025. And I wanted to be forward looking, but I didn't want to make a forecast because forecasts are really hard to do, right? So I didn't want to forecast the currency. But what I did do is look at the 30 year treasury bond in the 30 years Swiss government bond. Because this is where people were buying and putting in depression funds last year. And the strange thing was that the US rate was around 4, 4,5% going out over the next 30 years. And the Swiss rate was around 0.4. So a gap of 400 bits per year. And so I just highlighted the theory of uncovered interest rate parity, which says when you look at a currency pay, the one that pays you a higher yield is likely to be the depreciating currency. And so here you have this massive gap between the two. And you know, we just can draw their own conclusion from that. But for me, it's kind of obvious that people buying the 0.4%, Swiss-Francov and bond for the next 30 years are assuming they could be wrong, but they're assuming they're going to be paid back in strong of money. The ones they wouldn't do that. And yeah, so that's how we get to the 2055 story. The market still seems to be extrapolating that. I checked this morning just before our call. And the 30 years of this rate is now at 0.56. And the US is morning at 4.94, which means the gap is wide into 438 bits. So clearly an interesting signal. The great thing about your book is the data accident. You referred throughout this discussion to the data. And that is in wonderful long-term charts. And we're a financial history podcast. We nothing but like more than to see charts of really high quality data going back a very, very long way. So thank you for writing it. I call it a mythbuster. I think from what you said, it's even busted a few myths and swits. I don't never mind amongst the international community. And of course, like all good books, it leads you down lots of rabbit holes. A really interesting little bits of that I want to discover more about it. So yeah, I really recommend it. It's a good primer. Trigger's thought. It's full of good data. So thank you for writing the book. And thank you for joining us on the Library of Mistakes podcast. Thank you, Russell, for discovering my book and reading it. I appreciate a lot. And thank you for this interview. [Music]