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Commentary: Switzerland pioneered negative rates in the 1970s. It got very ugly

To protect its currency, the Swiss government pioneered the use of negative interest rates.
The Swiss franc
(Chris Ratcliffe / Bloomberg)

In the looking-glass world of negative interest rates, the Swiss are in a special category.

The Swiss National Bank went below zero ahead of everyone else back in 2014; now the bank is poised to slash rates still further. Swiss banks such as UBS have followed suit: They’ll soon start charging larger depositors to hold their cash.

The Swiss pioneered the practice back in the 1970s for the same reason: to keep their safe-haven currency from appreciating too much. But the lessons of that monetary experiment should give pause to anyone who believes that negative rates can halt capital inflows and appreciation in countries where the currency is fundamentally strong.

The postwar Swiss economy was largely driven by high-value exports such as precision tools and watches. This worked well in the Bretton Woods system of fixed exchange rates that defined much of the postwar era.

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But when President Nixon suspended the conversion of U.S. dollars into gold in 1971, currencies gradually began to “float” against one another. The dollar went into a steep decline.

This unsettled currency markets. But one nation beckoned as a refuge from the growing storm: Switzerland. A combination of fiscal probity and monetary stability made the currency a safe place to wait out the crisis, and investors began buying up Swiss currency, driving up the value of the franc.

This was a disaster for Swiss exporters, and the Swiss government initially imposed reserve requirements on nonresident deposits. When that failed to stem the inflow of capital, the government banned interest payments to nonresidents. And when that didn’t work, it went negative, imposing a 2% penalty per quarter on anyone with the temerity to buy francs.

The government backed off this radical move in 1973, but in the fall of that year, the oil shock pushed many speculators to abandon the dollar for the Swiss franc. Capital poured into the tiny country, and the Swiss government swiftly reinstated negative rates on foreign depositors.

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In November 1974, the situation had gotten worse, leading to further measures. When the Swiss government imposed a 12% negative rate on nonresident deposits, “the move stunned market participants,” prompting the dollar to surge, according to the Wall Street Journal.

And then the dollar fell — again. The government imposed more onerous reserve requirements on foreign depositors in December 1974. An official from the Swiss National Bank expressed confidence to a reporter that this latest move would put an end to those pesky inflows. “Taken together, these measures should represent some discouragement. They are rather heavy,” the official told the Irish Times.

They were heavy. But nothing could stop the influx of capital. In January 1975, the Swiss government held an emergency meeting and then took the extraordinary step of slapping a 41% annual penalty on foreign deposits.

But even this failed to stem the tide. The franc continued to appreciate against the dollar — a total of 70% in nominal terms between 1971 and 1975 alone.

The export sector stumbled, and the Swiss economy, long the envy of the world, suffered a serious recession. Industrial production fell 15% in 1975, plants worked well below capacity, and exports declined by over 8% in real terms. Before the downturn, official unemployment figures only acknowledged 81 unemployed people — yes, 81 — in a country of 6.4 million. That figure quickly jumped to 32,000, but it would have been higher had the Swiss not sent 150,000 foreign guest workers packing.

As the recession tightened its grip, industrial production plummeted. Swiss unions went on strike, mounting between 30 and 40 demonstrations a week. Normally, such signs of unrest would have deterred foreign capital. But the rest of the world snickered at the idea of blood running in the streets of Zurich. Swiss labor radicals? Come on.

Waldemar Jucker, of the country’s Trade Union Federation, complained to Forbes about the positive media coverage of the strikes: “The damned foreign journalists write that we behaved ‘in a very disciplined manner,’ and the franc strengthens even more.”

The only growth sector in the economy was — you guessed it — finance, with bank profits up 15% between 1974 and 1975 alone. As factories stood idle, banks pulsed with activity, all fueled by the influx of foreign capital.

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For the rest of the decade, Switzerland tried and failed to deter foreign capital. It didn’t help that both the government and the central bank keep a tight rein on finances throughout the ordeal. Little wonder that the nation’s inflation rate of 2.5% was the lowest in the world.

And therein lay a deeper problem. As one of the few studies of this strange episode concluded, Swiss attempts to fend off appreciation using negative rates and capital controls “were fundamentally inconsistent with the thrust of tight domestic monetary policy, which was the ultimate source of the capital inflows into the country.”

The suffering of the Swiss ended only when the country’s central bank focused exclusively on the exchange rate, inflation be damned. That meant massive amounts of unsterilized intervention in currency markets. But this came at a serious cost, as inflation started to rage out of control.

By 1982, the Swiss had abandoned this approach, a decision made possible by the fact that the U.S. had finally tamed inflation, thanks to Federal Reserve Chairman Paul Volcker. And so things sort of returned to normal.

The situation now is very different from the 1970s, given that inflation is nowhere to be seen. But in the current climate of competitive debasements, countries with strong currencies — Switzerland, Denmark and others — are apt to try to fend off capital inflows with negative rates.

They can try, but history suggests they’ll be unlikely to halt appreciation, particularly now that everyone is playing the same game.


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