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A blog on financial markets and their regulation
I wonder whether someday the Swiss would be tempted to simply demonitize the 1000 franc note and earn a windfall gain. After falling for decades, Swiss currency in circulation started rising after the global financial crisis and is now higher than at any time in the last 35 years. Notes in circulation are now well above 10% of GDP and the 1000 franc note accounts for 62% of this or over 6% of GDP. The Swiss central bank publishes a nice set of tables and graphs about all this. Even the US whose currency circulates so widely all over the world (half of all US currency is estimated to circulate outside the US) has a currency to GDP ratio of only about 8% (currency data from the FED and GDP data from the BEA).
As Swiss interest rates remain in highly negative territory (-0.75% at the short end and negative all the way to 30 years), the extremely high denomination 1000 franc note has become very attractive to investors. It is conceivable that if this environment persists Swiss currency might approach 15% of GDP and the 1000 franc note might by itself edge close to 10% of GDP. In a regime of negative interest rates, currency is not a source of seigniorage, but is a costly form of borrowing. At some point, the Swiss may well start thinking about just extinguishing this liability and earning a windfall gain of more than 5% of GDP.
I am not talking about an outright default. The Swiss could start by citing the decision of the European Central Bank (ECB) last month to “permanently stop producing the €500 banknote … taking into account concerns that this banknote could facilitate illicit activities”. They could say that in accordance with global best practices, they too are abolishing the 1000 franc note. Unlike the ECB which retained the existing notes as legal tender, the Swiss could require holders of the 1000 franc note to exchange them for lower denomination notes or bank deposits. The sting in the tail would be a statement that the exchange would be carried out in accordance with the Financial Action Task Force (FATF) recommendations that require member states to seize and confiscate proceeds of money laundering and property involved in financing of terrorism. Therefore, holders of 1000 franc notes would be required to establish their identity as well as the source of the funds.
It is a fair assumption that a significant fraction of the 1000 franc notes will not be tendered for exchange under these conditions, and the Swiss would have made a profit of several percentage points of GDP. The question to my mind is how large that number would need to be for the Swiss to be tempted.