Last week the FT brought the story that a certain Swiss canton, Zug, is asking its taxpayers to delay paying their taxes and their bills. Surely to anyone this piece of news sounds astonishing. The authorities are asking their taxpayers not to pay their taxes on time? What an atrocity! What is to make of this?
First a few words on the specifics of the Swiss tax system. The authorities of the canton are simply asking their taxpayers not to pay their taxes early. A policy of the Zug canton has been to reward early payments of tax bills by giving discounts to those who do. This means that a taxpayer can lower its tax bill by paying early. It is a great encouragement for both the authorities to maximize their fiscal capacity and tax collection, and for the taxpayers to pay their taxes (the alternative of not paying - tax evasion - carries a greater opportunity cost once you are given an incentive to lower your tax bill. The policies of tax amnesty are similar in its incentives and expected results, although I personally find the tax discount policy much more effective).
Anyway, ever since the Swiss national bank introduced negative interest rates, making it very expensive for anyone to hold large cash reserves, the Zug canton is reconsidering its tax discount policy, as they are finding themselves holding too much cash, which is becoming costly. Their tax discount policy is thus actually losing them money due to negative interest rates.
So what's the story with negative interest rates in Switzerland?
To understand this we must go back to when it all started - the crisis of 2008 and the subsequent troublesome recovery.
The Euro sovereign debt crisis and its effect on the Swiss franc
When the crisis started in the US and when it spilled over to the rest of Europe (and the World), the main currencies of the major economies all started 'losing value'. Or better yet, the Swiss franc started appreciating against all other currencies. Why? Simple, it was considered a safe asset. When there is a crisis investors usually dump (short) the risky and depreciating assets and go for the safe ones. This is why during crisis times we can always notice an upsurge in the price of gold - it has a reputation of the safest asset. A similar story is with currencies. If the US, the Eurozone, and Britain are all facing economic difficulties, then investors will seek to offload their currencies, the dollar, the euro, and the pound, and go for a safe one - the Swiss franc. Naturally, this high demand for the franc will cause it to rapidly appreciate against all of its main competitor currencies (the euro in particular).
You can see this on the graph below. Notice that in 2007 one franc would only buy you 0.57 euros. Today, they are almost in parity. The steady appreciation of the franc against the euro was on course since 2009. The biggest spike however, was in 2011. This was the most turbulent time ever for Europe (it's also when I started the blog - my motivation was the turbulence on the markets and my primary focus of concern was the Eurozone sovereign debt crisis). Interestingly enough, it was triggered by the S&P downgrading the US credit rating in August 2011. This is when the yields on Spanish, Italian and Greek bonds started to rise again. They were partially delayed by the ECB in August, buying time for reforms in Italy and Spain, but were again skyrocketing come November. I was living in London at the time and recall some of the conversations I had with people working in finance, consulting and politics. People were convinced the euro was doomed and that it will never live to see 2012. The FT even had lead articles by some of its most prominent columnists saying this was "the end of euro".
|CHF/EUR exchange rate, 2006-2016. Source: XE.com|
The sovereign debt crisis was indeed in full motion. Greece was going under and it was threatening to drag with it Italy and Spain. If this would have happened it would literally trigger the end of the euro project. By November 2011, the governments of Italy and Greece were replaced by technocratic governments. It was the bond market that led to the downfall of Italy's untouchable PM Silvio Berlusconi. The ECB reacted once again in December, but the shock wasn't fully averted until Mario Draghi made his famous speech in July 2012, saying he will do "whatever it takes to save the euro". That finally calmed markets down and restored some confidence back to the ECB and its currency.
The Swiss reaction
Back to Switzerland. As the franc upsurged in value due to even higher demand, the Swiss National Bank (SNB) needed to take measures. It needed to prevent further appreciation of the franc and it started massively buying euros. A monetary operation of buying euros means pushing a lot of newly 'printed' francs on the market. A new supply of francs should lower its value, or at least keep it steady since the demand was still very high (this was going on for the next three years, until 2015).
However this proved to be much harder than it seemed. The SNB ended up not only buying euros but also euro-denominated assets such as sovereign bonds. And recall that buying sovereign bonds of Eurozone countries at the time was a very risky investment. The SNB was facing tough decisions during the entire period, but by 2015 they decided to abandon the exchange rate floor and opted for using negative interest rates to make the franc less attractive for foreigners. The immediate reaction to abandoning the currency floor was another strong appreciation of the franc in the beginning of last year. It has been slightly going down since but it is still very high, at least with respect to the euro (it declined more against the dollar and the pound - the reason it's staying strong against the euro are the troubles Europe is still facing, such as the refugee crisis. Notice that the euro was in decline against the USD and the GBP as well throughout last year).
So how does the negative interest rate scheme work? As its name tells you, it offers negative interest rates on savings. Anyone holding cash reserves is facing a decline in its value. The way this is actually being done is via the banks charging large fees to their customers for holding big cash reserves. It is a policy aimed against the savers, or to be more precise, to encourage the savers to start spending and companies to start investing their money and thus boost domestic demand. Greater domestic demand (higher investment and consumption) would lead to more job creation which would improve the conditions on the lending side of the market as well. People who lack liquidity would thus get jobs, improve their credit ratings and increase the demand for credit. Obviously this should lead to a further increase in the supply of domestic currency and create additional depreciation pressures.
It's all good in theory but it doesn't seem to be working quite yet. The vivid consequence is the decision of the local authority to ask its taxpayers to delay tax payments. Holding cash in Switzerland is like a hot potato. The people are simply dropping it to the governments, and they have no one else to unload it to. That's why they are asking for a delay in tax payments - they simply have too much negative-yielding cash. How's that for a problem?
You think you've got problems? In Switzerland having money is costing you money! How's that for a problem? :) https://t.co/5vMQ95ak1j— Vuk Vukovic (@im_an_economist) January 18, 2016