ETF's, Central Banks, Trade Deficits, and Currency Manipulation
The ETF has created an investment vehicle for price insensitive investors. A price insensitive buyer cares little about price, so when they enter a market they tend to push prices higher. One of those price insensitive buyers is the Swiss National Bank (SNB). The SNB is responsible for monetary policy, and most importantly: issuing Swiss franc banknotes.
While you will never see it stated in their mission statement, the SNB’s prime objective seems to be to keep their currency from appreciating against other currencies. A low franc gives a Switzerland based company a competitive advantage over foreign competitors, because their products become more affordable in other countries. This strategy has been deployed against the US throughout history; first by the Japanese, and then by the Chinese.
To understand how this plays out let’s imagine a Switzerland based cheese company that we will refer to as Swiss Cheese Corporation (SCC) that produces and sells cheese. SCC uses the franc to buy raw materials, pay employees, and pay for other expenses as they produce cheese. The cheaper those inputs are the better for SCC. Next, SCC sells their cheese to American’s, and receives US dollars in exchange.
Let’s isolate this trade and pretend it is the only trade done between the two countries (cheese traded for US dollars). In this instance because SCC sold the US cheese, and the US did not sell any product to the people of Switzerland, the US would have a “trade deficit” with Switzerland. Paper dollars were exchanged for something of true value.
In a free market, this would decease the money supply in the US. With fewer dollars circulating around the US economy, the economy would slow because there is less money to do business with. A slowing economy would deflate the price of goods and assets. Less money would also decrease credit supply, and all of this would likely cause a recession. On the other hand, Switzerland’s money supply would increase. More money would speed up the Swiss economy, increase credit supply, prices in Switzerland would start to inflate, and their would be an economic expansion.
Furthermore, the franc would start to appreciate in comparison to the dollar. SCC would need to convert the dollars they collected through US cheese sales into francs, because their employees and suppliers would demand to be paid in the local currency. In a free market, SCC would have to sell dollars to buy francs, the law of supply and demand would force the franc to appreciate in value compared to the dollar.
All these factors in a free market would help to equate the trade imbalance. Since the US economy slows down the US would most likely begin to demand less Swiss cheese. Sales at SCC would fall. Also, as the franc appreciated against the dollar it would further make Swiss cheese more expensive for Americans to buy. Further hurting sales at SCC.
At the same time people in Switzerland are now richer because of the influx of dollars into their economy. The franc, now being worth more than the dollar, could be used to purchase more goods in the US than in the past. These affects would induce the Swiss people to buy more American products. Americans would naturally slow their purchase of Swiss cheese, and the people of Switzerland would naturally start buying American cheese. Eventually the trade balance would equate or even swing to the US’s favor.
We Don’t Have a Free Market
The Swiss National Bank intervenes into the free market system. The Swiss like having a trade surplus with the US because, as illustrated above, it makes their economy boom. They want the good times to roll, so they can’t be having this whole free market thing get in the way.
Instead, after taking in dollars, Swiss Cheese Corp (SCC) needs to exchange the dollars to get francs. As stated previously, this would cause the franc to appreciate against the dollar. In enters fiat currency. Fiat currency is paper money that has no true value. Fiat currency only has value because the population trusts that others will accept it as payment. In order to keep the franc low the Swiss National Bank (SNB) simply increases the supply of francs by printing more francs. This levels out the supply and demand for francs. SCC can now stay very competitive in the US market because A.) the increased money supply into their business due to high cheese sales, and B.) their cheese stays cheap relative to the dollar because the franc was manipulated lower. SCC can use the influx of money to reinvest in their business while at the same time stay competitive on pricing with American cheese producers.
Paper is Cheap to Produce
Money is relatively cheap to produce. Machines are printing ink on paper (and really we are to the point money is created with a computer keystroke). Very inexpensive. The SNB not only does this for Swiss Cheese Corp, but all corporations in Switzerland. Throughout the whole Swiss economy, corporations can exchange their dollars for newly printed francs. This dynamic helps corporations in Switzerland to keep and build their business in Switzerland while staying overly competitive with US corporations.
It does not end there. The SNB has now stockpiled billions of dollars it exchanged for newly printed francs. The SNB now has two rational options for those dollars: 1.) Stash the dollars in their vaults 2.) Invest the dollars. The SNB elects to do both, but it is important to understand what happens when they invest the dollars. The SNB prints pieces of franc paper, uses that paper to exchange for dollar paper, then uses dollar paper to invest in US businesses that have real assets (real estate, factories, trucks, technology, etc), provide services, and produce income. It is like I agree to buy your house and I come to the closing with a few yellow legal pads of paper for the exchange. We are giving away real assets for pieces of paper.
The fiat money creates an inflow of money into our markets, and that inflow pushes up prices of our stocks. This is great for American’s that already own a vest amount of assets, but those of us that do not, it creates inequality. When you do not own a lot of stock the last thing you want is for the stocks to become more expensive. Not only does it make it more expensive for American’s to invest, but the American cheese factory is forced to close because it can no longer be competitive with the Swiss cheese factory that is flourishing and hiring more Swiss citizens to work.
In this scenario the rich in the US win: their stocks grow exponentially. The rich in Switzerland win: they own the flourishing Swiss factories. The common folk in Switzerland win: they get the jobs and pay raises because the Swiss factories are flourishing. The common folk in the US lose: American cheese factory jobs are lost, pay is lost or stagnates, and the stocks they do not own are now much more expensive to buy.
The SNB currently has close to $100 billion invested in US EFTs. They invest regardless of price because why not, they did virtually nothing to earn the US dollars. The paper they print the francs on are essentially worthless, but the economic activity and international competitive advantage that a low franc gives Switzerland is invaluable. I can’t think of a more inefficient market participant than the SNB.
Our markets have been used against us for decades. The Japanese and Chinese exploited our treasury bond market for decades. After decades of manipulation it has driven our bond yields to the floor. This is great if you need a loan (and can secure one), but meanwhile mom and pop who saved up $2 million thinking it would be enough to provide income in their later years lose badly. When they began saving a 10 year treasury bond yielded 6%, and at that interest rate $2 million would yield $120,000 in income per year. But since yields have been manipulated down, the yield is currently at 3%, only providing $60,000 of income. Rather than let the market dictate winners and losers the central banks of the world are picking winners and losers, and we have been allowing this to happen for decades.
The poster displayed at the the beginning of this piece was illustrated in the report written in 1913, “U.S. Money vs. Corporation Currency”, by Alfred Owen Crozier to oppose the the Aldrich Plan; legislation that established our central bank (The Federal Reserve). The central argument was those who control the money supply control the world. From the first chapter:
“This power to increase and decrease the supply or quantity of money and credit, and the interest or price charged for same, is the power of absolute life and death over the 24,392 banks and the business of every individual and corporation in the United States. If carried to extremes it would cause general panic, disaster, bankruptcy, and ruin. By this means it could at will raise and lower the prices of all securities, property, and human labor (my emphasis added). The committee truthfully said: ‘Such a power is not now possessed by any institution in the United States.’ Even the Federal Government itself has no such enormous and dangerous power. It is power to do all things that Wall Street seeks. With it, the few who will control the private corporation easily can soon own the entire republic and its 94,000,000 inhabitants in fee simple.”
The Aldrich plan was passed and it created the Federal Reserve. Today the major central banks around the world jigger the price of interest and money supply. For decades the Japanese and Chinese manipulated their respective currencies lower and used the dollars they accumulated to invest in the US treasury market. We got cheap money and goods. They got a boom in economic activity and jobs. Taken to the extreme we have become to realize it does not matter how cheap a product is if you don’t have a job or living wage. These trade practices if not reversed will literally suck the life out of the US economy from the inside out.
With the US treasury market at rock bottom yields the SNB decided to use US ETF’s to invest their dollars. The SNB dollar inflow into ETF’s is certainly creating price inefficiencies, and a buyer at any price is very dangerous to market participants that actually had to work for the money they are investing. Price inefficiencies do not correct gradually. They are very swift, and this is yet another reason why you should be treading lightly in todays stock market.
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