Absolving Quartz

Fables are amazing, powerful things. They take on a life of their own. They can play the role of social glue, binding a community together in shared understanding and belief. Fables can become so convincing that a community might become confused and start to treat fables as facts.

This is particularly likely when a fable is built around a skeleton of facts, as is the case of the "quartz crisis" fable. The facts in this fable are as follows: in 1969 Seiko released the first quartz watch (the Astron 35SQ).

The quartz movement of the Seiko Astron.

The fable hanging off these facts: due to the high accuracy and low cost of this innovation, the Swiss mechanical watch industry experienced a downward spiral. Numerous brands folded and innumerable jobs were lost.

I've retold this fable myself, taking it as factual. This week, though, I started reading some scholarship on the events of the 1970s, the period over which quartz reputedly claimed most of its victims. My research reveals that the actual crisis in the watch industry can not reasonably be attributed to quartz alone. It is easier to blame quartz, and placing the blame there serves some other purposes, many of which I'll describe later.

In order to get at the truth, we need to take a side trip down the road of international monetary economics. Most trips worth doing aren't necessarily easy, but I will do my best to keep it interesting. My personal opinion is that it is worth it, in the end.

Chicago Invades Berne
As I was reading about the trials and tribulations of the watch industry in the 1970s, I learned that the Swiss currency appreciated in value during those years. I wasn't personally familiar with this currency market episode, so I started to look at the data. Money is like anything else in the world: there is a supply and there is a demand. If a currency, like the Swiss franc, appreciates then there can be only three explanations: demand increased, supply decreased, or both.

Supply is usually the easiest to gauge because modern money is offered by a monopolist: the central bank (one exception is cryptocurrency, but that is a rabbit hole unto itself). I pulled up the data on what Switzerland's central bank was doing in the 1970s, it is included here.

Base of Swiss francs

The volume of francs forming the base of Swiss money followed a very interesting path. It was, essentially, two straight lines implying that the bank created an additional CHF 119M in the base each month during the 1970s and CHF 85M in the base each month in the early 80s (the blue and grey lines, respectively). Very few things involving humans follow straight lines. Even when humans are asked to form a straight line in person, it is rarely straight.

When I saw this anomalous shape, I said to myself "it looks like the Swiss central bank was following a Friedman rule." Milton Friedman was a Nobel Prize winning economist on the faculty at the University of Chicago in the 1970s.

Milton Friedman

He co-authored the first real book on monetary economics. A Friedman rule stipulates that a central bank, such as the Swiss National Bank (SNB) in Berne, should increase the money supply at a constant and predictable rate and let all the other cards fall as they may.

Following a Friedman rule would create a path for the franc like the one I included here. When I ran the numbers, I was quite surprised that the estimates I obtained from a very simple Friedman rule model could explain roughly 85% of the Swiss franc's behavior in this era. The SNB's own official timeline of major events indicates they attempted to implement a Friedman rule in the 1970s. They established and announced targets for the volume of francs they would supply.

Breaking Bad: OPEC Style
As we wrestle with a health crisis thrown upon us by nature, it is easy to forget that in the 1970s there was a somewhat similar crisis. That crisis also made it difficult to travel. But it was intentionally manufactured by a small group of people. Although this sounds like some kind of illuminati-inspired conspiracy, it isn't.

The Organization of Petroleum Exporting Countries (OPEC) is a cartel that, in the 1970s, successfully restricted the supply of oil though a series of embargoes.

Gas lines during one of the OPEC embargos.

This lead to shortages (hence difficulty in traveling) and astronomical increases in gas prices. It was a very successful strategy, from OPEC's perspective. An astonishing amount of wealth flowed in the direction of oil producing nations. In a 1975 article in World Affairs, Christopher Joiner noted that revenue per barrell of oil quadrupled in the early 1970s.

OPEC has an interesting historical connection to Switzerland.

Its initial headquarters was located in Geneva. This is not a coincidence. When you find that you are suddenly awash in vast pools of money, as OPEC was in the 1970s, you are, of course, happy. But this is also a curse. As many successful drug dealers know, you need to figure out what to do with all that money, and you need to figure it out quickly.

Walter White check-free checking account.

Famously, the character Walter White in the TV show Breaking Bad buried his gains from selling crystal meth in barrels in the desert. This would have been an option for OPEC as well.

Instead, they sent a lot of their embargo-derived largesse to Swiss banks. It is hard to confirm this with data, given the notorious secrecy of Swiss banking, but we can tell from commentators at the time that this was happening. In fact, the International Monetary Fund included Switzerland in a list of oil producing nations from which it borrowed in the 1970s.

List of "oil" lenders, note Switzerland's inclusion. IMF Annual Report, 1980.

Since the Swiss received funds from oil nations, borrowing from the Swiss was logically equivalent to borrowing from OPEC. Why Switzerland? Well, if you ran an OPEC nation and you were deposed by an unruly mob, you could at least count on that secret bank balance to carry you through your troubles.

This is what set the stage for the appreciation of the franc. Like Rolex with its Submariners, the Swiss National Bank doggedly limited how many francs would be available (see what I did there?).

A talk given by Otmar Ettinger, published in 1975 in World Today.

OPEC nations were running to Switzerland and buying up as many francs as possible so that they could deposit their oil proceeds in Swiss banks. A German Bundesbank official acknowledged as much at the time (see picture). Like any product with too much demand chasing too little supply, the franc appreciated in value. Rapidly.

Horology Doesn't Appreciate Appreciation
Rapid currency appreciation is brutal on a country's export industries. It makes it much harder for the nations importing your products to buy them (because those nations have a weakening currency). The franc's appreciation in the 1970s was absolutely incredible.

Dollars per CHF.

It amounted to a 290% increase in value (see figure). Switzerland has not seen anything even remotely similar in subsequent years.

Very few export industries, such as Swiss watches, would be able to survive this kind of situation. In essence, the franc-denominated revenue from a watch would drop by 64% if the Swiss kept the dollar (or yen) denominated price stable. This is not sustainable when you have to pay your workers, suppliers, taxes and utilities with francs. You've got a cash flow problem and it is really really bad (one possible alternative would be to increase watch prices by roughly 2.75X in other countries, but this would almost certainly create even more problems).

We know that the Swiss watch industry was panicked and we know they knew the source of their difficulties. The watch industry complained to the Swiss National Bank. According to the SNB's official history, the bank faced political pressure from the watch industry and responded (see attached excerpts).

Excerpt from SNB's publication "The Swiss National Bank, 1907-2007.

After all, it was the SNB's decision to pursue a Friedman rule that ultimately lead to the run-up in the franc's value. In order to mollify the industry, the bank's official records indicate that they created specific accommodations for the watch industry, to include lending directly to watchmakers. For example, according to SNB's "major event" list here, the bank created an "Agreement between the SNB and the watch industry on foreign exchange forward transactions (in effect until 27 September 1979)" in November of 1976.

This is a stunning turn of events. Imagine that the Federal Reserve, in the United States, started making loans to your local McDonalds because it was struggling. That's an analogy (admittedly imperfect) for what the Swiss central bank decided to do in the 1970s.

The Reason for Deceivin'
So, why is there misplaced blame for the 1970s watch industry crisis? Why blame quartz? There are many possible explanations. One has to do with the fact that discussing watch mechanisms is something that the community is more likely to enjoy. Monetary policy rules and international capital flows are not exactly the stuff of watch meetups. Another reason has to do with potential sensitivities in Switzerland.

At the end of the day, the Swiss monetary authority decided to favor one industry (banks) at the expense of another (watches). The appreciation of the franc in the 1970s made Swiss deposits even more attractive to OPEC nations and made life easier for bankers. This is akin to a situation where parents (the Swiss government) end up favoring one of their kids over another. If you are the child who is out of favor, you have to decide if you want to complain about the reality of the situation. If you do, though, you could end up alienating your parents (the government) and your sibling (the banks). That's not really in your long-term interest and it is not likely to improve your life.

Moreover, OPEC nations are an important market for the watch industry, to this day. Although their role in the 1970s crisis was not intentional, it might undermine sales if the Swiss watch industry pointed out that their struggles were a consequence of OPEC decisions. Certainly, marketing departments are unlikely to recommend that kind of thing.

Although it might seems like this is arguing over the number of angels dancing on the head of a pin, I believe it is very important that we have a common understanding of the truth when it comes to the history of watchmaking. For one, there is the hackneyed saying about repeating history if we don't understand it. Further, when I began to drop hints about this topic on Instagram, I learned that others have been equally dubious about the quartz fable. James Dowling (@misterrolex on IG), for example, reached out and noted that, when Seiko launched their first quartz watch, it carried the same price as a Toyota Corolla. He fairly asks, "How is that going to hurt Tissot?"

Honesty and truth lead to trust and confidence, perhaps two of the most important virtues in any industry. So let's not call it the quartz crisis anymore. It would be just as accurate to call it a Friedman crisis (after the monetary policy rule in play) or a franc crisis. The industry's subsequent recovery is no less miraculous, even if the crisis itself is far more nuanced than fable allows.