The decision of the Swiss National Bank to set a limit on the strength of the Swiss
franc so that it cannot trade below a minimum rate of CHF 1.20 against the euro is
one of the most dramatic interventions seen in the foreign exchange markets for
many years. The Swiss economy may only account for 0.8 per cent of global gross
domestic product, but its currency and the influence of its central bank far outweigh
its economic size.
The reasons for the SNB’s announcement – which, incidentally, completely reverses
the policy it has pursued since last summer – are not very hard to fathom. The
Swiss franc’s “safe haven” status was becoming immensely onerous, even though it
had only a limited amount to do with the Swiss economy itself. It had more to do
with the long history of previous appreciations in the Swiss franc during earlier
crises. This, and the impact of momentum trading in recent months, meant that the
rise in the currency became self-perpetuating. If the world had decided that Mars
Bars represented a safe haven, then the same might have happened to the price of
the chocolate bar.
Mars Inc. could have stopped this happening by creating a huge number of extra
Mars bars, and this is what the SNB has now threatened to do to its currency. The
alternative would have been to allow the franc to strengthen further, with the Swiss
economy becoming an largely innocent casualty of the rising distaste which
investors are showing for the prospects in other economies. By August, the franc
had become spectacularly overvalued, as the graph shows. It had risen to three
standard deviations above its long term average in real terms, which is an
overvaluation of 35 per cent. Few developed currencies, not even the Swissie itself,
have reached such extremes.
This was threatening to push the Swiss economy into a very deep depression. The
adverse effect on the manufacturing export sector is obvious. In addition, stories are
circulating that many asset managers who have recently emigrated from the UK
were beginning to plan their return to the City of London, as their costs soared. The
threat of outright deflation, mentioned by the SNB in its public announcement, was
very real, and it deserved to be countered by a major easing in monetary policy,
which is what this move involves.
Is the SNB’s new ceiling credible? That depends on the degree of its resolve.
Ultimately, the SNB, like the producers of Mars Bars, can produce as much of its
own asset as is required to keep its price down. (I assume here that the monetary
effects of the intervention are not sterilised by the SNB.) However, there will be two
adverse effects.
First, there could be a rise in inflation, as there was after the SNB tried the same
policy in the late 1970s. This, however, is likely to take a very long time to emerge
in present conditions. Second, if the policy is tried and then abandoned in the face of
market pressure, the SNB will incur trading losses on its currency portfolio.
Normally, this would not really matter for a central bank, but the SNB is peculiar in
that it has genuine shareholders, in the shape of cantons (which rely on its annual
profit distribution) and private investors. These shareholders have previously
torpedoed efforts by the SNB to stabilise the franc through currency intervention,
and the same could happen again. But I expect the new policy to hold for quite some
time. (See Claire Jones’ excellent piece at the FT’s Money Supply.)
The effects on other markets are not entirely obvious. Some people have argued
that the euro will rise against all other currencies, because the Swissie is now being
forced down against it. This seems unlikely. The ECB has made it clear that they will
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not actively co-operate with the SNB by intervening in the markets, or by
tightening its own monetary policy. This should mean that the euro is broadly
unchanged against the dollar and other currencies. In fact, if the SNB acquires euros
through its intervention, and then diversifies its reserve holdings into dollars and
other currencies, the euro might actually be slightly weaker than otherwise.
There could, however, be some much larger consequences for other safe haven
currencies like the yen. The Japanese currency is not overvalued in the same way
as the Swiss franc – in fact, it is not overvalued at all – but the Bank of Japan would
not welcome the increased inflows which could be triggered by its new status as the
only safe haven among the major currencies. It may have to follow the Swiss
example, and increase its intervention, if it is avoid an unwanted appreciation. It will
probably do so, though not necessarily with the unequivocal force of the SNB.
Finally, what about the impact on equities and other risk assets? The SNB’s move
amounts to another dose of quantitative easing by a major central bank. It is
probably not part of a co-ordinated move to ease monetary policy, but others like
the Bank of England, the Fed and even the ECB also seem to be thinking of an easier
stance, for their own reasons. And the SNB’s example might invite several other
central banks to follow suit, should their currencies start to rise. There is no doubt
that QE is losing its “shock and awe” impact on risk assets, but all this should help
rather than hinder.
Finally, there is the impact on gold. For investors who are already in love with the
yellow metal, this will be another confirmation that those who can print money will
always end up doing so. Its safe haven status has just received another large boost
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