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 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.
