This morning, the Swiss National Bank (SNB) removed its policy of setting a minimum exchange rate against the Euro (EURCHF) of 1.20. This decision is the reversal of the decision it made in September 2011, when, in response to a rapidly appreciating Swiss Franc, the SNB chose to set and maintain the aforementioned minimum exchange rate. It defended its actions in a further statement following the announcement this morning:
The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation.
As for why the SNB felt that now was the right time to make the move, it said the following:
Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated substantially against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB has concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.
Indeed, when the policy was implemented in September of 2011, the EUR/USD traded at roughly 1.40. In the hours before the announcement, it had been trading between 1.17 and 1.18. The SNB had been buying Euros all the way down from EUR/USD 1.40, to defend the EUR/CHF peg at 1.20, and with the prospect of the ECB announcing QE next week, odds are it would have had to escalate its Euro purchases even further as it faced the prospect of a further declining Euro. To date, the SNB purchases of Euros in defense of the peg were extraordinary in comparison to the size of its balance sheet – a fact which was not widely mentioned, but to a few astute commentators this presented a potential ticking time bomb.
Apparently the SNB saw the writing on the wall and feared it would have to expand its balance sheet to an even more dangerous degree to continue buying continually depreciating Euros. In essence, it has decided that continuing to print good Swiss Francs and throwing them after bad Euros was a bad idea, and it’s time to cut its losses.
Despite a return to relative sanity, the SNB has come under fire from some elements of the investment and business community. From Reuters:
Swatch Group Chief Executive Nick Hayek called the Swiss National Bank’s decision to discontinue the minimum exchange rate on the Swiss franc a “tsunami” for the Alpine country and its economy.
“Words fail me! Jordan is not only the name of the SNB president, but also of a river and today’s SNB action is a tsunami; for the export industry and for tourism, and finally for the entire country,” Hayek said in an emailed statement on Thursday.
“Absolutely shocking … For companies with international operations – translated earnings are going to be lower and if companies make products in Switzerland it is going to hurt margin. It is a terrible day for corporate Switzerland,” Kepler Cheuvreux analyst Jon Cox said.
Beyond that, much has been said about the ‘loss of credibility’ the SNB has brought upon itself by not telegraphing its move, and making it a complete and total surprise. Dennis Gartman, speaking on CNBC earlier, called it the ‘worst decision made by a central bank’ in his 40 years of time in the markets.
This consternation stems from two ideas. The first is that the SNB originally acted in 2011 to prevent a strong CHF-induced ‘deflationary spiral.’ This feeds into the bog standard deflation-phobia that permeates the economic understanding in the developed world. The story is that a strong currency hampers exports, and reduces economic growth.
I have responded to that claim a few times on this blog, most recently when discussing Abenomics in Japan, a policy which is founded on that same basic idea. The bottom line is that currency depreciation makes it easier for exporters to sell goods overseas, swelling their coffers. This is merely a short term effect, however, as the rise in input costs tends to reduce any advantages provided by the weakened currency. As non-exporters, and any other entity of the currency loses out via reduced purchasing power, the end result is that any currency devaluation scheme does nothing more than transfer wealth from the holders of currency to the exporters. It is noticeable that the early voices of dissent at this move have been such large multinational exporters and financial institutions. It is important to understand that their concerns are largely based on a removal of the policy driven subsidies that they once enjoyed, rather than a true deterioration in the prospects of the Swiss economy.
Those fortunes will be determined by one thing – the ability of Swiss producers to manufacture high quality products. This has not changed with the SNB announcement, and has always been true. What the SNB announcement, and the appreciating Franc does is to force Swiss producers to maintain their competitiveness through continued efficiency, rather than ‘coasting’ as an artificially cheap Franc artificially boosted their sales.
The horror stories put forth by mainstream economists and large exporters simply do not jive with the historical record. If the EURCHF going from 1.20 to parity is to cause the Swiss economy to implode, why didn’t an even more precipitous move – the 2007 to 2011 move from 1.67 to parity – already destroy the Swiss economy? Furthermore, the Swiss Franc has been on a terminal ascent since the 1970s, yet Swiss companies have been able to thrive. This is because they have been consistently producing high quality goods and services, and doing so in an efficient manner. The experience of the Swiss economy over the last number of decades gives the lie to the idea that weak currencies are the key to economic growth, such that a central bank is wise when it engages in a policy to weaken its currency.
The other idea which has driven disappointment in the SNB is related to the ‘deflation is bad so currency strength must be prevented’ argument. It is the fundamental belief that central banks have everything under control, are able to manipulate markets flawlessly, and are steady hands that can guide the ship through the turbulent waters of uncertainty. The actions of the SNB should render this view, which is pretty much ubiquitous throughout mainstream academia, Wall Street and the government, to be foolhardy, but I doubt it will have that effect.
Ultimately, the SNB engaged in price fixing, holding the CHF at an artificially low level against the Euro for nearly 3.5 years. Price fixing in any capacity does nothing but create imbalances. In this case, these imbalances were exposed when, after the peg was dropped the EURCHF fell nearly 40% in less than 30 minutes. The speed of this move has been another talking point in this saga, with large multinationals, financial institutions, and hedge funds all potentially caught out in a negative manner. Undoubtedly such a rapid, unpredictable move resulted in some bloodshed. The blood is on the SNBs hands, not for removing the peg, but for having it in the first place. Absent the peg, today’s move would have happened over 3.5 years, rather than 3.5 minutes.
Do those in opposition of today’s decision think that the SNB could have kept the peg on indefinitely? The economic realities determined that the Swiss Franc was to be bid higher. Central bankers are powerless to alter real economic conditions. The only thing they have at their disposal is the ability to postpone the effects of those economic realities via a printing press. This is what the SNB did, and as a result of their continuous printing, they ignited a real estate bubble. Defending the peg against what was to be a further onslaught driven by European QE would have only meant a further buildup of inflationary pressures, and a further squandering of capital in an unsustainable, depreciating Franc-driven mania. The SNB was right to end its peg, because in doing so it corrected the mistake it made when it put the peg on in the first place.
Today a central bank essentially admitted it can’t control real economic conditions, and that it can’t hold the hand of market participants while it walks on water to the Promise Land. That this is considered to be a ‘loss of credibility’ by the vast majority of commentators and economic participants tells you all you need to know about the state of economic thought and the reverence central bankers have attained in the 21st century. The bottom line is that the SNB learned a dear lesson today, which I doubt will be acknowledged by it, or any other central bank. Whatever moves the SNB was so afraid of back in 2011 happened anyway, except today, these moves happened in minutes as opposed to months or years, creating the very instability they thought the peg was preserving. Furthermore, they have given birth to a housing bubble, which too will lead to instability where they thought stability was assured. It is the same lesson which central bankers across the developed world refuse to learn, which is that economic problems can’t be solved via intervention in markets.