The Swiss National Bank stunned markets on Thursday with an abrupt decision to abandon its commitment since 2011 to hold the Swiss franc at 1.20 francs/euro, as a result of which the franc appreciated almost 20% within the space of a few minutes.
I have seen some commentators suggest that the Swiss were forced into such a move. Michael Casey wrote:
Ultimately, though, it was again the ECB that foiled the Swiss central bank’s policy. In hinting at a big new bond-buying, or quantitative easing, program, the ECB drove a new, large influx of euros into francs, so many that its Swiss counterpart could no longer keep buying them to maintain the CHF1.20 rate.
And from Bloomberg:
“Nobody, who’s active in the export industry, could expect that the exchange rate of 1.20 per euro would be guaranteed for ever,” economist William White, a former member of the Bank for International Settlements’ executive committee, told Switzerland’s Finanz und Wirtschaft. “The time has come to accept the inevitable.”
I find such claims puzzling. It is one thing to say that a central bank may lack the power to keep its currency value high. Given a finite amount of foreign currency (for example, dollars) that the central bank holds as reserves, it can only buy so much of its own currency with its own holdings of dollars before a speculative attack overwhelms the central bank’s arsenal.
But in this case we’re talking about a commitment from the central bank to keep its currency value low. The policy to implement that calls for buying as many euros as needed, paying for them with francs of which the Swiss can perfectly well create as many as they want all by themselves.
A central bank with the power to create new Swiss francs could hardly claim that it does not have enough francs to buy all the euros that are offered for sale. Here’s the game– you specify a number, and I see if I can make up a bigger number. I should be able to win that game.
If the market is saying the Swiss franc is oh so valuable, oh so desirable, and I have the power to create as many trillions of them as I choose, surely I can change the market’s mind if I try, buying up the entire world, if need be, with Swiss francs that I costlessly create.
Of course, what I could end up doing with such a peg is create inflation. And this is why Lars Svensson proposed a variant of the former Swiss strategy as part of a “foolproof way” to escape deflation and a liquidity trap.
But there appear to be no signs of inflation yet in Switzerland. So why did the Swiss think that the peg could no longer be maintained? I simply do not understand the claim that the central bank was forced to abandon the peg.
I conclude that instead the central bank just wanted to try something different. But I confess that it is a great mystery to me why they wanted to do that. This has to be a major hit to Swiss exports and tourism, leave the Swiss National Bank with little credibility and negative capital, and will likely cause significant financial disruptions in many places around the world.
Switzerland is a small country.
Exchanging too many francs for euros may eventually cause inflation.
And, what happens if the euro collapses?
It would take more euros to buy back francs.
I doubt Europe has dealt enough with its structural problems.
The U.S. also has structural problems, although on a smaller scale, e.g. the recent explosion of entitlements, which likely is causing disincentives to work, for people receiving benefits and people paying benefits.
Of course, a safety net is needed.
And, promoting employment will strengthen the safety net.
Yet, too many Americans dropped-out of the workforce or work part-time.
Entitlement spending too often makes bad situations worse, e.g. causing couples to, irresponsibly, have more children than otherwise, which society pays for (in many ways).
Some people will limit or avoid work (for years) to eventually receive low-income housing, “free” medical care, government checks, food stamps, etc..
And, some people may be getting more government benefits than others, just because they know how to “play-the-system.”
Moreover, why are Americans paying for tens of millions of low-skilled immigrants and their children from dirt poor countries? The U.S. didn’t create the poor economic policies in those countries. What about black Americans, who are poorer than other Americans, after suffering from slavery and racism for many generations? Why encourage more poor immigrants to receive more entitlements, or reward irresponsible behavior?
I think, we need to gradually raise the minimum wage to $15 an hour, remove and reduce some of the $2 trillion a year of federal regulations, and direct government benefits to the really needy instead of creating a society where most people are always on government life support.
Peeak Trader wrote “And, what happens if the euro collapses? It would take more euros to buy back francs.”
When the Euro collapes Switzerland would own huge amounts of German Bunds etc. which would become much more expensive as the Neuro whould gain in respect to the Franken.
The problem for Switzerland would be IMHO greater when the Euro does nor collapes. 🙂
The ECB would get the bonds and the SNB would get the euros.
A euro collapse means the euro will depreciate further and the franc will appreciate further.
Selling bonds to drain euros out of the system won’t make them more expensive, although the euro will appreciate.
And, before quantitative easing has even started:
JANUARY 16, 2015
“…the SNB’s balance sheet is now about 500 billion francs, which is 80 percent of gross domestic product. To put this in perspective, 80 percent of GDP is a level three times larger than the balance sheet size of the U.S. Federal Reserve or the Bank of England relative to the size of their respective economies. It is enormous. Only the Bank of Japan has been more aggressive.”
The issue is, what we consider a collaps:
1) A desintegration of the Euro zone would inevitably lead to a northern Euro which would dramatically appriciate against the Franken. Owner of Bundesobligationen (the SNB was the most important buyer the last years) would gain a lot.
2) A weak Euro policy with QE without real collaps would make the Bundesobligationen of the SNBs cheaper and would inflict losses.
Therfore, the SNB does not expect a desintegration of the Euro zone, not more not less.
Huh? According to the post the object of the abandoned policy was to cause inflation (devaluation of the franc) continuously. If the value of the franc drops below the target range all the SNB has to do is stop buying euros with francs and let the franc rise a little. And if the euro collapses? That alone will cause the franc to rise almost by definition. As Mr. Hamilton pointed out, the SNB can then create enough francs to buy all the euros it wants.
I suspect that there were large holders of francs with enough political clout to force the SNB to stop devaluing the franc. They certainly saw a nice jump in the value of their franc holdings.
This was supposed to be a reply to Peak Trader’s first comment.
I think this is perhaps the wrong audience for you. You should perhaps try someplace with commenters (and bloggers!) who don’t know any economic theory.
Perhaps you are right Fred. I certainly wouldn’t feel comfortable at a site that allows evidence-free ad hominem comments.
Joe, you only cited the franc was pegged to the euro, and your sidekick didn’t explain anything.
Then you came up with a (biased) political reason, that’s not supported by anything, rather than an economic reason.
My statement doesn’t contradict professor Hamilton’s statement.
So, learn some economics and maybe someday you can cite a possible economic reason why the Swiss stopped pegging the franc to the euro, rather than playing more of your little games attempting to fool people.
Fred and/or Joe, I have degrees in economics.
You don’t seem to understand there’s more than one theory.
Professor Hamilton may be correct and his theory optimal.
Yet, the SNB changed its policy.
or maybe it was just another big insider scam
bankers can pretty much get away with anything
like, really, how many bankers go to jail?
almost as many as politicians who go to jail for treason, war crimes and genocide
same bunch
p
Well, it would be one thing if all these Swiss Francs that were “created” were distributed evenly to every Swiss resident….but somehow that never happens that way.
The other thing with economists and their inflation obsessions: has there been inflation or deflation in the wages of the lower quintiles?
http://go.bloomberg.com/market-now/2013/12/31/for-us-men-40-years-of-falling-income/
http://eml.berkeley.edu/~saez/saez-UStopincomes-2012.pdf
I just started reading this excellent blog. Keep up the good work!
I believe there is another reason that the Swiss did what they did. The largest industry in Switzerland is not watchmaking or tourism, but hard money. Ever wonder why a small country like Switzerland has such a huge banking sector? It’s because wealthy people worldwide trust the Swiss to protect their wealth. This has also led to a major “industry” of second homes and dual citizenships. If the SNB were to do what you say, this trust would be reduced. There’s no point in storing your wealth in an asset the supply of which is going to infinity. I know that you might say that this worry is pointless; there is no inflation in Switzerland. But actual inflation is not the point here – we are talking about perception and asset price inflation.
This is the kind of issue that does not appear in the standard economic models, and indeed it is probably not that relevant in most large economies. This is pretty much a special case.
One more thing: The SNB is actually a public exchange-listed company. It has private minority shareholders. So the losses it took on its Euro holdings have legal implications.
“One more thing: The SNB is actually a public exchange-listed company. It has private minority shareholders. So the losses it took on its Euro holdings have legal implications.”
Interesting point Burt.
It reminds me of a dispute here in Belgium. Our CB sold gold between 2006-2012 and the capital gains were transfered to the State. Minority shareholders went to court but their demand was rejected.
Basically our CB is allowed to act in the best interestn and gold is part of our monetary policy and therefore the transfer was judged not only lawful but also fair.
I wonder whether the losses on euro are legal and fair in a Swiss context? And whether private shareholders can demand that the losses are transfered to the Swiss state?
http://www.nbb.be/pub/01_00_00_00_00/01_06_00_00_00/01_06_01_00_00/20070309_ztoelichting.htm
It’s interesting how historical anomalies can affect things. I know that the BIS had individual shareholders until a few years ago. Not sure if they bought them out.
Indeed they couldn’t be forced to abandon the peg. I think it’s clear they anticipated a large depreciation of the euro when QE is announced and decided not to be dragged along. I guess it was a calculation about the asset side of their balance sheet and they decided not to commit to buying the euro at that price anymore. I don’t think they meant to entirely give up suppressing the franc. And I don’t think they’re fussed about the credibility issue. A currency peg never has long-term credibility and doesn’t really need it.
My guess is that the squealing of the gold bugs became so loud the bankers lost their nerve.
It’s a lot like the barking of Fox News in the U.S. causes politicians to do stupid things.
Could this be a result of the declining Euro? Does anyone know the exposure that Swiss Banks have in regards to the Euro and/or the Dollar?
“I conclude that instead the central bank just wanted to try something different. ”
I think this interpretation is the only one that makes sense … the SNB depreciated and still got deflation. So they gave up on the currency peg, and will probably try something else (although I’m not sure what: QE?, helicopter drops?)
http://informationtransfereconomics.blogspot.com/2015/01/switzerland-depreciated-their-currency.html
Saying ‘oops’ a lot?
How about the simple idea that sanity in Switzerland returned? When you have decent governance and a history of solid monetary policy, floating your currency within reason is a superior policy. It is a shame that the Swiss must suffer somewhat in international trade in the short term because of the previous fix, but it will be better in the long term. And don’t forget every saver in the country got their savings returned to where its value should be.
Ed
Is the earlier franc peg a form of currency manipulation similar to the crime China was accused off? Why the fuss now that the Swiss right such wrong?
I considered this good enough reason: The Swiss thought it was too unwise for the whole nation to take on such a big bet(of keeping the franc peg) when it was not sure of the ultimate benefits or risks. After all keeping the peg means going against market forces.
the reason why you ask this question may be the same reason why you joined academia instead of business.
it is not really that much about (rather academic notion of) inflation but rather about stuffing Swiss cantons with huge pile of (potentially) worthless paper (EUR). EUR currency reserves owned by SNB were already close to 50% GDP. what happens if EUR disintegrates? what happens if there is no more safe (“Nordic”) debt paper to buy for SNB’s EUR cash?
What the SNB did was simply a decision based on risk management considerations to not over-leverage the Swiss economy to a black swan event in EUR…
it could have been done better – like over the weekend – but they had to let it go one day. and they gave exporters plenty of time to adjust since the last (2011) huge appreciation of CHF.
If having so much in Euros is a problem, then the answer is to buy real assets with those Euros. What you have then done is create a sovereign wealth fund out of thin air. As one of the historically most Calvinistic countries this probably just doesn’t right to the Swiss public. Unlike holding dictators ill gotten gains for profit.
Aren’t people strange.
JDH: I find such claims puzzling.
Amen. Although I suspect the two comments by Burt and Joseph cut through a lot of what’s really going on, thereby making it all a little less puzzling.
In Greece, there is a gerneral election coming soon (Jan. 25). The radical and euro critical party Syriza may be going to win, as german-ordered austerity has already mostly destroyed this country’s economy. If Syriza wins, Greece will default and return to its former currency. Many people guess, that may put the euro zone into a downward spiral. The swiss guys are leaving the sinking ship, just in time.
I’m curious why you call Syriza ‘radical’? They seem pretty sensible by my standards.
see wikipedia : http://en.wikipedia.org/wiki/Coalition_of_the_Radical_Left
“The Coalition of the Radical Left (Greek: Συνασπισμός Ριζοσπαστικής Αριστεράς, Synaspismós Rizospastikís Aristerás), known colloquially by its acronym SYRIZA (Greek: ΣΥΡΙΖΑ, pronounced [ˈsiɾiza]), is a left-wing political party in Greece, originally founded as a coalition of left-wing and radical left parties.”
Though, also a radical party can be sensible.
Professor,
I am surprised that you are surprised. This action is called political self-preservation by the SNB. The Swiss were on a semblance of a gold standard until April of 1999 (effective in 2000) when the constitution was changed to give the SNB a free hand. Prior to that time the CHF was required to hole 40% gold against the CHF.
By 2011 the SNB had allowed the CHF to fall to 1.30 to the euro – perhaps free fall would be a better phrase – and the Swiss gold holdings were down to 7.7%. On September 6, 2011 actions by the SNB helped the CHF recover to 1.095 to the euro. Then the SNB announced a minimum exchange rate of 1.20 and their intentions to “buy foreign currencies in unlimited quantities.” The result was disaster. The CHF fell 9% against the dollar in 15 minutes. By the end of the day the CHF fell 9% against the euro, 10% against the dollar, and 8%% against the 16 most active currencies.
This huge mismanagement by the SNB since 2000 led to 100,000 Swiss citizens signing a petition to vote on a draconian referendum to restore the CHF and increase Swiss gold holdings. Polls prior to the vote on the referendum showed that 44% of the voters favored the referendum. The final vote was only 23% but the vote sent a shock wave through the SNB and the central banks through out the world. One provision that received little press required the repatriation of 30% of Swiss gold held by Canada and the UK. All CBs are resisting repatriating gold to the country of ownership. The US flatly turned down Germany’s request and would not even let them see their gold.
The recent actions and announcements by the ECB have sent the signal to the SNB that the link between the CHF and the euro would worsen the conditions that led to the recent referendum. Any continued slide in the CHF against other currencies such as the dollar simply to maintain the CHF at 1.20 would lead to a greater loss of gold and the SNB would be under the gun. There is little doubt that the vote would be much closer if the provisions of the referendum were relaxed, especially if the SNB allowed a continued decline in the CHF.
The SNB made the decision as protection and prevent to prevent the huge embarrassment of having their wings clipped for their huge mismanagement of the currency. The size of the correction is somewhat surprising but the fact is not.
Gavyn Davies has your answer:
http://blogs.ft.com/gavyndavies/2015/01/18/the-swiss-currency-bombshell-cause-and-effect/
Here are comments from a friend at Bretton Woods Research.
There are also economic risks to the SNB’s decision. For Eastern European economies, where many mortgages are denominated in Swiss Francs, the decision is a deflationary neutron bomb as debt payments suddenly become much more expensive. Although default risk is currently less than 25% for most Eastern European countries, CDS prices are rising this morning on the news for Ukraine (where default risk remains very high), and for Poland, Czech Republic, Croatia and Romania.
According to Bloomberg, approximately 40% of Polish mortgages are denominated in Swiss francs. As a result of today’s SNB decision, the zloty is trading 16% lower against the Swiss Franc. To be clear, those loans are now 16% more expensive in zloty terms. This phenomenon is happening at varying, but troubling degrees through Eastern Europe.
Hungary’s Viktor Orban who has been fed up with ongoing currency wars and forex volatility began converting foreign currency mortgages into forints last year. Today’s news suggests that he has been ahead of the curve. The Polish government is expected to make an announcement on the state of Polish banking sector later today. Poland’s opposition Law & Justice Party, which had a proposal for dealing with Swiss franc mortgages, which was never acted upon, will likely gain support.
We expect serious voter anxiety in Poland, and are concerned that the Swiss National Bank’s decision today may have unintended consequences throughout Eastern Europe.
Ed Hanson,
You might be interested that the Bretton Woods Research paper was written by Vlad.
The Swiss made the right move to save their currency.
Open-ended European QE starts ‘with a bang’
Excerpt from the Telegraph.
Mr Draghi’s package of asset purchases [€60bn euros per month], including bonds issued by national governments and EU institutions such as the European Commission, is intended to boost the eurozone’s flagging economy and to ward off the spectre of deflation.
It took a dramatic toll on the euro, which dropped to an 11-year low against the dollar at $1.14.
From the same article:
“There must be a statute of limitations for those who say there will be inflation,” Mr Draghi said.