Buy on the Rumour, Sell on the Fact

No one expected the Swiss National Bank’s (SNB) sudden announcement that it would no longer hold the Swiss franc at a fixed exchange rate with the euro. Panic ensued in the world of central banking. On 14 January, the euro was worth 1.2 Swiss francs; a day later, its value had fallen to 0.85 francs at its lowest point. Hedge funds globally incurred losses, the Swiss stock market collapsed and the country’s exports will be severely damaged. So, why would the SNB provoke such chaos?

Photo courtesy of Schutz, © 2007, public domain
Photo courtesy of Schutz, © 2007, public domain

Similar to American government bonds, investors considered the Swiss franc a safe haven. Risk averse from the international financial turmoil, the Swiss government provided a comparatively comfortable safety net. Its balanced budget, for example, provides investors with foreseen stability. But through the increased demand for the franc, its value was dramatically pushed up, hurting Switzerland’s heavily export-reliant economy. To correct this fluctuation, the SNB introduced quantitative easing (QE), increasing the supply of francs relative to euros on the foreign-exchange markets and ensuring a euro was worth 1.2 francs by purchasing government assets through money it has “printed”. As a result of this policy, Switzerland’s central bank had accumulated approximately $480 billion-worth of foreign currency, equalling approximately 70 per cent of Swiss GDP. Effectively this meant that a country of about 8 million people was single-handedly keeping the euro-zone’s heart beating.

With 60 per cent of all Swiss exports sold in Europe, Switzerland’s economy has been sensitive to swings on the foreign exchange market as financial movements in the euro-zone directly impact the demand for Swiss products. The SNB expected the European Central Bank (ECB) to introduce QE, which entails the creation of money to buy the government debt of euro-zone countries. But it seems likely that this will not spur actual economic growth and merely deflect from the euro-zone’s structural problems in need of fiscal attention. The ECB’s actions consequently decrease the value of the euro, which would have required the SNB to continue to print francs in order to maintain the cap. Even though Swiss inflation is too low, it has become an (admittedly unfounded) political worry that hyperinflation may be resultant and the SNB has thus been under pressure to react from its critics. Nonetheless, the reliability of inflation targets stimulated by European quantitative easing is questionable; the Bank of England has missed its target for years and the Swiss shift did not help this cause of central bank credibility.

As a consequence of Switzerland’s previous dalliance with the ECB and other European nations, the currency’s revaluation, not devaluation, effects are extensive. Croatia decided to peg its currency to the Swiss franc as a means of helping out its citizens with mortgages in Swiss currency. In itself, the entirety of this interrelated continental system appears to be highly sensitive. Mismatched assets and liabilities are being developed on a short-run only basis. Tying your currency to that of another economy imports its monetary policy, even though this may be detrimental, as exemplified by Greece’s underlying economic deterioration. Economic union without political union can at times exacerbate unstable foundations; as the possibility of devaluing one’s currency is no longer available. This manoeuvre could have possibly avoided nominal wage and price cuts in Southern European countries during the crisis.

Conversely, the clear winner in the short run is the Swiss consumer. Now able to take advantage of luxury brands and greater “apparent wealth”, the Swiss queue to buy euros at plummeted rates, whilst banks run out of currency and the railway network has had to increase traffic to France and Germany for keen bargain shoppers.

How much the removal of the cap will hurt the Swiss economy is difficult to predict. The SNB’s most central mandates are to keep price stability and prevent unemployment, the latter of which has been put at risk. Many fear the possibility of a recession as UBS, a Swiss bank, downgraded its forecast for Swiss growth in 2015 from 1.8 per cent to 0.5 per cent already. Switzerland’s franc is forecasted to deflate in the near future. Overnight, all Swiss goods and services, from watches to tourism have become 20 per cent more expensive. Orders have been cancelled, tourism has seen a slowdown in bookings and the Swiss government has warned of the de-industrialisation of Switzerland. Short-term wage and hour cuts are expected.

In an increasingly globalised and open financial spectrum, currencies are becoming more and more important drivers of international sentiment, leading to extreme volatility. In 2014, Japan attempted to create inflation and weaken its currency in order to grow economically through changes in foreign investments. European monetary policy appears similar. Both are inadequate substitutes for real domestic adjustment and reorganisation through transferring the resultant cost to other countries. There is no current long-term plan of action, merely a pre-emptive speculative “reaction”.

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