Switzerland Ambushes the Global Economy
The Swiss National Bank's shock move today to stop intervening in the foreign exchange market all but guarantees the European Central Bank will finally introduce quantitative easing when it meets Jan. 22. Switzerland is surrendering before a wave of post-QE money fleeing the euro threatens to make a mockery of its currency policy. It's also capitulating as slumping oil brings global deflation ever closer.
It's an astonishing U-turn. Just two days ago SNB Vice President Jean-Pierre Danthine told Swiss broadcaster RTS that “we’re convinced that the cap on the franc must remain the pillar of our monetary policy.” He added, though, that it was "very possible" that QE would make defending the threshold more difficult. It seems highly probable that the ECB has winked about its policy intentions to its Swiss counterparts.
The ensuing whipsaw in the currency market is unprecedented. The franc immediately appreciated almost 30 percent against the currencies of the Group of Ten industrialized nations, and surged to a record against the euro:
The Swiss central bank has capped the franc's value since September 2011, intervening to sell its own currency whenever it threatened to strengthen beyond 1.20 per euro. The policy was designed to protect the economy from safe-haven seeking investors propelling the currency higher, and trashing exports.
Many Swiss financiers were affronted by the peg in the first place. The nation's private banking edifice was built on the principle of respect for private property and free movement of capital; market manipulation didn't sit well with that philosophy.
At a hastily arranged press conference, SNB President Thomas Jordan declined to comment on whether he'd been in touch with other central banks, saying that keeping the cap no longer made sense and that its end had to be sprung on financial markets. Judging by the televised feed, he isn't a particularly happy bunny today.
The official explanation posted on the central bank's website is that the Swiss economy "was able to take advantage of this phase to adjust to the new situation," and that the dollar's surge has offset euro weakness. Swiss exporters aren't convinced: Swatch Group AG Chief Executive Officer Nick Hayek immediately called it a "tsunami for the export industry and for tourism, and finally for the entire country." Exports of Rolexes and other watches account for more than 10 percent of the country's exports.
There are a handful of other immediate losers from the move. Any trader who was short the Swiss franc this morning is probably still in a state of shock; Forex.com, a currency trading website, suspended trading in the Swiss currency after the central bank announcement. Staffers at the Swiss central bank's Singapore branch, which opened in the middle of 2013 to replace the currency-defending night shift in Zurich, will probably be relocating.
Less certain are the implications for lenders including OTP Bank, Hungary's largest lender, Vienna-based Erste Group Bank, and Italy's Unicredit, who lent about $14 billion to Hungarians in foreign-currency mortgages prior to the financial crisis, the bulk of them denominated in Swiss francs. A November law obliges banks to convert those loans into forints, and the Hungarian central bank arranged a foreign-currency transfer at that time to cover those conversion needs. The law obliges banks to switch at about 257 forints per franc; today's whipsaw puts that exchange rate at 310, meaning any bank that left itself exposed is facing a huge loss.
In an accompanying move, the Swiss central bank will now charge banks 0.75 percent for the privilege of depositing money with it. In the bond market, investors in Swiss government bonds are getting negative yields on any securities with maturities of nine years or less; at one point this morning, your reward for lending to Switzerland for a decade dropped to 0.033 percent, or so close to zero that it really makes no difference.
In the past five years, Swiss consumer prices have dropped by an average of 0.1 percent; the most recent figures showed annual inflation dropped by 0.3 percent in December. It's clear from the central bank's comments that it sees a worsening global deflationary backdrop; keeping its currency weaker hasn't produced the higher prices suggested by economic theory.
For the rest of the world, today's move confirms that deflation is a clear and present threat to the global economy. Central bankers everywhere should be re-reading Ben Bernanke's November 2002 speech "Deflation: Making Sure `It' Doesn't Happen Here" -- and reviewing their policies to make sure they're doing everything they can to boost growth and make consumers and companies more confident about their economic futures.
(Corrects penultimate paragraph explaining implications of a weaker currency for inflation.)
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