Initial thoughts on the Swiss National Bank peg removal

The Swiss National Bank’s announcement that it had decided to scrap its floor for the Swiss Franc against the euro is the biggest thing to hit the foreign exchange market since the UK and Sweden were booted out of ERM. This is a very big deal and its implications are as yet unknown. I think there will be non-Swiss repercussions. Denmark and Sweden are particularly relevant but also Greece. Overall, the violent moves post announcement suggest that a eurozone breakup would result in a strengthening of whatever currency unit Germany is a part of. Initial thoughts below

The Swiss National Bank abruptly decided to end its minimum exchange rate policy of 1.20 Swiss francs to the euro. Thinking that raising the tax it will charge banks to deposit money, to 0.75% from 0.25% would be enough, it made the announcement to end the currency floor, a policy in place since September 2011. The SNB also said it would move its target for 3- month Libor to the range between -1.25% and -0.25% from the current range between -0.75% and 0.25%. The reaction was swift and violent with the Swiss Franc appreciating at one point 28%, one of the most dramatic moves in developed markets.

Now on its face, a strong currency is not necessarily a bad thing. But the violence of this move and the problems it causes regarding deflation are very much undesirable. Moreover, in a mercantilist zero sum world where exports are seen as Nirvana, this hurts the Swiss economy. As a result, the Swiss market is selling off in a major way right now. My initial reaction here is that a euro without Spain, Greece, Portugal and Italy looks like the Swiss Franc. Even more so, this is what Germany’s exiting the euro zone would look like and why the Germans are keen to keep the euro intact. I would also say that Greece should realize the SNB policy change gives them some leverage. Grexit would not just be a catastrophe for Greece alone. It would create upheaval for the entire eurozone and cause the euro to appreciate.

Now the speculation can begin against the Danish and Swedish currencies and the Eastern European currencies that are part of ERM II. The Danes’ pegging to the euro may become an expensive endeavour as the Danish currency now trades within a 1% band of the euro like the Guilder did vis-a-vis the Deutsche Mark. I expect these currencies to all come under speculative attack.

But let’s step back a moment. Why is a strong currency a bad thing? The Swiss Franc, the Japanese Yen and the German Deutsche Mark all appreciated against the US dollar for years in the 1970s and 1980s and their economies remained strong. In fact, these economies had some of the best growth rates in the developed world. I see two problems here. One is the violent nature of the move. Someone is losing his shirt in the markets right now because of how unexpected this policy decision was. And the violence of this move is going to create speculative moves to profit elsewhere, bringing the whole currency market into turmoil. That is a bad thing. More importantly to me is that the economic circumstances right now are quite different. We are in a low inflation, low nominal growth world whereas the 1970s was a high inflation, higher growth world. The Swiss are challenged by low growth and deflation, where a strong currency makes that challenge so much harder. Consider this a major break in the building currency wars, an outgrowth of a shrinking pie mentality driving economic policy.

Those are my initial thoughts. More to come as the situation develops