So you go on holiday for 3 weeks, and suddenly, it gets exciting.
Until Thursday last week, I was going to engage in a little gloating for my first proper post of 2015. Specifically, I was going to reference my November 2013 post about the Bitcoin bubble, and then show you this chart from yesterday:
Which goes to show that, if you’re looking for signs of a bubble, then the best place to look is right around you. If you have friends that are suddenly “investing in bitcoins”, and those friends can normally be found having Saturday brunch at a Wimpy, then you had best believe that things are at extremes.
But then last Thursday, the Swiss National Bank (SNB) decided that it had had enough of its euro cap on the swiss franc, and then this:
There was much panic in the market. Christine Lagarde tsked*. And the rumour mill went into overdrive.
*Christine went onto CNBC later in the day, and took a series of barbed swipes at SNB President Thomas Jordan. The general sentiment, phrased more implicitly: “Total prat.” Here’s the transcript.
So before I get to the reason(s)ing behind the lifting of the cap, I want to go back to September 2011, where everyone was equally as ooh-aah about this press release from the SNB:
The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.
The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained
weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.
Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures.
What the SNB was saying:
- All you speculators that are flooding into our Swiss Franc with your massive flows of money, trying to score some safety, shame on you.
- Really though, shame on you.
- You’re massively over-valuing our Swiss Franc!
- And that is bad for the Swiss – because it’s making it really expensive to live here.
- It’s also making us very uncompetitive – because no one wants to buy all our exports.
- So here is what we are going to do:
- Every time you come here wanting to buy a Swiss Franc?
- Well, we’re going to print you a new one.
- We’ll just infinitely print Swiss Francs to buy your foreign currency in unlimited quantities.
- And you can decide whether our own particular quantitative easing makes us a “safe haven”.
To The Present
Then, on Thursday, after over three years of doing so, the SNB was all “Just jokes – we didn’t meant unlimited when we said ‘unlimited’. We just meant… You see, right now, our foreign currency reserves are sitting at about 70% of GDP. And, well, we really have printed a lot of francs…”
Here’s the January 15 press release:
The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%. It is moving the target range for the three-month Libor further into negative territory, to between –1.25% and −0.25%, from the current range of between −0.75% and 0.25%.
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.
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 considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.
The SNB is lowering interest rates significantly to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions. The SNB will continue to take account of the exchange rate situation in formulating its monetary policy in future. If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions.
- We don’t think that the Swiss franc is overvalued against the US dollar any more, because the Swiss franc is fixed to the Euro, which has weakened a lot against the US dollar, so we’re letting ourselves float freely against the US dollar.
- Some may call that a circular argument.
- Except that, obviously, the real reason that the euro has weakened against the dollar is because it was the Swiss franc that was actually weakening against the dollar – but because the Swiss franc is linked to the Euro at a fixed exchange rate as supported by the SNB – the Euro had to weaken as well.
- But in case that isn’t the case, we’re also making our interest rates more negative.
Clearly, in retrospect, the markets didn’t quite feel that way. Because of the sudden ±20% appreciation of the Swiss Franc against near everything. And to be clear, that negative interest rate adjustment was a bit laughable – because losing an extra 0.5% of your swiss bank account balance annually is quite acceptable when the real value of your bank balance just leapt up 20% in real terms today.
Bad call, Thomas Jordan. Bad call.
But was it?
So this is where the rumour mill kicks in.
Because unless Thomas Jordan is really not-clever, then he would have realised that his argument was fluff. It’s partly why all those FX traders got left without their pants – because no one actually thought “Yes, the Swiss franc can go free-float again without the currency appreciating into overdrive.”
So if we assume that:
- The SNB does actually know what it’s doing; and
- The SNB didn’t make a mistake
Then you’re in speculative territory.
Here’s the main one (it’s the one that makes the most sense to me, at any rate):
- The ECB is almost certainly going to engage in some serious quantitative easing in the Eurozone (everyone is expecting that announcement on Thursday this week!).
- When that happens, the SNB would have to engage in parallel quantitative easing at the same levels (if not higher) just in order to keep that fixed exchange rate going.
- When you have to print quantities of money in a small economy in order to keep pace with money creation in nineteen other economies (at least four of which would be considered large economies), then you’re almost certain to hyperinflate.
- Just to be clear, by many GDP estimates, the Eurozone is the largest single economy in the world. Switzerland is the 39th largest. Which is smaller than South Africa’s economy. Or Venezuela’s economy. I mean, it’s small.
- So the folks at the SNB may well have been saying to themselves “Well kids, it’s been fun – but time to jump ship. We all know that we can’t keep up with that. Rather do it now, when the speculators aren’t expecting it and aren’t trading against us. Type that press release immediately before anyone suspects. No – no I’m actually not giving Christine a call. She’d turn this into a debate – and if the news leaks, this could be super costly for us. I’m trying to avoid a sudden wave of speculation, guy! Rather beg forgiveness…”
- And if the folks at the SNB weren’t saying that to themselves, then they’d be very not-clever.
Other theories that are out there:
- The SNB was finally reacting to the political pressure. Their build-up of forex reserves was not making them popular. And if you’ll cast your minds back to November, there was that referendum which could have imposed reserve restrictions and forced the SNB to invest much of their existing reserves in gold. It didn’t pass, but still.
- Something about the SNB having to pay out dividends to the cantons, who are part owners of the SNB. Admittedly, I’m not entirely sure how this theory works. Traditionally, the various cantons (provinces) of Switzerland derive some of their revenue from dividend distributions by the SNB. But that stopped in 2014, after the SNB started taking losses on their gold reserves. The cantons were quite upset about this. So, I guess, abandoning the exchange rate peg would allow the SNB to get rid of some of their forex reserves, reducing their losses because the franc would devalue? But the opposite happened! And given that the SNB was carrying forex assets equivalent to 70% of GDP on their books – when they dropped the peg, all those assets suddenly depreciated in Swiss franc terms. By, like, ±20%. Making the SNB (and thereby, the cantons) one of the biggest losers in this whole saga. So I reckon we can dispense with this idea almost entirely. Read more here.
For what it’s worth, I reckon that the political pressure and the ECB quantitative easing concerns worked in tandem here. And the SNB could hardly declare that the real reason for releasing the peg was that the ECB would be announcing QE on Thursday – because that would steal Mario Draghi’s thunder and that would upset him.
In case you’re feeling sorry for all those FX traders, you should read this article by Matt Levine: No One Was Supposed To Lose This Much Money On Swiss Francs.
PS: it’s good to be back.
Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.