Whac-A-Peg: When The Wonderful Stability of Centrally Planned Fiat Currencies Ends


Communication Breakdown

This morning the Swiss National Bank did what central banks supposedly don’t do anymore nowadays: it surprised the socks off the markets. After still solemnly insisting in its most recent monetary policy assessment that it would “defend the minimum exchange rate of the Swiss franc against the euro with the utmost determination”, the SNB’s planners finally got cold feet and decided to abandon the policy without warning overnight (not that a warning would have done any good).


1-EURCHF, peg dropped, dailyThe market swiftly reassesses the EUR/CHF exchange rate – click to enlarge.


In so doing, the SNB’s board members have not only violated modern-day central bank etiquette, but have presented us with a reminder of how wonderfully stable today’s fiat currencies are. Bloomberg adopts a miffed tone of voice in its report on the matter:


“The Swiss National Bank unexpectedly scrapped its three-year policy of capping the Swiss franc against the euro in a U-turn that may change the perception of a century-old institution known for reliability.

In a surprise statement that sent shock waves through equities and currency markets, the central bank ended its cap of 1.20 franc per euro and reduced the interest rate on sight deposits, deepening a cut announced less than a month ago.

The shift marks an attempt by the SNB to reinforce its defenses of the economy before government bond purchases by the European Central Bank that could crumple the franc cap. The currency surged after the announcement, Swiss stocks including UBS AG tumbled and the chief executive of watchmaker Swatch Group AG said the policy shift would hurt exports. SNB President Thomas Jordan defended the move, saying surprise was necessary.

“It’s amazing that such a stoic central bank could end up abandoning such a long held policy with such short shrift,” said George Buckley, an economist at Deutsche Bank AG in London. “I thought we were out of the situation where central banks surprise so significantly as this.”

With reverberations hitting everyone from currency traders in London to mortgage holders in Poland, economists responded to the SNB announcement with comments including “surprise” and “seismic.” Coming from a nation that has attracted investors for its stability, the change captures the scale of the battle policy makers have repeatedly faced going back decades to rein in a currency popular with investors at times of crisis.”


(emphasis added)


surpriseFX trader Margo Spreadbottom upon hearing the news

Youtube screenshot


These unreliable rascals! When the SNB originally announced its interventionist policy, no such indignation was in evidence at Bloomberg or elsewhere in the mainstream financial press. CHF holders sure got creamed at the time though, as the franc quickly collapsed after the announcement.

We conclude that any policy that results in money printing on a gargantuan scale and shuts down an avenue for investors trying to protect their savings gets the nod from our bien pensants in the financial media, regardless of whether the markets are “surprised” by it or not. On the other hand, ending the inflationary policy in the same manner appears to meet with opprobrium.


2-EURCHF(15 Minutes)EUR/CHF, intraday, 15 minute chart – within a mere 20 minutes the euro had lost more than 30% against the Swiss franc at one point (looking at this in CHF/EUR notation, the Swiss Franc had gained nearly 50%). The wonderful stability of centrally planned fiat currencies in all its glory!


Bloomberg continues with the one sentence that should probably surprise no-one:


“None of 22 economists surveyed by Bloomberg News between Jan. 9 and Jan. 14 expected the SNB to get rid of its cap in 2015.”


This may be a good time to remember that no economists expect a recession in 2015, no economists expect additional declines in treasury yields, nearly all of them expect the dollar’s rally to continue, and none are particularly worried about the stock market. Who knows, maybe there will be more surprises in the course of the year.

While SNB president Thomas Jordan had to “defend” himself for taking the decision to undo the peg, the SNB has by no means abandoned its interventionist ways. While the minimum exchange rate against the euro is no longer enforced, the SNB has at the same time moved administered interest rates more deeply into negative territory:


“The decision has been a surprise for markets — you can’t do it in any other way,” SNB President Jordan told reporters in Zurich today. “We came to conclusion that it’s not a sustainable policy.”

The change comes just one week before ECB policy makers meet to discuss new stimulus, including quantitative easing, a move that may add to pressure on the franc against the euro. The SNB spent billions defending the cap after introducing it in September 2011. Jordan said today it may intervene again.


To complement the lower deposit rate, the SNB also moved the target range for the three-month Libor to between minus 1.25 percent and minus 0.25 percent, from the current range of between minus 0.75 percent and 0.25 percent.


(emphasis added)

Yes, it was not a “sustainable policy” – we could have told Mr. Jordan that a long time ago. However, the same holds for negative interest rates, which are an utter absurdity. The natural or originary interest rate can never turn negative, as it is an inviolable, fundamental category of human action. A world in which human beings value future goods more highly than present goods is simply not thinkable. As Ludwig von Mises explains:


“Originary interest is a category of human action. It is operative in any valuation of external things and can never disappear.”


Indeed, if the natural interest rate were to turn negative, consumption would completely cease and we would soon starve to death. All our efforts and resources would be devoted solely to the production of future goods.

We know therefore with absolute certainty that the SNB’s negative interest rate policy is a severe distortion of the market, and will therefore result in as of yet unquantifiable negative consequences for the Swiss economy.


Why Did They Do It?

As one observer put it in a case of belaboring the obvious:


It may show that the SNB doesn’t want to widen its balance sheet any more,” said Maxime Botteron, economist at Credit Suisse Group AG in Zurich.”


Well, duh. We would certainly agree that the SNB tried to preempt the ECB’s upcoming “QE” announcement. While the European Court of Justice has not yet delivered its final verdict, its advocate general Cruz Villalon has already said that the OMT program (“outright monetary transactions”) in his opinion is compatible with EU law. In the vast majority of cases, the ECJ follows the recommendations of the advocate general (we will soon comment on these developments in more detail in a separate post). Thus a QE program by the ECB in which sovereign debt is monetized is now very likely on its way.

The SNB no doubt got cold feet at this prospect. In order to see why, one needs to take a look at the Swiss monetary base.


3-Swiss Monetary Base

Switzerland’s monetary base from January 1950 to November 2014 (the most recent data point available) – click to enlarge.


This explosion in the Swiss monetary base is a reflection of the accumulation of euro-denominated assets by the SNB in order to enforce the exchange rate floor. Stemming itself against yet another flood of newly printed euros in the wake of a sovereign QE program by the ECB would likely have resulted in the SNB’s foreign exchange reserves and balance sheet exploding even further into the blue yonder.

This is a monetary powder keg, not least as Switzerland’s money supply has increased more than that of any other major currency area as a side effect of these foreign exchange interventions. Switzerland has to contend with sizable real estate and stock market bubbles that have developed as a result. Incidentally, the Swiss stock market plummeted yesterday, which goes to show that rising stock prices are highly dependent on inflationary monetary policy.

The Swiss Stock Market Index (SMI) recovered from its intraday lows once the Swiss franc retreated somewhat from its intraday peak, but the losses were still quite significant by the close of trading, with the SMI declining by 8.67%.


4-Switzerland SMI (Daily)

The SMI readjusts as the Swiss franc soars.


Below is a chart of the Swiss monetary aggregates M1 and M2. M1 is the sum of outstanding currency plus sight deposits and transaction accounts, i.e., it is essentially equivalent to money TMS-1 (narrow true money supply). M2 also includes savings deposits and since the SNB differentiates between savings deposits and time deposits, we are assuming that these savings deposits are in practice available on demand as well, similar to US savings deposits. Thus M2 would be equivalent to money TMS-2 (broad true money supply).

As can be seen, the Swiss money supply has gown enormously since 2008. It is perhaps not too surprising that the SNB did not want to continue down this path, as the longer term consequences could prove quite problematic – this is to say, even more problematic than the bubbles that have been created up to this point as a result of monetary inflation.

In short, the SNB had to ponder whether the risks were still worth it – after all, aside from supporting the export sector, there is really no mileage for the Swiss in artificially suppressing the CHF exchange rate. An artificially low exchange rate can definitely not make Swiss citizens any richer.


5-Swiss Monetary AggregatesSwiss monetary aggregates M1 and M2 – a truly breathtaking increase since 2008. Both aggregates have more than doubled since then, with M1 up by 122% since June of 2008 and M2 up by 112% over the same time period – click to enlarge.


Unintended Consequences on the Horizon

However, the sudden increase in the CHF’s exchange rate is certainly not without problems. As far as we can tell, one of the biggest problems is that there are still a great many CHF denominated mortgages and other consumer loans outstanding all over Europe. Banks flogged these loans prior to the 2008 crisis, as it was widely held that the Swiss franc would forever remain stable versus the euro.

In a number of Eastern European countries it was moreover widely expected that their currencies would also remain fairly stable against the euro, so it was concluded that they would concurrently remain fairly stable vs. the CHF as well. As we know today, these assessments were quite erroneous. However, since the SNB has instituted the minimum exchange rate peg in 2011, borrowers and creditors alike were able to catch their breath, and many presumably rearranged their affairs on the basis of the EUR-CHF rate remaining close to 1.20. Now this is no longer applicable, and one wonders how many mortgages and other loans are once again hopelessly underwater overnight.

It is a good bet that fewer of these loans outstanding are still outstanding today than in the 2008-2011 period, but the amounts are very likely still sizable – especially as everybody thought the exchange rate problem was out of the way. In coming months it should become clear how big the problem still is. Whether the SNB has given any thought to this we cannot say, but presumably it was more concerned about the consequences of continuing the exchange rate policy for Switzerland rather than what abandoning it means for foreign borrowers and lenders.


6-CHFUSDCHF/USD – the Siss franc rose somewhat less against the US dollar, but it was still a sizable move even so, erasing many months of losses – click to enlarge.



The SNB probably felt it had little choice in view of the ECB’s likely upcoming attempts to debase the euro further. In our opinion, it should have never attempted to enforce a minimum exchange rate in the first place. Then the markets would have adjusted more gradually, and instead of inflicting a sizable amount of pain in one fell swoop, the SNB could have given people an opportunity to deal with a strengthening CHF in a more orderly manner. Moreover, it would not have presided over a huge expansion of the Swiss money supply, the effects of which have yet to fully play out.


Thomas JordanSNB chief Thomas Jordan – going from “utmost determination to defend the CHF-EUR peg” to “let’s skip it” overnight.

Photo credit: Philipp Schmidli / Böoomberg



In the meantime we have seen estimates that are putting the size of foreign loans denominated in CHF at around CHF 150 to 175 billion. This is a sizable chunk, and a lot of it is curiously found in Poland.

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