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“Francly” the Wrong Move

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Image: 123rf
Two months ago, the Swiss National Bank (SNB) unexpectedly abandoned the Swiss Franc’s exchange-rate peg to the Euro. The move rocked financial markets, and the value of the Swissie, as the Franc is known, soared the most in its trading history. The Economist quoted an analyst describing the Franc’s dizzying rise as a “20-plus-standard-deviation move,” something that should only happen once in “many squillions of years.” The decision by the SNB to remove the peg was unwise. Its ramifications will, and are, being felt by the Swiss economy.

In 2011, as the European debt crisis deepened, the SNB implemented a currency peg, tying the Franc’s value to that of the Euro. This was because the Swiss currency, seen as secure, saw massive inflows from investors searching for a “safe haven.” As Euros were sold and Francs were bought, the latter’s value rose dramatically. Switzerland, dependent on exports for some 70% of GDP, saw its competitiveness decrease. Due to the stronger Franc, it became more difficult for foreigners to buy Swiss products. In order to drive down the value of the Franc to a more suitable level, the SNB started printing Francs and buying Euros with the newly minted currency. This was a twofold measure, increasing demand for Euros whilst also increasing the supply of Francs. The overall effect counteracted the demand that had been driving the Franc’s value higher. 

Why did the SNB abandon the peg? There are various theories. Many in Switzerland were angered by the rate at which the Bank was printing Francs. Some said the increase in money supply could lead to excessive inflation. Those concerns are groundless: Switzerland has too little inflation, not too much. Another plausible reason is that the European Central Bank’s planned “Quantitative Easing”, QE for short, would make it increasingly difficult to maintain the peg. QE entails stimulating the economy through bond buying programs, essentially pumping money into the economy as assets are bought up. The resulting flood of Euros would devalue the currency, making it even harder for the SNB to prevent the Franc from appreciating. 

Whilst unpegging the Franc, the SNB attempted to strike a balance by simultaneously slashing deposit rates to negative 0.75 percent. Cutting interest rates on deposits held in a particularly currency should, in theory, reduce investor interest in that currency, instead encouraging them to seek better returns in other currencies. However, the dampening effect of the interest rate slash could not prevent the Franc’s massive rise.  

Regardless of the SNB’s thinking, the currency maneuver raises many concerns. The immediate fallout was felt by foreign exchange (FX) brokers and FX trading desks. FXCM, an American retail brokerage offering leveraged foreign currency trading, suffered losses large enough that it required an emergency bailout. Deutsche Bank, Citigroup, and Barclays lost a combined USD 400 million. 

The effects on the broader economy are even more worrying. On March 19, the SNB will be a giving its first policy outlook since the Franc’s cap was removed, and it is expected that the state of the economy will have weakened. Switzerland’s economy, propelled by tourism and exports, will come under immense stress. As the Franc appreciates, Switzerland’s exports become more expensive and therefore less attractive to foreign buyers. Tourism, such as visits to Switzerland’s famed ski resorts, becomes much more costly with the steep rise in the Franc’s value. The knock on effect from a slowdown in these two critical sectors will be felt throughout the Swiss economy, with likely results being a diminished growth rate, higher unemployment, and stagnant wage growth. The probable chill in the economy and wage growth risks exacerbating deflationary forces in Switzerland. Deflation will further drag on the economy, as consumers delay spending in the anticipation of even lower prices in the future. 

It is to be seen just how large an impact the SNB’s move to remove the cap creates. However, it is clear that its decision has potentially put Switzerland on a path of deflation and economic stagnation. 

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