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SocGen Thinks CHF is the 'Next Safe Haven to Fall'

The Swiss franc has become a 'safe haven asset' during the euro area's debt crisis, along with a number of other peripheral European currencies, especially the Scandinavian ones. Similar to the central banks in Scandinavian countries, the Swiss National Bank [SNB] thereupon instituted a major inflationary policy, including in this particular case not only ZIRP, but also the enforcement of a floor rate versus the euro, so as to avert deflation and damage to the export industry – in other words, the SNB decided to risk the value of its currency as well as the formation of a major asset bubble for misguided mercantilistic reasons. Nevertheless, buyers continued to pile into the CHF (one wonders what they were thinking?), thereby 'forcing' the SNB to continue to defend its peg by letting the printing press run 24/7.

Now Societe Generale, based on the idea that systemic risk in the eurozone is receding, thinks that the 'safety premium' may come out of the Swissie.

The Swiss franc, a currency that has provided refuge for investors since the escalation of the euro zone debt crisis, may be the next safe haven to fall, according to a new report from Societe Generale.

The bank forecasts the Swiss franc could weaken by almost 10 percent against the euro by mid-2014 to 1.35, as systemic risk in the single currency bloc recedes. One euro currently buys 1.229 Swiss francs.

Systemic risk has faded in the euro zone, and further progress will be made to tackle the solvency issues of euro zone countries, the Swiss franc should lose its appeal as an alternative investment," the bank said.

Further cooperation among European leaders, including fast tracking a banking union, for example, and an improvement in the region's growth prospects would be negative for the currency, it noted.

Recent economic indicators including the latest euro zone Purchasing Manager's Index [PMI] – which rose to a near two-year high in July – suggest a possible turning point for the euro area. "Moreover, the economic recovery in the U.S. and higher global yields will see capital flowing out of safe havens into higher beta and higher yielding assets," it added.

However, there is a risk that the Swiss National Bank may hike rates next year to counter housing inflation, the bank said, which could limit the currency's downside. Switzerland has seen a surge in property prices following the 2008 global financial crisis, driven by ultra-low interest rates.

(emphasis added)

We're not so sure that there are no longer any systemic risks in the euro zone. It looks to us more like a good helping of lipstick was put on the pig, and that lipstick could wear off anytime. There is an awful lot of Polyanna-type extrapolation involved in SocGen's assessment.

However, it is of course not knowable for how long the markets will continue to pretend that all debt problems have been solved by piling on even more debt. Moreover, as we have pointed out in recent weeks, the recent increase in euro area money supply growth argues in favor of increased 'economic activity', even if such activity ends up consuming even more capital and invites an even bigger bust down the road. So there certainly is a chance that the charade could continue for a while longer.

The Actual Problem

Having said that, there is a far more important reason to worry about the Swiss currency. Simply put, way too much of it has been printed in a very short time period. The monetary base has exploded into the blue yonder and so have Switzerland's monetary aggregates. Below are the most recent charts:

(Click charts to enlarge)

Switzerland's monetary base in billions of CHF

Swiss monetary aggregates M1, 2 and 3. Explanation: M1 consists of currency in circulation, sight deposits and 'transaction deposits', and thus is the equivalent of narrow money TMS-1 in the US. M2 is M1 plus savings deposits – it is therefore akin to U.S. broad money TMS-2, as savings deposits in Switzerland are not time deposits (i.e., they are available on demand). M3 includes M1, M2 and time deposits - click to enlarge.

As can be seen, both the narrow and broad money supply have roughly doubled since the fourth quarter of 2008. Presumably the SNB has some plan to take some of its monetization measures back once the CHF weakens – but then it would actually have genuine deflation on its hands. The idea that it might raise rates to counter the real estate bubble looks perhaps reasonable on paper, but in practice central bankers are usually not happy to preside over collapsing real estate prices, as the collateral for the mortgage loans the banking system has extended will then no longer suffice to cover these loans. We seem to remember that a little bit of trouble erupted over just such an issue in the U.S. in 2007-2008. It seems therefore likely that new excuses to keep the inflationary policy going will suggest themselves to the central bank.

In the past five years, the SNB has printed as much money as in its entire pre-2008 history. We're not sure according to which doctrine its managers are confident that this isn't going to have adverse consequences. We do however know from experience that once these adverse consequences become manifest, the initial reaction will very likely be to print even more money.

In a way Switzerland's experience is just a microcosm of what has happened elsewhere in the world since the 2008 crisis, so there may be little effect on relative currency exchange rates stemming from the expansion of the money supply as such – we would tend to agree with SocGen that exchange rates are far more likely to be driven by other considerations in the short-to-medium term, even if these considerations may turn out to be misguided.

It should be clear that doubling one's money supply in the space of five years is going to have serious long term effects, none of which anyone will like once they become obvious. Clearly we live in an age of accelerated devolution of fiat money.

The long flatlining CHF-EUR rate – 'down' means the CHF is getting stronger. The SNB has enforced a 'floor rate' at the 1,20 level since September 2011

Chart by: StockCharts