The move was dramatic to say the least.
After steadily rising for months as a safe haven trade, the rug was suddenly pulled out from under the Swiss franc. On Tuesday, the Swiss National Bank (SNB) announced that it would peg its currency at 1.20 francs per euro. The decision sent the franc plunging sharply lower by -8% versus major global currencies, which is a staggering move in foreign currency markets.
It may also be an indication of some deeply serious problems brewing under the surface in one of the world’s most highly regarded economies. If such problems exist, it could have severe implications for global markets.
Perhaps it was simply a move to protect their export markets, as this is implied in the press release from the SNB. But some of the language in the statement was notable. The following is the official SNB statement, with emphasis added.
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.
We live in an era of competitive currency devaluations, so perhaps the bold and explicit language should not come as a surprise. And in order for a currency intervention to have any impact, the move must be swift and decisive. So maybe the move is nothing more that what we see before our eyes.
Some of the facts that surround yesterday’s SNB decision do warrant a closer examination, however. And when put together into a single view, they may indicate reason for deeper concern not only for Switzerland but for global markets. The following are a few items worthy of review.
First, Switzerland has some unsettling similarities to Iceland. Both are developed economies with highly educated populations and historically attractive standards of living. But while Switzerland has a vastly more diversified economy that is 40 times the size of Iceland’s as measured by nominal GDP, they share a defining key dilemma. As Iceland did in 2008, Switzerland has banks with balance sheets that are well in excess of the country’s GDP.
In the case of Switzerland, the combined balance sheets of UBS (UBS) and Credit Suisse (CS) are over five times the size of the Swiss economy. As a result, if these banks were to descend into crisis, the government would not have the capacity to fully intervene and could instead get pulled under by the weight.
Second, UBS and Credit Suisse are exposed to the debt crisis currently unfolding across Europe. While the direct exposure of both banks to Greece is considered immaterial at less than 3%, the potential spillover effects into Eastern European economies such as Hungary could prove far more problematic. This is due to the fact that these institutions extended business and consumer loans for years totaling in the billions of francs across Eastern Europe.
The rapid strengthening of the Swiss franc has already amplified the strain on the ability of these Eastern European borrowers to service or repay these loans. And if a Greek default resulted in a regional crisis, the potential loan losses for these banks coming from the region could prove debilitating.
Third, recent events suggest that these banks might be facing some difficulties. In mid August, the SNB tapped currency swap lines with the U.S. Federal Reserve for $200 million in liquidity. This was the first time that the SNB had accessed these swap lines in well over a year and are typically not used unless there is an urgent reason, raising questions as to whether either UBS or Credit Suisse might have required immediate funding. While the move may have been part of ongoing currency intervention activities, it raises questions nonetheless.
Lastly, the apparent urgency behind the SNB’s move was notable. Language such as “immediate effect”, “utmost determination” and “unlimited quantities” at a minimum express extreme resolve and conviction on behalf of the SNB to successfully intervene in weakening the franc.
But both the swiftness and the great lengths that the SNB has stated raises the question of whether more is behind the move. If so, what might the consequences be for the Swiss economy if the intervention fails as so many efforts in currency markets often do?
Perhaps these concerns are unfounded. Perhaps the move by the SNB was nothing more than an attempt to protect against choking off growth and to promote more export driven demand for their economy. Then again, perhaps risks are building under the surface in Switzerland of something far more severe such as the potential instability of their banking system. It seems hard to conceive from an economy that has long been recognized as a model of quality and stability. But such concerns and their potential contagion effects on global markets cannot be ruled out today, particularly in this time of crisis.
At a minimum, the role of the Swiss franc as a safe haven going forward must come under scrutiny. Any investment that can fall by over -8% in a single trading day at the induction of those that oversee the instrument cannot be safely relied upon as a destination to protect capital, particularly with the potential risks that could exist under the surface. For if such a banking crisis were to erupt in Switzerland, the subsequent currency depreciation could be massive.
So where is a safe haven seeking investor to turn? Gold (GLD) remains a primary choice. It is a hard asset that cannot be printed or debased by global policy makers. And its price performance has been steady and consistent. In other words, it is not anywhere close to being in a bubble despite what some analysts and commentators might say.
And while short-term pullbacks should be expected, gold should continue to receive a bid as long as worldwide fiscal and monetary policy remains accommodative, countries continue competitive currency devaluations and global economies work their way out of crisis.
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Another safe haven alternative is the United States. While there is certainly much to grumble about in regards to the U.S. dollar (UUP), it is still the reserve currency and is backed by the largest and most sophisticated economy in the world. Within the U.S., Treasuries (IEI, IEF, TLT, TIP) are also a solid choice for investors seeking capital preservation while also generating yield and the potential for upside returns.
Disclosure: I am long GLD, IEI, IEF, TLT, TIP.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
