The Swiss Dirty Float: Enlightened Self-Interest or Self-Destruction?

Includes: FXE, FXF
by: Bruce Krasting

G-7 currency intervention has not been implemented on a coordinated basis at any time over the past eighteen months. The carnage in the capital markets during this tumultuous period may have been averted or slowed if currency intervention had taken place. In an abundance of caution the G-7 Central Bankers chose not to act.

There are valid reasons why there was no coordinated intervention during this violent period of economic history. They include:

  • Currency intervention is the last arrow in the quiver. It should not be used lightly.
  • Currency intervention may have added to capital market volatility in the short term.
  • Currency intervention can fail. When it does a period of even greater instability will follow.

Given the demonstrated reluctance of the global Central Banks to commit to a policy of intervention it is both surprising and shocking that the Swiss National Bank would embark on a currency war in March of 2009. What are they thinking?

Members of the SNB Governing Board

Jean-Pierre Roth, Chairman
Philipp Hildebrand, Vice-Chairman
Thomas Jordan, Member

Over many decades the Swiss National Bank was a source of stability in the currency exchanges. In past times of trouble their steady hand helped calm, rather than roil markets. The Swiss National Bank always had a 'seat at the table' when global Central Banks had hard choices to make. This history makes it even more surprising that the SNB would adopt a go it alone or beggar my neighbor policy.

There must have been some very strong motivation for the SNB to break with its tradition. It is not clear what that motivation was, based on a review of the data.

In the ten weeks thus far in 2009 the Euro/CHF rate has ranged from a high of 1.5200 to a low of 1.4700. This is not market volatility that justifies intervention. During that same period the CHF fell by 5% against the dollar. That Sterling is broadly weak is not an acceptable excuse for the SNB moves.

It should be no surprise to the SNB that the CHF is strong on a historical basis in the 1st quarter of 2009. Global financial developments are driving this. Over many years the Swiss have both benefited from and paid a price for their status as a Reserve Currency. From the period September 2001 through March of 2003 the Euro/CHF rate was below 1.4700. That period of overvaluation had its roots in 9/11. The SNB did not intervene then. Clearly the rules of this game have changed.

An argument has been put forward that the SNB has acted in response to the fact that the big Swiss banks have a mountain of CHF loans outstanding to Eastern European borrowers. Those borrowers earn salaries in Euros, or even worse, in local currencies that have lost much of their value. This factor was not mentioned by the SNB in their official communique. The SNB has an obligation to the banks. If concern for the assets of the banks was a motivating factor there were a variety of alternative options available to them. Currency manipulation is never justified.

The timing of the SNB moves is also confusing. The Swiss Finance Ministry is fighting a war on the front pages over banking secrecy. The US IRS has Swiss banking giant UBS in a vise. The currency moves by the SNB are unlikely to mend any of the many fences that have been torn up. It almost appears that the SNB is retaliating. It is also difficult for the SNB to cry poor on Thursday when on Wednesday Roche (RNNBY.PK) announces from Basel that it is finalizing its $47 billion deal for Genentech (DNA). Business can't be that bad.

In December SNB Chairman Jean-Pierre Roth announced that he would retire. No successor has been announced. It is rumored that Vice Chairman Phillipp Hildebrand is going to get appointed Chairman. It is surprising that such a significant step was taken by the SNB while the Chairman's position is open. It begs the question, “Who is calling the shots at the SNB?” Is it possible that Swiss Finance Minister and President Merz orchestrated the SNB actions? If that were to be the case then it would explain why the SNB chose to abrogate its international obligations in favor of purely domestic considerations.

It is unclear what the medium term consequences of the SNB moves will be. The darkest outcome would be that the actions taken by the SNB destabilize the Euro Zone further. If six months from now there is a 'two tier' Euro it will have happened in part because the SNB chose a dangerous course. One has to wonder if that potential outcome was considered by the SNB. If instability in Europe is a consequence then the Swiss economy will pay a high price. The end result of the instability will be that the CHF will be stronger than ever vs a basket of Switzerland's trading partners. The risks and rewards of the steps taken by the SNB do not seem to add up properly.

One outcome seems clearer. The position and image that the SNB has held in global financial matters for the past fifty years has been tarnished. It's likely that we will all pay a price for that.