Swiss national bank “pegs” the currency: What’s it mean?

With people running away from European banks, and global investors nervous, they have been moving swiftly towards “safe” assets – such as the Yen and the Swiss Franc.

There has been sustained intervention in these currencies since late-July, but now the Swiss National Bank has gone a step further – they have set a minimum exchange rate. [Marginal Revolution also discusses here]

So they’ve pegged their currency to the Euro!

Not quite – they’ve set a cap regarding how high strong currency can be against the Euro.  They’ve said in their statement that:

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

This is still, in a large part, consistent with an inflation targeting mandate – they have just said the following:  “be aware that we are going to print money and buy up foriegn currency until our currency is back at a level that is consistent with our inflation mandate” – they have just identified a level of the exchange rate that wouldn’t carry the strong risks of deflation they are currently experiencing.

Furthermore, it seems apparent that the Swiss National Bank views the current level of the currency as a bubble – people running to saftey see the Swiss Franc as attractive, and people who want to invest expect this to continue, leading to a self-fulfilling expectation driving up the value of the Franc.

Now I’m not the biggest fan of messing around with relative prices in this way – as it could just be that Europe is so far in the toilet that the weak Euro is telling us something … as a result, my preference would be for the Swiss to just print a whole lot of money and buy currency without setting an explicit “target” in the way they have (outside of stabilising inflation rates).

My CONCERN is that this will lead to further exchange rate management around the world – although not as dangerous as protectionism, I can still see nasty side effects from this.

The real problems are in Europe – and they need to sort them out.  However, given they won’t other countries are stuck introducing “second best” policies (with the potential for unintended consequences) which is sad.

In terms of NZ this means nothing – they are worried about an asset price bubble in currency markets due to people running to “low risk” currencies … we are the polar opposite 😉 .  Also they are worried about deflation, we aren’t.

  • Raf

    This has been around the traps for a few weeks now and no doubt current concerns have forced their hand. SNB taking very strong action here given the cross was trading just above 1.10 and looking like it might crash back through. Their timing was excellent. 

    What’s so bad about exchange rate management? Exchange rates should reflect, as much as possible, economic fundamentals so that trade relationships can be kept in balance.

    The imbalance we have seen in trade has created a nasty feedback loop in the capital account as surplus currencies are fed back into the asset system causing misallocation of funds. The inability of currencies to do the traditional work has led to the major macro-economic imbalances we have now.

    It’s a big call by the SNB but the Chf has risen so much in the last year that it’s got to ludicrous levels. I think it’s a very good move and will calm markets down. It will remove speculative flows, program and algorithmic trades and still allow real capital flows to take place. 

     

    • The long-term currency manipulation by Asian countries which caused the long-term imbalances is the prime example of the problem with exchange rate management – not a signal that everyone should be doing it.  Currencies can be pegged – short term variability due to speculation is a non-issue … the issue has come FROM exchange rate management.

      In net terms I think the Swiss move was a good one – especially since they framed it in terms of active monetary policy.  However, I am concerned with naming exchange rates – generally “setting” prices is not a good idea.

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  • Raf

    “The long-term currency manipulation by Asian countries which caused the long-term imbalances”.

    That’s a bit of a reach. Long term problems caused by several issues: trade liberalisation, excessive hot money flows, speculation and asset bubbles on the back of pegged currencies. The pain of the AFC then caused Asian countries to build large surpluses so they wouldn’t get shafted by the IMF/World Bank again.

    (The real long-term imbalances go back to 1944 and the unipolar financial system created at Bretton Woods but that’s another story).

    I think we should have floating rates for the trade account…that’s how trade works BUT it’s the capital account that is the problem. Hot money flows, carry trades plus speculation in general overwhelms any trade related currency flows and so currencies are often way out of line. 

    The current financial system is so out of control that serious measures are needed to stabilise it. This may involve short term currency action, changes to margin requirements, transaction taxes etc….

    I don’t think the SNB move is permanent by any means (though we can’t rule out the Swiss joining the Euro!) and I agree fixing rates is not a long term solution. But it’s good that they have taken some action to bring the market back to more justifiable levels and remove some of the volatility. 

    • Miguel Sanchez

      “I think we should have floating rates for the trade account…that’s how trade works BUT it’s the capital account that is the problem. Hot money flows, carry trades plus speculation in general overwhelms any trade related currency flows and so currencies are often way out of line.”

      Nonsense – with a floating exchange rate, net trade flows = net capital flows. GROSS capital inflows can overwhelm trade flows, but then you have an opposing gross capital outflow… why would you think that one leg affects the exchange rate but not the other?

      I find it hard to muster sympathy for a country that already has a massive, and growing, trade surplus – the goods balance alone is now up to 4% of GDP, when it was balanced a decade ago.  And how does this square with the G7/G20/etc commitments to reduce global imbalances?  For some countries to reduce their current account deficits, the others have to be willing to reduce their current account surpluses.  The rising Swiss franc was part of the market’s effort to reduce those imbalances; policymakers are exacerbating them.

      • That is a good point – I had actually only looked at the export side, not the net export position, so this is new information for me.

        In that context, there push to get the currency down seems less appropriate – I can understand loosening monetary policy but not mentioning a level of the exchange rate …

        We have the same issue with Japan …

    • “That’s a bit of a reach. Long term problems caused by several issues: trade liberalisation, excessive hot money flows, speculation and asset bubbles on the back of pegged currencies.”

      In terms of the developed world, I would say that “hot money” and trade liberalisation are inconsequential at worst, and beneficial at best.  The relative price issues that have come about in many developed economies do stem from the management of savings and exchange rates in Asia though – understanding these issues is key to understanding what has gone on.

      “The pain of the AFC then caused Asian countries to build large surpluses so they wouldn’t get shafted by the IMF/World Bank again”

      That is a good point – and I’d note that I don’t see the “imbalances” as necessarily all bad – just a description of something that happened and needs to be explained.

      “Hot money flows, carry trades plus speculation in general overwhelms any trade related currency flows and so currencies are often way out of line. “

      Hot money requires a demand side – why were people in NZ borrowing?

      It is true that real interest rates were lower overseas, but was this the sole driver of the increase in borrowing here – or did our demand for credit also rise.  Once we have ideas about both drivers we can discuss what is going on … and in both cases having a floating exchange rate is still appropriate.

      “The current financial system is so out of control that serious measures are needed to stabilise it”

      There are definitely issues in the financial system – namely, transparency and government involvement (which brings us back to intervention in Asia) … interestingly, the US appears to have one of the healthier financial systems out of the big countries at present, a far cry from 3 years ago.

      “I don’t think the SNB move is permanent by any means (though we can’t rule out the Swiss joining the Euro!) and I agree fixing rates is not a long term solution. But it’s good that they have taken some action to bring the market back to more justifiable levels and remove some of the volatility. “

      It is definitely not permanent – nor is it a “peg”.  I am sure their justification for intervention was sensible, and the risks of deflation were rising.  I am just hoping people don’t see it as a peg – as that is something a bit different.

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