16 Jan 2015

The cuckoo clock chimes for the Swiss franc

“Five hundred years of democracy and peace, and what did that produce? The cuckoo clock.” So runs Orson Welles’ famous verdict on Switzerland, from The Third Man.

To be fair they produced the Swiss army knife, numerous luxury watch brands that have now been turned into down-market mass-luxury operations, and the Davos conference, which starts next week.

But now Switzerland is famous for something else. This week its central bank abandoned a currency peg with the Euro with all the suddenness of a film noir plot reversal.

To explain. During the euro crisis, with money flowing into Switzerland driving the value of its currency up, the Swiss National Bank announced a currency cap. It would intervene in the markets, and print money, so that the Swiss franc’s value stayed pegged to the euro.

Given the money of the global rich is stored in Swiss francs, and quite a lot of east European mortgages also, the sudden rise in value after the cap was lifted works like this:

a)    The value of people’s savings held in Swiss francs rises

b)   The value of people’s debts in Swiss francs also rises, especially people in east Europe who took out mortgages with Swiss banks

c)    The big Swiss manufacturing and export sector will get hammered

d)   The central bank itself will lose a lot of money, because some of the money it printed was used to buy assets in euros and dollars, and these are now worth less in Switzerland. And that means Swiss cantons, including Graubunden where the Davos jamboree is held, will lose money – because they lose or gain from central bank profits.

If you’re trying to work out whether this is good, bad, catastrophic or just a non-event, join the queue. Analyst Wouker Sturkenboom, at Russell Investments calls it a “high impact non-event”.

Nevertheless there will be losers. A few small foreign exchange brokers have been heavily hit: Alpari in London has entered insolvency, after its clients made losses they could not cover. Sturkenboom’s note says the Swiss economy will now suffer a “massive deflationary hit” – as 50 per cent of Swiss trade is with the eurozone, and all its exports just got massively dearer, and its imports cheaper.

In Poland, 46 per cent of home loans are denominated in Swiss francs, and the repayments are set to get steeper, hitting growth there in the longer term.

The SNB’s move came, simply, because it could not go on financing the cost of pegging its own currency. The central bank’s balance sheet had grown to 80 per cent of GDP.

Next week, it is probable that the European Central Bank will make an equally dramatic move, announcing between €500bn and €1tr worth of quantitative easing, in a move designed to end stagnation in the eurozone.

And right now, with the Greek central bank denying reports that two Greek banks have asked for emergency assistance from the ECB, economists are keeping a watchful eye on Athens. Around €3bn flowed out of the banking system before Christmas, in anticipation of the snap general election which the left looks like winning.

This month the Greek government found fewer takers for its short term debt among foreign banks, and the Greek banks reportedly had to buy more.

As I write the Greek central bank has denied that any banks have applied for emergency loans. If they do, it will have to go to the governing council of the ECB, whose spokesperson points out that, in effect, the risks are still being taken by Greece, not the rest of Europe.

What we’re seeing, then, is three central banks engaged in an attempt to use monetary policy and bank regulation against a tide of deflation and low growth. You could think of it this way: there is very little growth available in this corner of the world and one way of competing for it is by stimulating your economy with QE, and letting your currency fall against others.

The ECB’s gambit next week is a kind of “join the club” move – because everyone else will do it. Switzerland’s move was really an admission that: we can’t do anymore. And the Greek situation is being driven by voters signaling – via the poll lead of the far left Syriza party – that “we can’t do anymore”.

If it sounds like a multiplayer 3D chess game, where the pieces don’t obey you and the strongest players get to suddenly change the rules, then that’s what it really is.

The technical term for it is currency war.

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3 reader comments

  1. das kapitol says:

    As to FUBAR chess, “you cannot lose if you do not play”.

  2. Boffy says:

    There are not that many FX dealing firms left, and most is now conducted by machine rather than humans. It appears that US firm FXCM is on the rocks, with an 88% drop in its share price, and Jeffries arranging a $300 million rescue package. Of course, we don’t know how many banks trading desks may have been caught on the hop. A major problem may be the extent to which currency bets are made using very large amounts of leverage. If you have leveraged your losing trade to the extent of 10 times, for example, then a 25% loss, becomes essentially a 250% loss!

    According to the WSJ, both Eurobank and Alpha Bank in Greece have asked the ECB for emergency liquidity injections.

    The ECB’s proposal for QE if it amounts to anything next week, will not provide economic stimulation, for the same reason that QE did not do so in the US and UK. It can only devalue the currency, and help blow up financial bubbles. The growth in the US, just as with the growth that initially occurred in the UK and EU, in 2009, prior to conservative governments killing the economy with austerity, has come not from monetary stimulus, but from fiscal stimulus. That is why, in reality, Syriza with its policy of keynesian fiscal stimulus, and debt write-offs (which are little different to the policies implemented in the US) represents not a threat to European industrial capital (global financiers who are likely to lose their shirt are a different matter) but its saviour.

    Trotsky once wrote that industrial capital often looks to such left social democrats when it has tried everything else, in order to save it. That is very true in Greece. Frau Merkel should bear in mind that if Syriza fail, or are forced into abandoning their Keynesian policies, the only obvious choice for the Greek masses will be to turn to Golden Dawn, or as happened in Egypt, once more to the military strongman, as indeed Greece did itself in the 1960’s.

    Instead of spending time and effort considering some further money magic, the EU leaders and central bankers would do better getting together to discuss the implementation of some large scale US style, fiscal stimulus, backed by the issuing of EU Bonds, supported by a single EU fiscal union. As it is, they may well need to add another acronym to QE, LTRO, OMT and so on.

    That acronym would be FUBAR!

  3. Paul Powell says:

    Mr. Krugman is caught lifting the intro and underlying logic of an article by Paul Mason who correctly quotes Orson Well witty dialog from the “The Third Man.” ““Five hundred years of democracy and peace, and what did that produce? The cuckoo clock.” Well unfortunately for Krugman, Mr. Well’s dialog is witty but inaccurate and reveals Krugman has a plagiarist, how ironic. The Swiss did create a Chalet style clock in the 19th century but that’s what they are noted for and all the double talk in the world can’t save Krugman on this one. He got caught….

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