On January 15th the Swiss National Bank (SNB) dropped a soft peg of 1.20 Swiss francs per euro that it had been maintaining since September 2011. The SNB had been maintaining this peg because their currency had been seen as a safe haven from volatility in the Eurozone. The euro had been volatile due to the debt crises that had been occurring in Spain, Italy, Greece, Portugal, Ireland, and elsewhere (i.e., PIIGS). Prior to adopting this peg, the Swiss currency had been trending downward (strengthening) against the euro for years as foreigners sought the relative safety of Swiss currency. This strengthening is good on one hand, but bad on another. For one, it is good for the Swiss consumer, whose franc now buys more than it did before. For example, a change from 1.60 Swiss franc per euro to 1.20, implies that a franc now buys about 28.6% more euro produced goods than before (Using the midpoint of 160 & 120). However, it also means that Swiss manufacturers and retailers prices are now 28.6% higher than they were before. This jump in prices would lead to rising unemployment and reduced competitiveness by the Swiss, and a reasonable expectation of avoiding deflation.
It is important to note that the Swiss artificially weakened their currency from where it would have been otherwise by maintaining a 1.20 Swiss franc to euro exchange rate, when it would otherwise have been closer to 1.00 to 1.00 (as it is now). It is easy to maintain a peg that artificially weakens your currency, since all you have to do as a central bank is print the additional money that foreigners want to hold. The SNB statement notes that “[t]he euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the U.S. dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.”
The move by the SNB is expected to lead to rising volatility in forex markets in the coming weeks as money sloshes around in its search for a new safe haven. Investors now might wonder if the SNB can commit to other policies, and might undermine their effectiveness in the future. This loss of credibility could lead to future difficulties for the SNB if they need to turn to similar policies. While it does not necessarily make it more difficult to maintain a future peg that is artificially weak, investors who think they cannot commit to a policy would be willing to push the SNB limits by attempting to accumulate currency in the hopes that they would abandon their peg and each franc is suddenly more valuable (about an 18% swing in the midpoint of a 1.20 to 1.00 change recently experienced). Much of the problem experienced by the SNB is that the size of the Swiss economy is not large enough to accommodate all the inflow of money that would be necessary to act as a safe haven. The US now takes on additional ‘safe haven’ burden. Some believe that the US should always benefit when the dollar is stronger, while others doubt that it is beneficial to all.
Questions you might want to answer
Remember, don’t try to answer all of these questions, just focus on one, provide some evidence, and support your opinion. NOTE: There is a delay between you posting your comment and it appearing, since I have to approve all comments by hand. Make sure you save your comment in a word processor file before posting it here. I cannot help you if “the ether” ate your homework.
- What do you think about the US “strong dollar” policy? Should the US continue to advocate a strong dollar or is this not in our long term best interest? Provide some facts to back up your opinion.
- Compare the Chinese policy of keeping its exchange rate ‘artificially weak’ as the Swiss have done. How does this result in economic benefits (or costs) to the Chinese, and how has it impacted their price levels? What is a primary difference between the Chinese yuan and the Swiss franc?
- What do you make of the Swiss policy of having a short-term policy rate of -0.75% (yes that is a negative sign). What does this mean? Why are they doing this, and is this something that the US could implement?
- Recent events in Greece have led to an anti-austerity party taking nearly full control of their legislative and executive bodies. What does this mean for exchange rates, and how has it already appeared to affect markets?
- For any comment, please make sure you have facts to back up your opinion, and make sure you are not saying something that someone else said previously.