The SNB on the SNB’s recent move
I’ve been asked to comment on the recent Swiss decision to tighten monetary policy. I’ll just quote from the SNB statement, which tells us all we need to know about why it was a bad decision to return the SF to a level of “exceptional overvaluation”:
The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate. The economy was able to take advantage of this phase to adjust to the new situation.
Yup, it worked. So . . . . ?????
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15. January 2015 at 07:35
I don’t understand their statement. They are lifting the min exchange rate but lowering rates to keep the SF from strengthening too much (whatever that is) against the euro but provides a reason (goal?) for lifting the cap that it caused “the Swiss franc to weaken against the US dollar.”
So does the SNB wish to strengthen the SF v. the USD but stay weak against the euro?
15. January 2015 at 07:39
That’s not exactly it. I’m sure the SNB would prefer to stay at the 1.2 peg if they could. But this isn’t about SNB. It’s about the ECB.
The correct answer to someone who says “But Scott, you said that a determined central bank can always depreciate its currency” (or something like that) is, “Yes, and the ECB has finally decided to depreciate its currency”.
QE in the Eurozone is coming, and the SNB realized they can’t stop a determined central bank. The Sumner theory of central bank power still holds.
15. January 2015 at 07:40
I love how they explicitly say their intent is not to tighten monetary conditions (I don’t recall the Fed being so direct on a regular basis), but you call it tightening monetary conditions. I think you’re right of course, a 50bps rate cut isn’t as powerful as the FX floor.
The timing is weird to me though, with the ECB expected to start QE; having the FX floor in place would be good insurance against another ECB screw up.
15. January 2015 at 07:41
Scott, can you comment on these words of wisdom from CNBC (http://www.cnbc.com/id/102340182#.):
“Perhaps knowing that the likely impact on the euro would mean even greater upward pressure on the Swissie, they chose to take the initiative, rather than fight what would have been (in their eyes) a losing battle to defend the franc.”
Indeed. If the price of Francs goes too high, what could the poor SNB possibly do? Oh, sure, well, I *suppose* it could create 10 trillion Francs and use them to buy Euros, and if that didn’t drive the price down, it could try 100 trillion, but that would be, you know, umm, ….. Reckless! Irresponsible! Currency de-basers!
I just can’t get used to the foolishness I see when finance people attempt to comment on monetary economics. Somehow, they are constitutionally incapable of internalizing what it means to own a currency. As are the finance writers who quote them, apparently. The depth and breadth of the incompetence is breathtaking.
-Ken
Kenneth Duda
Menlo Park, CA
15. January 2015 at 07:56
Ken Duda,
I’ve seen a few on CNBC with a slightly more nuanced take: the Swiss believe they could defend the peg but do not want to in the context of depreciating that much against the dollar. I can’t really say this makes sense to me, but its out there.
15. January 2015 at 08:05
With regard to not wanting to defend the peg in light of divergence from other non-Euro currencies, couldn’t they just have moved the peg off 1.20, not abandoning it in its entirety?
Also, I don’t understand their justification of surprising the market. I think I understand how drastic action needs to occur as a surprise, but what is their justification for this specific surprise? Why did it need to be a surprise?
Sorry if these are overly simplistic questions. I’ve never dared to comment here before.
15. January 2015 at 08:20
Ken –
Welcome to my personal hell. Without fail my bosses in investment management profess backward ideas about monetary economics, currencies, and often the relationship of interest rates to the economy. The rates fallacies are the most frustrating, at least in fixed income. You can tell them they’re wrong and explain why, but they will not really understand: perhaps they’re too old/self-important and we can only move forward one retirement at a time.
15. January 2015 at 08:29
“I just can’t get used to the foolishness I see when finance people attempt to comment on monetary economics….The depth and breadth of the incompetence is breathtaking.”
Kenneth, please note the quote you are referencing was from one, Simon Smith, chief ECONOMIST.
15. January 2015 at 08:56
Anthony, They said:
1. An overvalued exchange rate is bad.
2. We fixed the problem
3. So we decided to go back to an overvalued exchange rate
4. ???????
Njnnja, If they wanted to stay at 1.2, then why didn’t they stay at 1.2? The forex markets expected them to stay at 1.2, so why didn’t they? What do they know that the forex markets didn’t know?
cthorm, Yeah, they are already in mild deflation, they are pegged to a eurozone that is itself deflating, and they just appreciated their currency 15% and stocks dropped 10% on the news. I’d say that’s tighter money!
Ken, Yes, I’m still trying to figure out what problem this is supposed to solve. A perfect example of where a central bank gets distracted by something unrelated to aggregate demand. In Sweden it was bubble fears, in Switzerland it seems to have been concern about the falling euro. Finance people seem incapable of understanding that monetary policy is a macroeconomic stabilization tool. It’s not about financial markets.
Nick, My hunch is that you are right, but it makes no sense. Focus on the macroeconomy, not exchange rates. Again, it doesn’t matter that the euro is falling if the eurozone is in deflation. The ECB is not running an inflationary monetary policy.
RSF, You should comment more often, those are great points. I thought the same thing as you—if they were really worried about the falling euro then why not a 5% devaluation? Why float?
15. January 2015 at 09:30
Sounds like they are trying to shoot the gap between the falling euro and the rising dollar, but to Scott’s point this seems like a tree/forest perspective problem. I’m not sure what problem they are trying to solve for. Is it possible they are worried about having to purchase too many falling euros to support the peg? Bizarre.
15. January 2015 at 09:36
This is just noise. IF ECB prints, SNB will to. Otherwise Swiss banks will lose money from defaulting foreign franc borrowers.
15. January 2015 at 09:39
Anthony, That’s possible, but this will make the problem even worse. After they pegged the currency in 2011 they didn’t have to buy as many euros.
If they want a small balance sheet they need a higher inflation target.
15. January 2015 at 10:10
“Anthony, They said:
1. An overvalued exchange rate is bad.
2. We fixed the problem
3. So we decided to go back to an overvalued exchange rate
4. ???????”
Is that what they said?
What I see that they said…
The Market thinks the Swiss Franc should be worth more that we think think it should be. We should install price controls to fight the market. The price controls have been working (in that the rate peg has held). However, we are spending a whole lot of francs to make this work.
Now the ECB has said that they want QE. The Market will put more pressure on the CHF. Do we want to commit more francs to holding this peg? Why are we fighting the market? What are we really getting for it? Why don’t we agree to stop fighting the market. In the mean time we will cut interest rates to make the franc a less interesting place for the market to park cash.
15. January 2015 at 10:26
Perhaps the SNB was embarrassing the ECB and was pressured to stop doing that. I can’t think of any better explanation.
15. January 2015 at 10:31
Staying at a 1.2 EUR peg once ECB QE starts has 2 big problems. First, if they keep the peg while EUR depreciates against USD, overall standard of living goes down as lots of things that Switzerland imports that are denominated in USD get more expensive. Basically a currency war only works for you if you are competing to be the lowest cost provider, which is definitely not the game Switzerland wants to play.
Second, although SNB could always print enough CHF to keep the peg, there are so many Euros out there that people could want to convert to francs that if they had to really defend the peg against a massive inflow it would get ugly. Since a large portion of Swiss GDP is dependent on their being a stable, safe haven for your cash, getting into a money printing competition with the >10 trillion EUR Eurozone would not be good. Even if it is successful at keeping the peg, the real winner would be banks on small Caribbean islands.
So they could keep the peg and help out the watch and chocolate exporters, while hurting the average CHF holder and possibly permanently damaging their reputation as the offshore bank jurisdiction of choice, or they could drop the peg, lose a little face, and buy more luxury German cars.
As for what did SNB know that the markets didn’t, clearly the markets didn’t expect that the SNB would change its mind. Even under strong EMH, market predictions of company CEOs, governments, or central banks are not predictions of the best thing to do, they are just predictions of what they will actually do. Markets were predicting SNB would keep the peg, which is not inconsistent with SNB changing its mind and deciding not to keep the peg, or with the new decision to drop the peg being the “wrong” decision (while the earlier decision was “right”).
15. January 2015 at 10:31
Today is a great victory for Draghi. He has eased monetary policy so much that the Swiss had to call it quits.
15. January 2015 at 10:35
@Doug M,
They weren’t “spending a lot of francs”, they were printing up pieces of paper and exchanging them for interest-paying foreign assets. Free money.
A central bank depreciates its currency (francs) by buying foreign assets denominated in foreign currencies. As it does so, it drives down the value of its own currency. The foreign assets it owns are now worth more in francs than what the central bank paid for them. It gains as its currency depreciates. The only way the central bank can lose is if it stops printing and its currency appreciates, making the foreign assets worth less in francs.
So this move by the SNB is doubly stupid. Not only are they exporting jobs by tightening money, they are also losing their taxpayers money via forex losses.
If the Swiss were experiencing high inflation this move would make sense. But they’re not.
15. January 2015 at 11:10
The SNB depreciated their currency and got deflation — a bit strange for any monetary theory. But not in the information transfer model …
http://informationtransfereconomics.blogspot.com/2015/01/switzerland-depreciated-their-currency.html
15. January 2015 at 11:34
They weren’t “spending a lot of francs”, they were printing up pieces of paper and exchanging them for interest-paying foreign assets. Free money.
They weren’t even doing that… they were putting marks bank book… no the made entries in a database, which represents a credit with the Central Bank. They gave these credits in exchange for someone giving them a credit for Euros. Euros which will now be exchanged back for fewer Swiss Francs than were originally credited.
15. January 2015 at 11:35
Doug, You said:
“However, we are spending a whole lot of francs to make this work.”
They were spending even more francs before the peg. Without the peg they’ll have to go back to QE as their policy tool. How does that help? Maybe negative IOR will help (I doubt it will help much) but then why not just negative IOR to reduce speculation? What does a huge revaluation do for Switzerland?
And yesterday the “market” thought SF’s were worth 1.2 per euro. Now 1.03. Currencies have no fundamental value, their value is determined by central banks.
Jeff, If they were pressured that would have leaked out–I really doubt it. The ECB can hardly complain about currency manipulation.
Njnnja, You said:
“Staying at a 1.2 EUR peg once ECB QE starts has 2 big problems. First, if they keep the peg while EUR depreciates against USD, overall standard of living goes down as lots of things that Switzerland imports that are denominated in USD get more expensive.”
I could not disagree more strongly. The eurozone is headed into deflation. If the SF had stayed pegged to the euro it would have also had deflation, despite higher import prices from the US. Whatever effect QE will have on the euro’s value in forex markets has probably already occurred (unless the QE is bigger than the market currently expects.) And that effect isn’t enough to stop deflation.
Draghi’s “victories” are measured in terms of degree of failure. How bad will the eurozone fail? That is still to be determined. But I’m quite willing to accept that Trichet was even worse.
Jeff, Maybe the voters will revive the gold referendum.
Jason. You need to check the forex data. The SF has been one of the strongest currencies in the world in recent decades. They did devalue in late 2011, but just for a few months. Your post incorrectly characterizes my views on the stance of monetary policy, which is best measured by NGDP expectations, not exchange rates.
The SF has been pegged to the euro for years. The euro is now in deflation. No mystery to be explained.
15. January 2015 at 11:36
Not only are they exporting jobs by tightening money…
Swiss unemployment is below 4%, they can afford to export jobs.
15. January 2015 at 11:43
Hi Scott,
I did say ‘sufficient’, not ‘optimal’ — in several posts here you point to exchange rates as an indication that central banks can affect monetary policy (most recently, Japan):
“BTW, Kuroda is engaged in monetary offset (the yen has recently fallen from 109 to 118), just as market monetarists would expect, and no, he is not doing all he can. ”
http://www.themoneyillusion.com/?p=28054
Yes, NGDP is the best indicator!
15. January 2015 at 12:21
I see your point – since German market rates are predicting no inflation, whatever QE the ECB is currently planning is insufficient (by EMH). However, I believe that the ECB will successfully create inflation. Maybe it doesn’t see it yet, but just as the market didn’t see SNB actions coming, I don’t think that they see what the ECB will eventually do either.
But if you stick to market expectations, then not only are we stuck with German deflation, but we also have a non-zero probability of Euro breakup. And in that world, it’s just going to be a big mess and there is no sense trying to defend a cap against the central banks of Italy, Spain, and Greece as they try to save their banks while handing out political candy.
15. January 2015 at 12:27
“Currencies have no fundamental value, their value is determined by central banks.”
Their value is determined by the market.
15. January 2015 at 12:51
If the Swiss were worried about the US dollar, why didn’t they switch to a peg against a basket of currencies–part euro, part dollar (maybe also part pound, yen, renminbi, whatever–but surely the euro should be the largest component)?
15. January 2015 at 15:32
The biggest cost of the SNB move is SNB credibility.
The next time SNB tries to peg its currency, you can bet there will be a tsunami of speculators trying to break the peg.
15. January 2015 at 16:55
Most recognized economists say central banks should be independent.
I wonder.
If the U.S. president ran monetary policy, would he or she choose a policy that suffocated the economy, or resulted in double-digit inflation?
We know that central bankers are happy to suffocate an economy in search of zero inflation, to fight “bubbles” or, lately, to even seek minor deflation.
As a citizen and econkmic participant, I would like to vote on Fed policy. In Europe…ooooh boy.
15. January 2015 at 17:21
The most interesting idea I’ve read.is that they were.starting to see massive inflows of Russian Euros. Also how much did the peg provide liquidity to the Euro. Had the Swiss become a lender of last resort through the peg?
15. January 2015 at 19:41
Great observation Steve.
15. January 2015 at 20:02
Jason, OK, but that undercuts your argument.
Doug, You said:
“Their value is determined by the market.”
Yes, and as monetary policy changes the market value changes. The market value was 1.20 yesterday, but not today.
16. January 2015 at 01:07
Interesting that Sumner is on the same page and seems to understand Duda. Either a wonderful example of great minds thinking alike, or, like the old joke about the economist asked by his sponsor what is 2+2=? and saying: ‘what do you want me to say it equals?”
As for you that argue ‘don’t fight the Fed’, and taking this as an iron law, Fischer S. Black spent a career and made money proving this is not true (the Fed follows the market often), and further, Soros broke the UK Fed (Bank of England) by speculating against the pound in the early 1990s. If one hedge fund can break the UK Fed, imagine what the entire country can do if the Fed loosens money supply, as Sumner proposes, when the entire country does not wish to spend or invest more. You’ll get stagflation at best, hyperinflation at worst.
16. January 2015 at 01:49
Dropping the ceiling basically says that the SNB intends to be less inflationary than the ECB. If they wanted to be as inflationary, or more inflationary, they could have left the ceiling in place.
16. January 2015 at 03:25
Good to look at the bio’s of the guy who started the SNB peg in 2011: Hildebrand (markets/CIO roles then SNB) vs Jordan who gave up (SNB, academia, SNB). Good experience vs No markets experience and the wrong theory. Although, to be fair, Jordan was interim head during the 2012 attack on the peg that lasted for 6 months (after Hildebrand had to resign to fight of a scandal related to his wife’s potentially conflicted trading).
The data from teh SNB also show no significant uptick in balance sheet over the last few weeks, nothing at all like the initial increase in 2011 or during the Summer 2012 attack, or even the modest mid-2013 taper tantrum attack. It had even fallen during most of 2014.
People think the political foolishness of the failed Gold Referendum may have had some impact. Mostly it looks like a bit of a c0ck-up, like most things in history, trying to get ahead of the curve somehow and misunderestimating the impact. Potentially through not taking the markets seriously enough, given the degrees of practical experience.
16. January 2015 at 04:35
“If they wanted to stay at 1.2, then why didn’t they stay at 1.2? The forex markets expected them to stay at 1.2, so why didn’t they? What do they know that the forex markets didn’t know?”
I would not rule out cultural influence. The Swiss really are some seriously conservative, hard asset loving, ‘fiercely’ financially independent people. If they felt they were going to be dragged into QE as the tail of the ECB dog, that alone is an affront to national pride.
Interestingly, how this was executed, appears to fly in the face of what we were discussing in the “great moderation” – coordination between markets and CB in order to create a stable environment.
You can’t blame the forex traders, since they were promised a peg, and that peg was held to since 2011. I saw a terrible article in FT, but the graph was all telling. 5 year volatility remained collapsed and definitely was informing you that people believed that peg was going to be held to.
Now what really surprises me are the balance sheet comments about Euros on the SNB balance sheet. It appears in mid ’11 and mid ’12 they would have had to accumulate Euros to hold the peg, but if their goal was to not hold a long Euro position it seems they had all of 2013 and the majority of 2014, to liquidate (or minimize) those positions. It seems it was only for the past few months that the level was being tested again.
16. January 2015 at 06:00
Derivs
The level was being tested but the official weekly data show it had become virtually costless as the sight deposits in CHF were not really rising. And the less frequent foreign reserves data was also flatt’ish. Of course, the official data may not show the real picture and various hard to observe actions may have been happening, but this seems unlikely. Snatching defeat from the jaws of victory.
In one sense it is a bit of a setback for MM, in that the SNB felt they couldn’t resist the “pressure”. Obviously, in another sense MM hasn’t been tested as it was only a forex ceiling that has failed and not NGDP Forecast Targeting.
16. January 2015 at 06:17
Ray, Yes, that’s right. For 6 years Ken and I have been on the same page. But the minute he donated money we only agree because he donated money. I admit it, I don’t really believe anything I’m say now, even though it’s exactly what I was saying before. You caught me!
The real question is “do you believe anything you say?” God I hope the answer is “no.”
Max, You said:
“Dropping the ceiling basically says that the SNB intends to be less inflationary than the ECB.”
Don’t you mean “more deflationary.” Neither central bank is inflationary.
James and Derivs, Thanks for the useful comments. A few responses:
The big purchases in 2011 occurred before the peg. The peg actually reduced the amount of assets that need to be purchased, Evan Soltas did a good post on this.
I suppose it would have been better for MM if they had continued. But 3 1/3 years is plenty, especially given they merely decided to abandon the peg, they were not forced off by massive purchases.
16. January 2015 at 09:29
Evan Soltas may have been a bit out of date. There were big purchases before the peg, around CHF 250bn in two chunks. In 2009-2010 of CHF 150bn during the early crisis, and then in the failed depreciation effort of mid-2011, another CHF 100bn. The 2012 attack on the SNB’s credibility was a long old battle of six months and led to CHF200bn more FX on the balance sheet. There was maybe another CHF 50bn in mid-2103 during the taper tantrum. However, for long periods the threat of, or memory of, shock and awe was enough.
16. January 2015 at 09:34
A lot of conspiracy theories out there today that suggest not incompetence but prudence ahead of next Thursday and the ECB announcement of big QE , or big and unlimited QE, or modest and limited QE, or hedged about and with no burden sharing QE or … no QE and a resignation of Draghi and a likely break-up of the Eurozone. Have the SNB had a steer?
Of course, if it is QE, MM’ers will want to know the goal of it all, rather than jsut the size.
16. January 2015 at 19:33
James, Isn’t all that consistent with what Evan said?
And I doubt the ECB will have much effect, but of course I hope I’m wrong.
17. January 2015 at 00:00
Scott
If you mean Soltas’ blogs around May 2012 then he was very out of date while he was writing.
http://www.forbes.com/sites/steveforbes/2014/12/01/why-that-swiss-referendum-on-gold-deserved-to-fail/
At that precise time the SNB was right in the midst of a massive battle to establish the credibility of the peg. It involved doubling the FX reserves from the very elevated reserves created in the battle in the battle to stop the appreciation without a peg. The battle was won by 3q2012, and there has been relatively little active action since then, until just recently.
http://www.snb.ch/ext/stats/balsnb/xls/en/snbbil_A3_2_M1.xls
The elevated size of the balance sheet meant some large mark to market moves in the value of the $ assets, bonds and gold. These moves led to “losses” and a suspension of cash dividends from the SNB to the cantons. They need this income. The suspension of dividends partly caused the Gold Referendum in November. The vote was lost, but the point was made.
http://www.bloomberg.com/news/2014-11-30/swiss-voters-reject-snb-gold-referendum-srf-projections-show.html
Dividends are being resumed, perhaps as as quid pro quo for the No vote, thanks to recent mark to market gains as the Euro fell against the $.
http://www.bloomberg.com/news/2015-01-09/snb-sees-2014-profit-of-38-billion-francs-resumes-dividend.html
There are currents in Swiss politics that outsiders can find hard to grasp, just like any country. What prompted the SNB to act may have been stupidity, it will cost them more to stop future appreciation now their credibility is so damaged, for sure. However, it would be foolish to underestimate the stakes around the ECB QE decision next week.
The break up of the Euro would be a major political loss to the European movement, with geopolitical ramifications (think Russia at the very least). The Greek elections are next weekend, too. Leaving the Euro may be a good opportunity to regain their monetary freedom, but the politics looks too ugly to be a net benefit. Any ensuing chaos is a good result for Russia.
17. January 2015 at 03:25
No. Evan didn’t have the data. He was writing in the middle of the attack. The numbers weren’t in until the end of the Summer. Perhpas your new Research Assistant could have a look.
🙂
Agree about the ECB, hoping but not expecting. If they fail there coudld be big consequences.
17. January 2015 at 06:22
“suggest not incompetence but prudence ahead of next Thursday and the ECB announcement of big QE”
Incompetence. I would have to believe that there were many ways to slowly back out from the peg as opposed to choosing the one where you are throwing a cold bucket of water on a market you yourself purposefully lulled to sleep. If you look at it, all the volatility created was really in Switzerland. For the average Euro person, what changed? Gelatti was the same price in Florence. Wiener Schnitzel the same in Vienna. The DAX was up 2%, and the Euro held within 2% of the dollar.
Note how the market took it out entirely on the Swiss Assets. Their equities (good indication for all Swiss assets???) were down 15.5% with a currency appreciation of 17.5% (net up 2% – same as the DAX), so the balance sheet arbitrage was 0 between Munich and Zurich. But it all came out of the Swiss side. Impressive even on a slow day.
Now we must watch the Cervinia vs Zermatt ski home index.
17. January 2015 at 06:52
James, Thanks for the info. I was certainly aware of the mid-2012 episode, my point was that the initial impact of the peg was that the SNB bought fewer assets.
It seems like the arguments you make are for switching out of euro assets into something like dollar assets, not letting the SF soar against the euro.
17. January 2015 at 07:46
To be fair to Soltas he did write a third and last blog (I can find) in June 2012 where he revised his view in the light of the ongoing defence.
http://esoltas.blogspot.co.uk/2012/06/swiss-watching.html
I guess the market was really testing the new Chairman. He eventually passed the test, and expectations trumped all.
Interestingly, the SNB had CHF 210bn of forex reserves in Euros out of a total CHF 470bn at July 2014. So, they were already diversified out of Euros.
However, they only had CHF 136bn of US$, the rest was roughly equally in C$, GBP, JPY and “Other”. At least the first three had also recently been falling against the $, following the Euro. The SNB was facing mark to market losses on non-$ assets overall, and this appears to have been politically problematic even if practically irrelevant.
17. January 2015 at 08:13
Sorry, got that wrong. The $ went up vs the Euro (and therefore the CHF) and most other currencies in 2014, meaning gains vs the $ and broadly no change vs non-$, non-Euro forex reserves.
The “breaking free” this January will have caused the mtm gains vs the $ to reverse, and now mtm losses against all other reserve currencies, including the Euro. If the losses cause political problems at home, these will have now intensified as a result of the peg break. So, lost international credibility and domestic. The Economy Minister was quoted as saying they had not been consulted or informed in advance. The gold bugs of the new right SVP were happy, though.
http://www.bloomberg.com/news/2015-01-15/snb-s-cap-exit-a-challenge-for-exporters-swiss-government-says.html
18. January 2015 at 06:38
James, Thanks for that info. BTW, by my math the SF is up more than 20%. So why does the press keep saying 15%?
18. January 2015 at 07:17
“James, Thanks for that info. BTW, by my math the SF is up more than 20%. So why does the press keep saying 15%?”
The Euro was down 17.5% (1.2-.99)/1.2 and the CF was up 21.2% (.833-1.01)/.833
Since I was a little kid I always loved how the percentage up/down, separating two numbers, are not the same.
22. January 2015 at 16:53
The big thing to remember is that the SNB is not nationally owned… that is it is more of a business than other central banks.
45 % of the bank is owned by private shareholders, and the rest is held by the Swiss cantons, which largely operate separate of each other. Although many countries can have a national bank which can hypothetically operate purely for economic goals of the nation, the national bank has a responsibility to the shareholders to operate without incurring high enough losses to lead to a referendum and vote on its operation.