What you need to know about the Swiss franc
The Swiss franc has been the currency to park cash in during recessionary times and Euro debt crises. Due to this, the franc’s demand during these times surges much higher than other European currencies and forces its appreciation to, at times, 120 per cent its usual value. The Swiss population is not so thrilled with this fact. When other countries force the appreciation of the franc, the Swiss feel it in their exports, and the increased price of these goods for foreign buyers hurts the bottom line in a major way.
With this in mind, the Swiss National Bank (SNB) placed a ceiling on the strength the franc could tolerate, and for a while, this seemed to work. The SNB set to use the value to print fresh cash with which they could purchase mass quantities of foreign currency. However, there was no guarantee on return, which caused the SNB’s currency holdings to explode. Unlike U.S. government bonds, for example, which can be held until they mature and can virtually guarantee a payback, the Swiss were now in possession of giant piles of currencies that could fluctuate in value, potentially exposing the bank to much bigger losses.
The SNB’s currency bet is huge, with foreign currency holdings now making up 75 per cent of the Gross Domestic Product (GDP). As such, the SNB decided to abandon the ceiling on the franc, which caught the market completely by surprise and flung the value of the franc upwards. As the performance of the Swiss stock market suggests, however, the strong franc will hurt the economy just as much, and with Switzerland already in such little debt, it is likely that this will force them into even more deflation – again, not the best thing for an economy.
What does this all mean? In its simplest form, it’s all but a done deal that the European Central Bank (ECB) will start its own bond-buyback program and force prices down. The euro weakened sharply, and European government bond yields fell as expectations grew that the ECB would be buying government debt. On the whole, this is a very good thing, as the European economy is in terrible shape. Of course, on the other hand, there has been some collateral damage. For some, like UK foreign exchange brokerage Alpari, this was too much to handle, and exposed other banks in the Hungarian mortgage market to losses, as they deal mainly in francs. The scariest of all, however, is the SNB’s total abandon of the fight against deflation.
While a decline in prices might sound good, if the economy were a car, deflation of this sort is like driving with the parking brake on. The decline in prices makes debt tougher to pay back and discourages the kind of capital investment that economic growth relies on. This pushes consumers to defer purchases in the hopes that prices will be lower in the future. As such, it will take serious political efforts from governments and central banks to move against the tide.
The ECB finally shows signs of joining the fight, which is a good thing, but the SNB’s decision suggests that some governments are giving up and just letting the current carry them away.