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Switzerland caused havoc on global markets on January 15 when the Swiss National Bank abruptly shifted its monetary policy to allow the Swiss franc to increase in value. The chaos drove several currency trading firms into bankruptcy and triggered billions in investment losses around the world. But what exactly happened, and why now?
Under pressure
The key thing to understand is that this was a dam breaking after years of built-up pressure.
Ever since the 2008 economic crisis decimated economies throughout Europe, investors have been stashing their money in Switzerland—which, we all know, is reputed worldwide for the strength and sobriety of its banking system. As money flowed in, the Swiss franc rose dramatically in value, from around 0.7 francs per euro to near parity in 2011. As a prolific exporter of pricey products such as watches and pharmaceuticals, Swiss companies were being harmed by their strong currency (Canadian manufacturers have the same complaint whenever the Canadian dollar rises against the U.S. dollar).
That’s why the Swiss National Bank announced in 2011 that it would cap the franc at 1.2 euros. How do you do that? By printing billions of francs and using them to buy foreign currencies. And that’s what the SNB did, successfully, for nearly three and a half years, pushing its foreign currency reserves to record highs.
Yesterday, with no warning, it pulled the plug. That sent the franc soaring about 30% (it later drifted downwards somewhat but it’s still much higher than the previous 1.2-euro cap). All those Swiss exporters? Their shares got beaten down, with the Swiss stock market declining about 9%. Shares in the watchmaker Swatch dropped 15%. “Today’s SNB action is a tsunami,” Swatch CEO Nick Hayek told reporters. “For the export industry and for tourism, and finally for the entire country.”
So why now?
The Swiss National Bank said in its statement that, essentially, it felt the worst of the danger was past and that the Swiss economy had had enough time to adjust to a strong franc. And while the franc was still uncomfortably high compared to the euro, the strengthened U.S. dollar was easing the pressure. All those Swiss exporters might have trouble selling their pricey goods to Germans and Italians, but they could happily sell to American and Chinese buyers. Finally, having billions of euros on its balance sheet may have become too much exposure to an already troubled currency that looks poised to drop further in value.
The intrigue here is that just days ago, the vice chairman of the Swiss National Bank said that the cap on the franc “must remain the cornerstone of our monetary policy.” Why the change of heart, and why so sudden?
The most widespread opinion is that the European Central Bank is going to announce a new round of bond-buying next week to try to stimulate the Eurozone economy, which will further depress the value of the euro and make the franc yet more attractive. The Swiss central bankers appear to have decided that they might not be able to hold back the tide as a new surge of investors poured their savings into the franc. Instead of trying—and possibly, even more disastrously, failing—to maintain the cap, they decided to remove it deliberately.
“It’s quite a rational decision,” says Karl Schamotta, Director of Foreign Exchange Research & Strategy at Cambridge Mercantile Group. “It’s more the tactical approach that left something to be desired.” The disarray in the foreign exchange markets in response to the Swiss move has exposed some previously hidden faultlines, says Schamotta. Currency traders work in “the deepest, most liquid market in the world. In this case, you saw trillions of dollars of liquidity boil off in a matter of minutes. No one expected that much liquidity to disappear that quickly. So that really is an unintended consequence here.” This incident may end up forcing many financial firms to re-examine their risk models and assumptions about global currency markets far beyond the franc.
