Currency Peg

Switzerland is the place that has traditionally stood above all the rest in its reputation for financial stability. Why? Because the currency was well-managed, the banking system was sound, and the country had a long tradition of treating capital well. Over the last few years, however, these advantages have collapsed. Just a small handful of countries inspire confidence in the marketplace. And the most popular seems to be Australia. Now, there’s really no such thing as a “good” fiat currency. But given such fundamentals, it’s easy to see why Australia is replacing Switzerland as a global safe haven.

The Treasury Department planted a "dirty bomb" at the Bank of Japan, and tossed a grenade at the Swiss National Bank.

Bitcoin has been all the rage lately. The stuff, or lack thereof, runs on peer-to-peer technology, is fully decentralized, has no patents, and is open source. Currently, there are almost 11 million bitcoin units in existence and the maximum amount of bitcoin units that will ever be created by the logic of its design are 21 million. While bitcoins are designed so that they cannot be hyperinflated in name, they certainly can be hyperinflated in substance. There is no doubt that bitcoin is a spontaneous answer to the monetary instability that we see all around us today. On one side of the pond people are worried about the glorified currency peg known as the Euro and on the other about the amount of damage that Bernanke is willing to inflict upon the world’s reserve currency. However, let us not become so enamored of an innovative stateless solution that we forget Austrian economics and hitch libertarianism’s wagon to something heading for a crash.

This week's events show that the Chinese government realises that its stimulus efforts have got out of hand and its economy is in trouble.

"Are the key governments and their leaders able to maintain confidence in this fragile system?" "Are 'they' going to do the 'right' things?"

• Dead Heat for Romney, Obama (WSJ)
• The Cheerful Billionaire Who Thinks Obama's a Socialist (Businessweek)
• "Get to work, Mr. Japanese Chairman": Japan Exports Tumble 10% as Maehara Presses BOJ to Ease (Bloomberg)
• Chinese Investors Fear Chill in Canada (WSJ)
• Rosneft Buys BP’s TNK-BP Stake for $26 Billion in Cash, Shares (Bloomberg)
• Hong Kong Defends Its Currency Peg for First Time Since 2009 (Bloomberg)
• Democrats threaten payroll tax cut consensus (FT)
• Spain's Rajoy gets mixed message in regional votes (Reuters)
• Merkel to warn UK on Europe budget veto (FT)
• Netanyahu says doesn't know of any U.S.-Iran talks (Reuters)... neither does Iran, so near certainty
• Der Kurrency Tsar: ECB’s Knot Backs Schaeuble Call for Stronger EU Budget Power (Bloomberg)
• Fannie Mae Limiting Loans Helps JPMorgan Mortgage Profits (Bloomberg)

"Prolonged economic weakness will persist - especially in the peripheral countries - with further periods of intense financial market stress" is how Citi's Willem Buiter's economics team sees the future in Europe. While they continue to believe that the probability of a Greece exit from the Euro is around 90% in the next 12-18 months; but more critically it is increasingly likely in the next six months - conceivably as soon as September/October depending on the TROIKA  report. There is a crucial series of meetings and events in coming weeks and while they believe that the ECB's conditional bond-buying (and ESM/EFSF) may help avoid a 'Lehman moment' around the GRExit, they believe that there will still be considerably capital flight out of periphery assets should it occur. The reason being simply that even if funding costs were reduced, the current mix of fiscal austerity and supply-side reform will not return any periphery country to a sustainable fiscal path in coming years.

The sole driver of risk in the past 3 years has been nothing but continued pumping of liquidity into markets by central banks: aka the Global Central Bank Put. How does this look visually? The below summary charts showing global balance sheet expansions should blow everyone's minds.

What's in the "Print" today? Not these issues.

Some time ago we said that in a world in which virtually every risk and liquidity benchmark is manipulated by either private banks (thank your Liebor) or central banks, if one needs to know the true state of events in Europe, the only real remaining, unmanipulated benchmark remain Swiss nominal bond yields. And at -23.5 bps for the 2 Year it is telling us that nothing is fixed. As usual. Also judging by the SNB's new head Jordan statements which just hit the tape, in which he says that he would not rule out capital controls or negative rates if the crisis worsens, the SNB gets it. Or does it? Jordan also said that the SNB is ready to defend the FX market with unlimited market purchases if necessary. However, as the note below from JPM shows, the SNB may simply be faking it, hoping it too can get away with simple jawboning, instead of actually putting its money where its mouth is. As it turns out the SNB has indeed been intervening in huge size in the month of May to keep the EURCHF peg. The previously undisclosed news is that it has also been sterilizing its purchases. As JPM further notes: "This is highly significant and undermines the credibility of the SNB’s claim that it is willing to do whatever it takes to hold EUR/CHF 1.20. For the floor to be credible the SNB needs to surrender control over the Swiss monetary based, i.e. it has to be willing to deliver both unlimited and unsterilised FX intervention. The intervention in May was certainly unlimited; it most definitely was not unsterilised." How long until the FX vigilantes decide to test just how far the SNB is truly willing to go in defending the peg? And what happens when Swiss nominal yields hit record negative numbers once again?

Nerves are frayed, tempers flare, the euro teeters

• How original: Syria prints new money as deficit grows (Reuters)- America is not Syria
• Former SNB head Hildebrand to become BlackRock vice chairman (FT)
• Osborne says Greece may have to quit euro (Reuters)
• Osborne Risks the Wrath of Merkel (FT)
• China second-quarter GDP growth may dip below 7 percent - government adviser (Reuters)
• Italian Borrowing Costs Surge at Auction of 1-Year Bills (Bloomberg)
• Greeks withdraw cash ahead of cliffhanger vote (Reuters)
• Merkel’s Choice Pits European Fate Against German Voter Interest (Bloomberg)
• Italy Tax Increases Backfire as Monti Tightens Belts (Bloomberg)
• Dimon says JPMorgan failed to rein in traders (Reuters)

All you can read.

..... The entire bond curve through the 5 year point is now negative (for the first time ever). At this rate, courtesy of the FX peg and the SNB's free put option, whereby EURs are converted into CHFs at a furious pace even as the facade of a collapsing Eurozone is itself crumbling, and the proceeds are use to buy Swiss bonds ever further into negative territory, we may soon have an entire bond curve trading at negative territory. Which, paradoxically, would lead to that Keynesian wet dream: the more debt Switzerland issues, the more money it would make courtesy of negative interest expense, literally, and the faster it would pay down its debt. Curiously, this may not be a bad offset to losses that the SNB is currently experiencing due to its currency peg. And some thought bizarro world was a sitcom construct.

Watch out for exchange controls in Switzerland this weekend.