How to Lose Friends and Make Enemies
Two headlines today from Switzerland tell an important story. The first is about the rapid increase of foreign reserves due to the currency “Peg” administered by the Swiss National Bank (SNB). The reserve rose by another CHF 41.4Bn ($43Bn) in July. This follows big increases in May (CHF 59.1Bn) and June (CHF 68.4Bn).
In an effort to protect the domestic Swiss economy from deflation, and all the other ills that are besetting the rest of the Europe, the SNB has purchased all of the Euros that have been coming into Switzerland the past three months.
Guess what? It’s working! With the benefit of unlimited printing of Swiss Francs and the "rigging" of the exchange rate, the Swiss economy is doing very well. This headline was also in the Swiss press this morning:
2.7% unemployed? That’s a remarkable result given the economic chaos that surrounds Switzerland. Its neighbors have much higher unemployment numbers:
France = 10.1%
Italy = 10.8%
Spain = 25%
Germany = 6.8%
I know that someone from Switzerland will say to me that that the low Swiss unemployment is a reflection of the efficiency of the Swiss manufactures and the hard working folks who work for those companies. I say “Rubbish”. Swiss unemployment would be substantially higher (and the economy much weaker) if there were not an artificial floor under the CHF.
I see the “Peg Policy” as economic warfare by the Swiss against its neighbors. The Swiss are winning this war for the time being, but they are suffering casualties in the process. To maintain the peg, the SNB must increase reserves of Euros. Reserves are now equal to 80% of GDP. Those reserves will rise to well above 100% of GDP before the end of the year.
Someone will put forth the argument that the SNB can continue this indefinitely. All they have to do is print more Francs to satisfy the demands of the market. That’s not correct.
At some point, the SNB will have to give this up. When they do, the Franc will appreciate to parity against the Euro. When that happens, the SNB will lose billions. I believe that the Swiss are already at substantial risk; to continue the peg puts the entire economy in jeopardy.
The next foot to fall on the Swiss will come from their neighbors who look across the border and see how “good” things are in Schweitz. At some point there will be a response. There has to be. Switzerland is beggaring their neighbors; they are doing it every single day.
The SNB invests its hoard of Euro reserves in short-term German government paper. They have avoided holding their reserves in debt instruments of Italy and Spain. This has influenced market rates in Germany; two-year yields have been at or below zero for months as a result of the Swiss. This has mucked up the European bond markets as it results in a huge spread between German and Spanish yields. The Swiss intervention is adding to the stress in Euro funding markets.
The SNB will be diversifying some of its holdings of Euros. They will sell the unwanted reserves for US dollars, Yen, Canadian/Aussie $’s. In the process, they will influence global exchange rates and there will be consequences to the countries that are on the receiving end. I wonder if the recent strength in the A$ is not the result of the SNB diversification effort. The strong A$ is not a reflection of high raw materials prices.
Draghi has told the world that he is prepared to do what it takes to stabilize the Euro Zone financial markets. Mario fully understands that the Swiss are working counter to his objectives. I would not be at all surprised if we start to see politicians, central bankers and Ministry of Finance types speak up against the Swiss in the coming months.
Switzerland has morphed into the new China. They are currency manipulators. Like the Chinese, they have gained a tremendous advantage as a result of their manipulation. That’s a very good way to make some enemies. The “riches” of the Swiss will be their undoing.
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