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The historically ‘neutral’ Switzerland, a safe haven for large capital, is now a victim of the worldwide currency war. While almost every central bank across the globe is trying to devalue its currency, the opposite happened to the Swiss franc (CHF) as the franc increased by 30% in value versus the euro, with an intraday jump of no less than 50%!
There is no longer a cap on the Swiss franc. Since the crisis of 2008-2011, the franc has been rising in value versus the euro, and the euro crisis of 2010-2011 created additional pressure for the franc. This was a smack in the face of the Swiss central bank, which decided to put a cap on the CHF on September 6th in 2011 after the Swiss franc had risen by 60% to 1.04 versus the euro and the negative impact of the much stronger currency became very tough on Swiss exporters. The franc would not move beyond 1.20 versus the euro.
If a central bank wants to devalue its currency, the strategy is quite simple: print money and use that money to buy foreign currency. This blew up the balance sheet of the SNB (Swiss National Bank) to no less than 85% of the GDP, without any inflationary pressure. The policy of the SNB created political pressure as well, since it was the opposition that pushed to organize a referendum to force the SNB to keep 20% of its balance sheet in gold. Although the motion was denied in November, the damage had been done, because the SNB was no longer able to defend its policy. It is expected, moreover, that the ECB will announce a program to purchase 550 billion euros worth of government debt this Thursday. No less than 93% of the economists surveyed by Bloomberg expect this to happen. This will most likely lead to enormous inflows for Switzerland as investors will look for safe havens, which would add hundreds of billions to the SNB’s balance sheet on top of everything.
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Source: WSJ, SNB
If the SNB would not have decoupled the CHF from the EUR, it would have become more dependent on the policy of the ECB and the bank must have seen an opportunity to get out right before the ECB’s QE program. You could ask yourself, by the way, whether there is not some big hedge fund hiding behind the SNB’s balance sheet. They practically bought everything: euros, euro investments, bonds , small caps, etc. You name it. This means that there is a lot of leverage in the system, and that it is intimately interwoven with the international banking system, which is what makes the SNB exceptionally vulnerable today.
The ‘collateral damage’ of the ECB’s decision was evident immediately. Not only were Swiss stocks that are dependent on export dumped, but Eastern European neighboring countries who held mortgages in CHF are licking their wounds as well; not to speak of bankrupted currency traders and hedge funds that were short on CHF.
The Swiss people will also not be very happy. Many economists believe that a central bank’s losses are not relevant and do not influence policy, as a consequence, but this would be hard to believe in the case of the SNB, however, since 45% of the bank is in the hands of private investors. Many of them are regular retail investors who receive dividends from the SNB, but the rest belongs to the Swiss cantons, which recently complained about insufficient cash transfers from the SNB. This shareholder structure is completely different from most other central banks, which are in fact government institutions, completely in the hands of the treasury and, consequently, tax payers. The workings of the SNB make it inherently scared of losses on the balance sheet, especially considering the fact that unhappy citizens can demand changes to monetary and reserve policies by way of a referendum. Needless to say, there are plenty of losses at the SNB today, rest assured.
It is also interesting to study the link between the SNB’s move and the price of gold. On exactly the same day that the Swiss National Bank coupled the CHF to the EUR to prevent massive inflows to the CHF, the gold price rose to an all-time high of 1,920 USD/ounce. Since then, gold has been going downhill, but that all changed recently and decoupling the CHF from the EUR caused the gold price to break out from its downtrend.
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Source: StockCharts
The gold price ‘feels’ that something is up, as it were. The Swiss central bank was the first one to jump into the currency war and it is also the war’s first victim. Three and a half years of built-up tension came to the surface in a single day, just like you can hold a ball under water for a very long time, but at a certain point…
People are losing faith in central banks. We believe that Switzerland could be the canary in the coal mine and that other currency wars are coming. Economic growth is on the weak side globally and betting on exchange rates is one of the last pieces of leverage one can use to stimulate growth. Asian countries like South Korea, Taiwan, and others, could take the lead here since these countries are suffering from the lower Japanese yen, although that is good news for their Japanese exporter counterparts. Large upcoming countries like Brazil, for example, will have to get creative with their exchange rates.
Ultimately, the intensity of the global currency war will largely depend on the US Federal Reserve. The Fed is most likely going to raise interest rates this year, while the ECB is going to do the opposite, which has made the USD much stronger in the face of the EUR. Until now the Fed has not made a move to contain the rise of the dollar, but the Fed might make a move in the coming period to slow down the dollar’s appreciation by postponing a first increase, which is expected this summer, by a few months. The increase of the dollar has put central banks in a difficult spot and forced them to review their position.
The conclusion is that investors should allocate a part of their portfolio to gold, now more than ever. Gold remains the ultimate currency and it functions as a canary in a coal mine; gold feels that something is up. When central banks across the world throw in the towel, confidence in currencies will be tainted to such a degree that investors will have to count on the only real insurance for a portfolio: gold. Gold is gaining strength and its momentum is building: inflows for publicly listed trackers (like GLD) are on the rise and the gold price itself is listed north of its 200-day moving average again. This gives us the feeling that gold’s recent recovery might be of the more sustainable kind than most people expect.
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