The Swiss Surprise

January 19, 2015

By: Kelly Diamond, Publisher

euro swiss francSo an interesting headline crossed my path the other day: “Swiss National Bank unexpectedly scrapped its three-year policy of capping the Swiss franc against the euro.”

The move shocked many in the EU, especially many Swiss exporters. The Swiss Frac soared, while business stocks were sent in the other direction. Indeed, when the Swiss Franc becomes so expensive to the rest of the world, exports will be the first one to take a hit when caps are removed.

The franc appreciated as much as 41 percent to 85.17 centimes per euro, the strongest level on record, according to data compiled by Bloomberg.

Switzerland’s benchmark SMI index declined 9 percent, with Swatch dropping 16 percent and Holcim Ltd., the world’s biggest cement maker, plunging 10 percent.”

It was a surprise move that many did not expect, and only few saw coming. Switzerland had a 1.20 Franc to Euro cap for the past couple years, and recently abandoned it due to the deflation they are experiencing and the very real prospect of an EU style quantitative easing.

I say “EU Style” because there are some clear laws which restrict the expansion of their balance sheets. Whereas the US style of quantitative easing is done on a political whim, the EU has Germany to contend with.

Not to say that there is NO buying of sovereign debts or bonds in the EU, because clearly there is. But buying sovereign debt to bail out a member is one of the perks of being a piss poor country in a wealthy union. The ECB (European Central Bank) is also buying a considerable amount of asset backed securities, especially since October of last year.

But while you can buy private corporate bonds quite easily in the United States, such is not the case for private businesses in the EU. They typically get their funding from banks. The ECB is offering negative interest rates to encourage lending, but to no real avail.

Let’s get back to Germany for a moment, though. Why are they so skeptical of QE?

  • The creation of asset bubbles;
  • Risking inflation
  • Oh yes, and they reduce the incentives for governments to stop overspending and make their economies more competitive.

To the first point, that is absolutely a legitimate concern. Asset bubbles tend to distort the markets considerably. Quantitative easing is like slipping the economy a mickey, or sorts. It pumps money into assets and stocks, making otherwise worthless assets and stocks look more appealing, whereby incentivizing people to spend at a premium to acquire them. Two great examples of this are the US housing and education bubbles. People were paying outrageous rates for dilapidated homes. And people are now paying exorbitant rates for college degrees that are diminishing in value on the open market. Once the bubble bursts, is about the time the “drug” wears off… and many are upside down or stuck with worthless assets.

Naturally, there is some concern that monies from quantitative easing tend to be channeled to these bubbles rather than to growing businesses and households, which is true.

As to the second point, if the EU is watching the US – which I very much believe it is – then it knows all too well that QE can become much like pain killers: addictive and nearly impossible to give up. Germany knows about hyperinflation all too well. There was a time when it was more cost efficient to physically burn money than to burn the very logs that money could buy them. Germany seems rather committed to their position of “never again” especially when it comes to the economic policies that lead them to a rather dreadful era of their history. So much so, in fact, that a German court indicated that QE would be against the laws and recommended it be reviewed by the EU high court.

Now the third point is quite telling: reducing the incentive for governments to stop overspending. Over spending typically translates to high taxes. Taxes remove money from the economy, which does nothing to solve the matter of deflation. Cheapening their money through negative interest rates in hopes that more people borrow is one thing, but what would happen if, rather than printing money out of thin air, money that was already printed and in existence were released into the market?

This is what people were saying about Bitcoin when the Feds confiscated the account of Ross Ulbricht, the alleged mastermind behind the online black market. If the Feds accessed the account and released all that Bitcoin into the markets, the price of Bitcoin would drop.

So it would stand to reason that if all the funds confiscated through taxation were released – i.e. stop taxing – the value of the Franc would also go down.

This brings us back to the Swiss surprise! The Swiss are hedging that the EU will be successful in its attempts to pass some sort of quantitative easing regime, and know for a fact it will blow the top off the 1.20 to 1 Franc to Euro cap. The question is, will the EU feel even more compelled to meet this move with QE?

No doubt the Swiss knew what would happen, but were willing to take the hit upfront rather than after it was too late. What will become of this decision is yet to be seen. Europe isn’t seeing the same recovery the US has seen, but the US is only enviable on paper. While we can point to certain politically postured numbers, the composition of those numbers tell a different story. European businesses are timid to borrow or expand, despite the negative interest rates. Many Eastern and Central European loans are in Swiss Francs, and those folks are probably wondering how they are going to pay back their new found additional loan.

The smaller struggling economies in places like Poland and Hungary are going to struggle even more now that so discretionary funds will be directed toward servicing debts to the Swiss.

Keep an eye on the EU. Their economy and their currency is volatile and fragile to say the very least.

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