The Swiss Drama-What is really going on?

Tuesday, January 20, 2015

By Farrokh Langdana, Director, Executive MBA Program & Professor of Finance and Economics

Faculty Blog:

Swiss fears of Eurozone's mass monetization of its outstanding debt leads to break in Swiss franc peg to Euro

Swiss mapBy now the facts are clear to most market-watchers. Switzerland, one of a handful of “safe haven” countries, has been hammered every time there is a “flight to safety” (which means investors park their money in what are perceived as low-risk investments, in this case the Swiss currency). As the Swiss franc appreciated with global capital fleeing global crises and rushing into Switzerland, its exports got clobbered. And since Switzerland is an export-heavy country, this was a problem.

Hence the currency peg to the Euro. The Swiss National Bank (SNB) established an upper limit on the strength of their currency to limit damage to their exports. They pegged 1.2 Swiss francs to 1 euro, and have held that peg in place over the last 3 ½ years. This was done by daily purchases of euros and sales of Swiss francs by the SNB, to artificially keep their currency weak. The result was that the SNB began to amass an ever-increasing supply of euros, to keep the peg in place. Until one day (January 15, 2015) it decided it didn’t want any more euros.

So what happened? Typically pegs blow apart when the two countries, A and B, find themselves in opposite phases of their respective business cycles. Typically, country A starts slowing while country B overheats.

Country A wants lower interest rates to spur growth, while B wants to engineer a soft landing by raising its interest rates.  If A still wants to maintain its peg to B, then A will also have to raise its interest rates and mimic B’s monetary policy. But this will exacerbate A’s economic woes further. So A has no choice but to break its peg to B.

But this is not the situation now. While the Eurozone is struggling and is about to push its interest rates to zero by mammoth monetization of outstanding Eurozone debt—read, by massive printing of money—Switzerland is not overheating. The two economies are actually not on divergent paths.

So why did the Swiss break their peg to the Euro?

One explanation is that the Swiss see themselves buying more and more euros as that currency gets progressively weaker with the impending Quantitative Easing (vast monetization) planned by the European Central Bank. The SNB does not want to be stuck with a currency that may be a liability if, say, one or more countries (Greece, Italy) have to opt out of the Eurozone.

The Swiss are being prudent, as they usually are, and cutting their losses, “getting out while the getting is good.” And this could mean the writing is on the wall for the Euro, at least in its current form.


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