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The Swiss National Bank did a very foolish thing last month. No, it was not foolish to stop pegging their currency to the euro. Fixed exchange rates are a bad idea. Central banks should target macro aggregates. Instead, the mistake was in letting the Swiss franc (SF) suddenly appreciate by 15% to 18% against the dollar and euro, at a time when Switzerland was experiencing mild deflation. There were two explanations offered, both completely bogus:

1. They feared the euro would depreciate sharply because of QE. Actually the EMH says it’s impossible to predict high frequency currency moves, or alternatively changes in real exchange rates, and hence the SNB was foolish to make that assumption.

2. They feared they’d have to buy lots of foreign assets to maintain the peg, leading to a larger balance sheet. But if it’s a small balance sheet you want then you don’t end the peg with a sharp revaluation, which just makes the SF even more attractive. You end it by devaluing your currency, to make it less attractive. They got things exactly backwards.

The good thing about the Swiss is that they are sensible people, and have mostly undone the damage of that foolish decision. The first thing they did is to start trying to depreciate the Swiss franc by buying foreign assets. Wait a minute, wasn’t that what they were (supposedly) trying to avoid doing by ending the peg? Yes, and it didn’t work. They were right back in the same mess as in mid-2011, before the peg.

The following graph shows that the SF has fallen from rough parity with the euro after the de-pegging, to about 1.08 SF to the euro today:

And this graph shows that the Swiss stock market, which crashed on the decision that some claimed was “inevitable” (hint, markets NEVER crash on news that is inevitable), has regained most of its losses.



Indeed the recovery is even a bit more impressive than the recent fall in the SF. Why is that?

Obviously it’s partly because global markets have rallied with the Greece agreement. But it also reflects the recent fall in the euro against the US dollar. When the Swiss first pegged to the euro in September 2011 it traded at about $1.35 to $1.40/euro. It was still in that range in the first half of 2014. Today the euro trades at $1.13/euro. That means the SF has actually depreciated against the dollar in recent years. In trade-weighted terms the SF is probably up slightly, but less than the euro/SF exchange rate might suggest, and indeed far less than even a month ago. Here is the value of the dollar in terms of SF.

Given that the Swiss economy was doing fine a year ago at a euro/SF exchange rate about 10% lower than today and a dollar/SF exchange rate about 5% higher, it’s not surprising that stocks have recovered much of their losses, although they remain modestly below the levels of right before the float.

When the Swiss made this foolish decision I suggested that a revaluation of something like 5% might be defensible, but not the 15% to 18% revaluation that actually occurred. I’m pleased that the Swiss National Bank has seen the light, and that Switzerland has preserved its reputation as one of the best-run economies in the world.

Now they just need to nudge the SF a bit lower, and they’ll be fine.

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This entry was posted on February 23rd, 2015 and is filed under Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



