Even the winners from the crisis are starting to suffer.
The Swiss National Bank has set out to halt the franc's relentless appreciation by pledging to buy unlimited amounts of foreign currency. After seeing the euro move close to one Swiss franc in August from 1.25 franc at the start of the year, the SNB has drawn a line in the sand at 1.20 franc. The euro zoomed 8.8% higher against the franc Tuesday, and the 1.20-franc level held. But this is a big gamble.
The Swiss central bank has been here before. At times of market stress, the franc becomes a magnet for safe-haven flows. But the appreciation of the currency threatens to hurt the economy. The SNB already intervened in 2009 and 2010, but in a limited way and when the euro was far stronger. That just piled up losses for the SNB as risk-averse investors flocked to the franc. Encouragingly, the SNB did succeed in the late 1970s in putting a floor under the Deutsche mark-franc rate, albeit at the cost of surging inflation. But this was at least partly because global stagflationary forces started to recede.
This time the SNB is up against the euro-zone crisis, which shows few signs of receding. True, the latest effort is credible. The level of 1.20 franc looks defendable as it still overvalues the currency; fair value based on purchasing-power parity is above 1.30 franc, UBS says. With inflation falling to just 0.2% annually in August, the SNB realistically can follow through on its promise to open the purse strings. But euro-zone strains are intensifying and investors still may flood into the franc, testing the SNB's resolve, particularly because it is acting alone.
There is no support from Europe to drive the euro higher. The SNB essentially is choosing to risk its balance sheet rather than risk mounting unemployment, deflation and economic damage.
This will cause distortions elsewhere. Domestically, while consumer-price inflation may remain low, there is the risk of asset-price bubbles. Housing is a particular source of risk given Swiss interest rates are at zero. The SNB also will need to invest its burgeoning foreign-exchange reserves. Simply buying German bunds potentially will exacerbate the euro-zone crisis by causing yield spreads on Italian and Spanish bonds to widen. Internationally, the reaction was swift: The search for safe havens drove the Norwegian krone higher against the euro, and gold vaulted above $1,900. The Swiss action may encourage other countries facing similar pressures, Japan foremost among them, to take similar actions.
Increasingly, countries are going it alone in their policy choices. Global policy makers must ensure that Switzerland's move doesn't end up being an opening salvo in currency wars that raise the specter of capital controls and, ultimately, protectionism. But that challenge is looking harder by the day.
Source: http://online.wsj.com
The Swiss National Bank has set out to halt the franc's relentless appreciation by pledging to buy unlimited amounts of foreign currency. After seeing the euro move close to one Swiss franc in August from 1.25 franc at the start of the year, the SNB has drawn a line in the sand at 1.20 franc. The euro zoomed 8.8% higher against the franc Tuesday, and the 1.20-franc level held. But this is a big gamble.
The Swiss central bank has been here before. At times of market stress, the franc becomes a magnet for safe-haven flows. But the appreciation of the currency threatens to hurt the economy. The SNB already intervened in 2009 and 2010, but in a limited way and when the euro was far stronger. That just piled up losses for the SNB as risk-averse investors flocked to the franc. Encouragingly, the SNB did succeed in the late 1970s in putting a floor under the Deutsche mark-franc rate, albeit at the cost of surging inflation. But this was at least partly because global stagflationary forces started to recede.
This time the SNB is up against the euro-zone crisis, which shows few signs of receding. True, the latest effort is credible. The level of 1.20 franc looks defendable as it still overvalues the currency; fair value based on purchasing-power parity is above 1.30 franc, UBS says. With inflation falling to just 0.2% annually in August, the SNB realistically can follow through on its promise to open the purse strings. But euro-zone strains are intensifying and investors still may flood into the franc, testing the SNB's resolve, particularly because it is acting alone.
There is no support from Europe to drive the euro higher. The SNB essentially is choosing to risk its balance sheet rather than risk mounting unemployment, deflation and economic damage.
This will cause distortions elsewhere. Domestically, while consumer-price inflation may remain low, there is the risk of asset-price bubbles. Housing is a particular source of risk given Swiss interest rates are at zero. The SNB also will need to invest its burgeoning foreign-exchange reserves. Simply buying German bunds potentially will exacerbate the euro-zone crisis by causing yield spreads on Italian and Spanish bonds to widen. Internationally, the reaction was swift: The search for safe havens drove the Norwegian krone higher against the euro, and gold vaulted above $1,900. The Swiss action may encourage other countries facing similar pressures, Japan foremost among them, to take similar actions.
Increasingly, countries are going it alone in their policy choices. Global policy makers must ensure that Switzerland's move doesn't end up being an opening salvo in currency wars that raise the specter of capital controls and, ultimately, protectionism. But that challenge is looking harder by the day.
Source: http://online.wsj.com
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