The Power of Money

Early in 2015, global markets were roiled by a highly unusual occurrence. The Swiss National Bank (SNB) made a surprise announcement. Its country’s currency, the Swiss franc, would no longer be pegged to the euro.1 From one day to the next, the Swiss franc gained more than 20 percent in value against the euro and nearly 20 percent against the U.S. dollar. As The Economist explained:2

“Currencies don’t normally move that far on a daily basis – 2 to 3 percent is a big shift. The exception is when a country on a fixed exchange rate suffers devaluation; then a 20-30 percent fall is a possibility. But a 20-30 percent plus upward move is almost unprecedented. That, however, is what happened to the Swiss franc on January 15th as Switzerland’s central bank abandoned its policy (instituted back in 2011) of capping the currency at Sfr1.20 to the euro.”

The SNB’s policy shift jolted markets around the world. The BBC reported every stock on the Swiss exchange lost value, as many Swiss products – Valentine and Easter chocolates, luxury watches, pharmaceuticals, ski vacations – became about 20 percent more expensive overnight. Swiss railroads may have seen gains. They had to add extra trains for Swiss shoppers who rushed to France and Germany, eager to capitalize on the buying power of the newly strengthened Swiss franc. In fact, so many people lined up to buy at Swiss banks, to buy deeply discounted euros, that banks ran out of currency.3

The side effects in central and eastern Europe

The Swiss economy may not be the only one hurt by the change in Swiss monetary policy. The New York Times reported many ordinary Europeans hold mortgages and other types of loans denominated in Swiss francs rather than their countries’ domestic currencies. They opted for Swiss franc loans because the interest rates were much more attractive than those on loans denominated in Polish zlotys and other currencies.4
Homeowners, some of whom took out loans before the global financial crisis, have seen their payments rise significantly. The value of the Swiss franc has increased by more than 40 percent. Poland has $40 billion in Swiss franc denominated loans. That’s about 8 percent of its gross domestic product (GDP). Austria’s loans are estimated at $41 billion, which is about 10 percent of its GDP.4

Why did the SNB remove its peg?

A currency peg links the value of a country’s domestic currency to the value of currency in another country, often a trading partner. Having a currency peg can confer advantages to a country’s businesses. It lets them plan ahead, making purchases and sales without worrying that a dramatic swing in currency values could negatively affect profitability.5
Switzerland decided to peg its currency to the euro in 2011 when Swiss francs and U.S. government bonds were perceived to be safe havens for investors. As investors moved money into Switzerland, the value of its currency increased. That hurt the Swiss economy because 70 percent of the goods and services it produces are exported and higher prices made their exports less competitive. In order to improve its competitiveness in the euro region, Switzerland pegged the value of its domestic currency to the value of the euro.1
The trouble with currency pegs is they require the pegging country to follow the monetary-policy lead of the country to which its currency is pegged. In this case, Switzerland was going to have to follow the lead of the European Central Bank (ECB) which had indicated it would expand its quantitative easing (QE) program to fight deflation in the euro region. QE was likely to push the value of the euro lower and cause the Swiss to have to print even more francs to maintain the cap. Instead, Switzerland removed its peg.1

Where are they now?

In early February, Swiss businesses and non-Swiss loan holders may have found some relief. The value of the Swiss franc dropped against the dollar and the euro on news that the SNB was keeping the currency, unofficially, between 1.05 and 1.1 Swiss francs to the euro. Experts cited by MarketWatch.com said the Swiss franc is likely to depreciate further:6

“”We expect the central bank to announce that it will operate a dirty float of the franc, against a basket of currencies where the weights are not disclosed,” they said… A dirty float describes a managed float regime where a central bank occasionally intervenes to moderate substantial moves.”

The full measure of consequences for the Swiss economy has yet to be realized, but some analysts have reduced the country’s economic growth estimates for 2015 from up 1.8 percent to up 0.5 percent.1 This shift should remind us of how global markets and foreign policy, at times, affect the markets here in the United States and how the power of money can have a domino effect on our daily lives.]]>