The extraordinary surge in the Swiss franc overnight as Switzerland’s central bank abandoned its three-year-old peg against the euro is a dramatic illustration of the unintended and potentially unpleasant consequences of unconventional monetary policies.
The Swiss franc initially rocketed almost 40 per cent against the euro before settling at a still jaw-dropping one-day move of 18 per cent against the euro. That was after the Swiss National Bank announced it was abandoning the cap of 1.2 euros it had set in September 2011.
The original policy came at a time when the eurozone was in crisis and there were severe doubts about the solvency of a number of European governments and their banks.
From early 2010 until the SNB unveiled its response, the Swiss currency had appreciated a staggering 44 per cent against the euro as European investors and individuals fled the euro for their traditional safe haven. Not surprisingly, given the impact that was having on the competitiveness of Swiss industry, there was enormous pressure on the SNB to do something and it did.
Since 2011 the bank has been printing francs to buy euros. It has printed a lot of francs, with Switzerland’s foreign exchange reserves rising by about SFr240 billion since the policy started.
The Swiss, however, now find themselves on the cusp of being caught between divergent monetary policies of the eurozone and the US, a divergence that would almost inevitably see the SNB having to increase the scale of its sales of SFrs and purchases of euros exponentially.
The European Central Bank is about to launch its own version of quantitative easing -- perhaps as early as next week -- even as the US is expected to start normalising its monetary policies sometime this year, having ended its $US3.5 trillion program of bond and mortgage purchases last October.
The ECB program, which could see its balance sheet expand by about €1 trillion over time, will see it printing money in order to buy sovereign bonds and will drive the Euro down against the US dollar and other stronger currencies.
The SNB self-evidently believed that it couldn’t stand against the imminent tide of inflows into the SFr by trying to continue to keep a cap on the value of its currency relative to the euro and that it was a better and less costly strategy to pre-empt the ECB’s action with its own rather than be forced to do so later by the scale of inflows and at far greater cost.
The SNB did try to moderate the impact of the move by reducing its primary interest rate by 50 basis points to minus 0.75 per cent to try to deter safe haven inflows but whether that will have any impact on investors and companies fleeing the euro or rouble is questionable.
The SNB’s move blind-sided the markets -- and other central banks. The extent of the initial appreciation of 39 per cent against both the euro and the US dollar was an obvious signal that there were very substantial short positions out against the SFr (US investors alone held short positions of more than $US2.5 billion) and that there was a mad, panicked scramble to cover them. The waves that the SNB decision sent through international currency, equity and bond markets could be a preview of more volatility and unexpected policymaking to come.
The disciplined and conservative Swiss have, in effect, been innocent victims of, first the reckless behaviour of their eurozone neighbours, and now the latest desperate attempt to prevent the eurozone from sliding further into deflation and lengthy recession. Swiss exporters have had their competitiveness decimated in an instant.
We’ve had a taste of what that’s like, with the QE programs run by the US and Japan post-crisis keeping the Australian dollar up at levels that haven’t enabled the currency to reflect and ease the massive adjustments needed to rebalance activity after the bursting of the commodity price bubble.
With the eurozone about to initiate its own QE experiment the normalisation of global monetary policy and currency settings is still a long way off, despite the likelihood that the US will start raising interest rates from near-zero levels either mid-year or in the second half of the year.
The US Federal Reserve Board may be influenced by the extent to which the US dollar appreciates against the other major currencies, particularly the euro, and therefore it threatens to reduce the rate of recovery in the US economy.
There are some reservations about how effective a eurozone QE program might be in improving European competitiveness and in sparking modest levels of inflation.
Unlike the US, where companies -- including relatively small organisations -- are funded by markets, funding in the eurozone if primarily via bank channels and therefore the ECB doesn’t have the ability to inject liquidity directly into business in the way that the Fed has.
The ECB, and other central banks, are also going to be confronted by the tide of deflation occurring as a result of the collapse in the oil price in particular and commodities hard and soft in general.
The extent to which the Fed’s program has contributed to the gradual recovery in the US economy is unclear. Japan’s version of QE is struggling to generate any significant momentum in its economy. There is a continuing debate about the real effectiveness of the unconventional policies that have been trialled since the financial crisis.
What is beyond dispute, however, is that when the major economies implement unconventional policies on a grand scale they do have unexpected and potentially unpleasant consequences for third party investors and economies, as the Swiss have now discovered.
With the three major developed economies entering quite different phases of their post-crisis experiences, the potential for more shocks, stresses and volatility in markets and real economies is arguably rising more than six years after the crisis rather than receding.