Defending the Franc Is a Loser's Game
07/26/2010 12:05 pm EST
Axel Merk of Merk Investments says the Swiss National Bank’s efforts to defend the Swiss franc against “speculators” is futile.
Efforts are under way to undermine Switzerland’s rock-solid reputation as a safe haven.
The Alpine nation is under attack from one of their own, the guardian of the Swiss franc: the Swiss National Bank (SNB).
The euro and the Swiss franc are traditionally two highly correlated currencies; however, there are rational reasons why each currency has periods of strengths and weakness. SNB chairman Philipp Hildebrand does not appear to see it that way; he was on a mission against “speculators” that gauged the Swiss franc to be a safer place than the euro. As his influence rose in early 2009, Switzerland began to intervene in the currency markets, apparently with the aim of pegging the Swiss franc to the euro.
As the Greek crisis intensified, it became ever more difficult for the SNB to achieve its goals. It appears to us that investors scared of any fallout from Greece were treated as enemy combatants for seeking refuge in the Swiss franc.
There’s a perception at the SNB that a strong Swiss franc versus the euro hurts Swiss exports—the SNB prefers to use the more dramatic and over-used term “deflation.” On the margin, that may well be true, but Swiss banks depend on the trust in the Swiss franc.
If the SNB were to succeed in actually weakening the Swiss franc in a meaningful way, the confidence loss in the banking industry may easily exceed the short-term benefit of boosting exports.
[Also,] as a result of buying euros, well, the Swiss National Bank’s balance sheet now holds significantly more euro than Swiss francs. The SNB may be running out of ammunition as it has a dwindling supply of Swiss francs.
Theoretically, that should not stop a central bank: indeed, the SNB can create Swiss francs out of thin air (a mere keyboard entry into its accounts) to buy euros. However, politically, it will be an uphill battle for the SNB to claim it is pursuing its Swiss mandate should [it] almost exclusively hold euros.
In our assessment, the biggest problem with central bank currency intervention is not whether it is effective or not, but that investors start focusing on possible intervention rather than underlying fundamentals. While this may not be the last fight the SNB puts up, it appears the markets have little confidence the SNB can implement its threats.
We would rather have the SNB focus on sound monetary policy than on a cat-and-mouse game with speculators [it is] bound to lose. As policy makers are throwing around billions, if not trillions, of dollars in desperate attempts to enforce their objectives, rational capital allocation suffers, planting seeds for new distortions and bubbles.