Swiss peg franc to the euro--that's one less safe haven in the financial markets and one more reason to favor gold

09/07/2011 5:41 pm EST


Jim Jubak

Founder and Editor,

And then there was one less—safe haven in the financial markets, that is.

Yesterday the Swiss National Bank moved to fight the damage done to the Swiss economy by a rising Swiss franc by pegging the currency to the euro at a ratio of 1.20 francs to the euro.

The franc tumbled 8.2% against the euro immediately and 8.8% against the dollar.

The Swiss National Bank has tried to intervene in the currency markets by selling francs in order to force the currency lower. That hasn’t worked and cost the bank about $23 billion in losses last year and $12 billion this year.

A peg to the euro won’t require the bank to flood the market with francs and thus won’t expose the bank to currency losses but it does impose other costs on the Swiss economy. The bank will simply print francs to keep the currency peg in force but that will result in a potentially huge inflationary surge in the money supply. To counter that, the bank will have to intervene to try to soak up some of those extra francs. This process, called sterilization, is never perfect and the peg will almost certainly increase the inflation rate in the country.

But that’s a price that the bank is willing to pay in order to avoid having Swiss exports priced out of world markets by the rising franc—or having Swiss companies move jobs overseas to cheaper currency countries.

The world’s financial system will pay a price too. Pegging one of the world’s strongest currencies to one of the world’s currently most troubled currencies will heighten fears that we’re headed to a competitive currency war where individual countries try to protect their domestic economies and their share of global trade through devaluations of their own currency. The fear is that this could set off a race to the bottom in currency markets with countries devaluing in a replay of the global trade wars that helped globalize the Great Depression. The Swiss move puts particular pressure on the Japanese and Brazilian governments, which have been fighting to damp the appreciation of their own currencies.

In the shorter term the peg removes one more safe haven from the world’s financial markets. If investors can’t count on the Swiss franc to hold its value, because it is linked to the euro, that means they have one less place to hide from the current financial turmoil. That leaves gold—which oddly fell yesterday on the Swiss announcement as computers programmed to believe that gold and the franc traded in tandem got the trade wrong—and a handful of strong currencies such as the Singapore dollar and the Norwegian krone. Unfortunately, none of those currency markets is especially large and their ability to absorb large cash flows without rapid appreciation is extremely limited.

And the Swiss move is likely to give many investors thinking about another safe haven currency pause: If the Swiss National Bank felt forced to devalue the franc to protect its domestic economy, what would make any other currency and central bank more trustworthy in the face of currency appreciation?

You can’t see it today when the risk on/risk off needle has swung to risk on—and gold has sold off as a result—but the effect of the Swiss peg is to increase gold’s allure as the only safe true haven.

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