Evan Soltas
Jun 14, 2012

Swiss Watching

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Roughly two weeks ago, I wrote two posts on Switzerland which used their currency peg of 1.20 against the Euro to argue the power of credible monetary promises. (See here and here.)

I've written before that I have no problem admitting I'm wrong. This blog is a learning exercise for me. And while some of what I argued remains true, in other respects some of what I argued I no longer stand by.

The Swiss central bank's latest balance sheet has me going back to re-evaluate where I went right and where I went wrong. The big news was that, amid Europe's  "bank jog" (the slow version of a bank run) and correspondingly large capital flows, the SNB's holdings of foreign currencies expanded to 303 billion CHF in May from 238 billion in April.

I had implied in both posts that the floor was so credible that it did not require an active defense. Indeed, for several months after its establishment, the SNB did not have to conduct any trades. That is no longer true; I realize now that the correct conclusion to make was not that the Swiss currency floor would not require any currency purchases. Rather, the floor's credibility eliminates the need for foreign currency purchases to the extent that those seeking to buy Swiss francs are speculating on exchange rates. To the extent, however, that Swiss franc buyers are seeking to park money in Swiss assets or deposit accounts, the SNB will have to purchase foreign currency to maintain the floor.

As the integrity of the European financial system is ever more in doubt, more of the currency purchases will reflect non-speculative capital inflow.

Quotes from this Reuters article -- which, it's worth noting, discusses the probability that the floor won't be maintained -- reflects the fact that non-speculative capital inflows will indeed compel SNB forex purchases:

"Don't be surprised if the Swiss franc catches fire as a safe haven even with the 1.20 cap set by the SNB."
"But, investors still want to hold Swiss francs, even if they cannot expect gains," he said. "In relative terms, it is better to have a zero return than a negative return."
Nevertheless, the case for a currency floor -- or any species of monetary policy commitment -- is stronger than ever. Swiss real GDP growth for the first quarter of 2012 hit 2.8 percent annualized, rising from 1.2 percent in September when the floor was established. The SNB has also revised upwards its expectations for real growth. Amid a sea of double-digit unemployment rates across Europe, Swiss unemployment ticked up to 3.2 percent from 3.1 percent, seasonally adjusted.

I can't imagine what Switzerland's neighbors would trade for those stats. (Perhaps, and we'll see over the next few days, weeks, and months, their Eurozone membership.)