Financial Markets Roiled as SNB Ends Three-Year-Old Cap Against Euro

By Victor Sperandeo with the Curmudgeon



Victor's Comments and Analysis:

Thomas Jordan has become the greatest bank robber in history!  With last Thursday's unexpected move to suddenly end the Swiss Franc cap on the Euro (at 1.20) and increase the NEGATIVE interest rate on bank deposits to -0.75%, the Swiss National Bank's (SNB) President surpassed Jesse and Frank James (1847/1843), Robert Leroy Parker, Harry Alonzo Longabaugh-AKA Butch Cassidy and the Sundance Kid (1866/1867), Willie Sutton (1901) and John Dillinger (1903). Mr. Jordan has worked for the Swiss central bank since 1997, climbing up the institution’s ranks to become its head in 2012.


Jordon's bank robbery was accomplished not with guns, but with misleading policy, i.e. deception. The surprise SNB moves caught global currency traders off guard, which resulted in big losses for investment banks and financial institutions. The Swiss stock market also suffered a huge (-9.6%) one-day decline.


“There was a big silence, and then someone said ‘boom,’” Ipek Ozkardeskaya, an analyst at Swissquote Bank SA in Gland, Switzerland, said of the atmosphere in her office when the announcement hit. “The reaction, it was panic.”


This story brings to mind the set-up of then Fed head Ben Bernanke saving Bear Stearns in March 2008, but letting Lehman Brothers fail in September of that same year. The SNB's move is in one respect worse because just three days before, Jean-Pierre Danthine SNB VP said the Swiss franc/Euro ceiling "must remain the pillar of our monetary policy."


See:  When Central Bankers Eat Their Words 


This echoed Thomas Jordan's Jan 5th statement that the cap is "absolutely central" for the Swiss economy. "Absolutely central” as a "pillar" of policy was thrown out and caused an intra-day appreciation of the Swiss Franc (SF) of 39% closing up 16%. This caused one firm - currency broker FXCM - to have a negative net equity of ($225 million dollars) by the end of the day as reported - so far!  Other currency brokers reported that many of their client account balances went negative.


Swatch CEO Nick Hayek said Thursday's decision to scrap the minimum exchange rate for the Euro will have disastrous consequences for Swiss business and for the country as a whole.


"Words fail me" and "Jordan" isn't only the name of the SNB President, but also a name of a famous biblical river.  Today's river Jordan is a tsunami for the Swiss export industry (buy as many Rolex watches as you can as the price is going up), for tourism, and the entire country. 


The biggest business of Switzerland is banking and bank stocks took a big hit after the SNB announcement. UBS stock fell (-11.7%) and virtually all big Swiss banks had more or less the same declines.  Many U.S. banks admitted to losses, e.g. Citibank said they lost more than $150 million dollars.


The "Duh" statement of the day naturally came from a (famous?) world government official - Christine Lagarde - head of the IMF - who said that she found it "a bit surprising" that the SNB had not warned HER of the move. Is she angry because she wanted to be tipped off so she could go long the Swiss Franc, before the announcement?) .


People like Lagarde, or the Socialist Central Planners of Europe all suffer from a classic misunderstanding of why Central Planning can NEVER work in the long run.  That has been demonstrated 100's of times over again in history.  Let's examine a very appropriate historical reference.


"The Use of Knowledge in Society" is a scholarly article written by economist Friedrich A. von Hayek, first published in the September 1945 issue of The American Economic Review. Written (along with The Meaning of Competition) as a rebuttal to fellow economist Oskar R. Lange and his endorsement of a planned economy,  it was included among the twelve essays in Hayek's 1948 compendium Individualism and Economic Order.


Hayek's article argues against the establishment of a Central Pricing Board (advocated by Mr. Lange) by highlighting the dynamic and organic nature of market price-fluctuations, and the benefits of this phenomenon.  A centrally planned market could never match the efficiency of the open market, Hayek maintains. The article also discusses the concepts of 'individual equilibrium' and of Hayek's notion of the divide between information which is useful and practicable versus that which is purely scientific or theoretical.    


This principle means that no individual no matter how brilliant he or she is can know more than a market (composed of all participants) on any subject.  That's especially true for interest rates and currency exchange rates, as they affect all the people.  Setting the "price" kills the market price guiding mechanism.  In truly free markets, investors should allocate capital to supply what participants demand, not what a politician/bureaucrat "wishes" to occur because of his or her agenda and/or payoffs to special interests.


To this end, the SNB tried or planned to artificially hold down the value of the Swiss Franc (SF) with its currency peg by buying Euro's on the foreign exchange market.  It thereby wound up with a bloated balance sheet of SF 495bn in foreign reserves (50% of which are Euro's).  That's about 80% of Swiss GDP and growing larger!


Jordan said the policy was no longer sustainable, because the SNB would have to continue buying Euro's at a rate of 2 billion a day - for the next several years.


In this foolish endeavor, the Swiss banks are now on the hook for loans in SF, but the currency has appreciated to the point that prices will have to rise proportionately for them to repay the loans.  It has an equivalent negative effect on any company or individual which took out a loan in SF's, but uses another currency (e.g. the Euro) for business or living purposes.  That will be difficult as deflation hits Switzerland and the ability to repay by many borrowers will be questionable.


Two events in Europe this coming week may have been the impetus for Thomas' policy reversal as they might cause the Euro to weaken even more (it's now at an 11-year low vs. the dollar).


1. The EU has gotten approval by the courts to do QE (buying European sovereign bonds), which ECB President Draghi has been hinting at for years.  That might cause the Euro to decline further (if the ECB's QE hasn't been completely discounted by the world currency markets).

2.  The Jan 25th election in Greece could give a majority to the Syriza Party, which has threatened to pull out of the European Union (EU) unless they write off half the debt of Greece.  If they win, that will likely cause the Euro to decline further.


To say that Mr. Thomas made a mistake is very polite and kind on my part ...the loss to Swiss taxpayers was estimated at SF 60-100 billion "to start." I believe the appropriate policy would be to have ended the Euro peg over time, rather than all at once.


As for business and economic consequences - James Shotter wrote in the Financial Times (on-line subscription required) that "Exporters warn of massive pressure on jobs and wages."


Moreover, the essence of a central banker's attitude in this regard is concisely stated by the 20th U.S. President James A Garfield:

"Whoever controls the volume of money (he meant currency) in any country is absolute master of all industry and commerce." 


To which I say: "Se non e' vero e' ben travato." 


It may not be (completely) true, but it is well founded.


Curmudgeon Comment:


It seems that central bank monetary policy all over the world is failing miserably.  We've written extensively how the Fed's QE has done little to stimulate the real economy, the ECB "talk the talk" hasn't been able to prevent most of Europe from sliding into recession and deflation, JCB's "QE on steroids" hasn't lifted Japan out of recession, and China's central bank liquidity measures have produced one bubble after another [Since Zhou Xiaochuan became People’s Bank of China governor in late 2002, China's broad money supply base has expanded almost seven times to 122.8 trillion yuan (=$20 trillion)]. 


The result of all the global central bank money creation and excess liquidity has been to greatly inflate financial assets (and in some cases real estate), while doing little or nothing to boost economic growth.


The Curmudgeon believes that there is way too much leverage in the financial markets which at some point (an unexpected event or chain reaction) could result in a gigantic global crash in many financial assets.  It's as if no lessons were learned from the 2008-2009 financial crisis.  While that's very troubling to some, most will continue to be oblivious and continue to dance while the music is playing.


Till next time...


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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