Switzerland Drops Its Currency Peg

The Swiss National Bank stunned markets on Thursday with an abrupt decision to abandon its commitment since 2011 to hold the Swiss franc at 1.20 francs/euro, as a result of which the franc appreciated almost 20% within the space of a few minutes.

I have seen some commentators suggest that the Swiss were forced into such a move. Michael Casey wrote:

Ultimately, though, it was again the ECB that foiled the Swiss central bank’s policy. In hinting at a big new bond-buying, or quantitative easing, program, the ECB drove a new, large influx of euros into francs, so many that its Swiss counterpart could no longer keep buying them to maintain the CHF1.20 rate.

And from Bloomberg:

“Nobody, who’s active in the export industry, could expect that the exchange rate of 1.20 per euro would be guaranteed for ever,” economist William White, a former member of the Bank for International Settlements’ executive committee, told Switzerland’s Finanz und Wirtschaft. “The time has come to accept the inevitable.”

I find such claims puzzling. It is one thing to say that a central bank may lack the power to keep its currency value high. Given a finite amount of foreign currency (for example, dollars) that the central bank holds as reserves, it can only buy so much of its own currency with its own holdings of dollars before a speculative attack overwhelms the central bank’s arsenal.

But in this case we’re talking about a commitment from the central bank to keep its currency value low. The policy to implement that calls for buying as many euros as needed, paying for them with francs of which the Swiss can perfectly well create as many as they want all by themselves.

A central bank with the power to create new Swiss francs could hardly claim that it does not have enough francs to buy all the euros that are offered for sale. Here’s the game– you specify a number, and I see if I can make up a bigger number. I should be able to win that game.

If the market is saying the Swiss franc is oh so valuable, oh so desirable, and I have the power to create as many trillions of them as I choose, surely I can change the market’s mind if I try, buying up the entire world, if need be, with Swiss francs that I costlessly create.

Of course, what I could end up doing with such a peg is create inflation. And this is why Lars Svensson proposed a variant of the former Swiss strategy as part of a “foolproof way” to escape deflation and a liquidity trap.

But there appear to be no signs of inflation yet in Switzerland. So why did the Swiss think that the peg could no longer be maintained? I simply do not understand the claim that the central bank was forced to abandon the peg.

I conclude that instead the central bank just wanted to try something different. But I confess that it is a great mystery to me why they wanted to do that. This has to be a major hit to Swiss exports and tourism, leave the Swiss National Bank with little credibility and negative capital, and will likely cause significant financial disruptions in many places around the world.