September 6, 2011 10:34 pm
By promising to sell Swiss francs at a fixed euro rate to any buyer and in any amount, the Swiss National Bank is playing its last card to prevent the incessant rise of the national currency. As a midsized open economy, it is the victim of events and policy choices beyond its control. Even if the Swiss move could trigger a currency war, the SNB had little option but to act, decisively and radically.
Monetary stimulus in the US and Europe has filled investors’ pockets with cash they fear to place anywhere but in haven currencies or gold. The resulting 20-25 per cent appreciation of the franc has squeezed exporters till the pips have finally squeaked.
For a while the SNB tried to keep the franc down without giving up control over domestic monetary policy. In a world of mobile finance, that is at best an ephemeral outcome. Like the Bank of Japan’s interventions, the SNB’s attempts to have it both ways over the past year proved unsuccessful. It also stored up political trouble when the central bank’s purchases of foreign currency led to paper losses as the franc kept rising.
The SNB has now come down from the fence by adopting an all-out exchange rate target. It will print unlimited money to enforce a ceiling (or a floor for the exchange rate) at 1.20 francs a euro. This is certainly achievable. While defending a currency under downward pressure depends on sufficient foreign exchange reserves, no such limit applies when the problem is appreciation.
Whether it is a good idea is a different matter. The money supply will now be determined by the appetites of global investors. Sterilising the inflows may just make the Swiss franc even more attractive, and capital controls are not something a country so dependent on finance will want to contemplate. If the peg persists, it will not be long before the Swiss feel the effects of monetary expansion in inflation, asset bubbles or both.
For the moment, these are problems the Swiss may prefer to live with. Deflation not inflation is the more urgent threat to Switzerland, unlike Latin American raw materials exporters also struggling with capital inflows. But rising inflation could eventually erode the export competitiveness the peg is meant to protect; and asset bubbles have never served any economy well.
The global implications are more worrying. Switzerland is too small to directly cause macroeconomic imbalances, unlike China. But its move could inspire other countries to follow suit and employ the ultimate option of capital controls.
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