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Last updated: September 6, 2011 10:31 pm
The Swiss National Bank is testing the paradox of stability. The central bank has promised to keep a single number constant – a minimum euro exchange rate of SFr1.20. To do so, it has invoked one of the most dangerous words in the monetary policy lexicon – “unlimited”. The potentially infinite supply of newly created money has destabilising implications.
The SNB’s goal is worthy: protect Swiss exporters, which have suffered a 30 per cent real revaluation of their currency since the beginning of 2010. That follows a decade during which the franc’s only significant move against the euro was an 8 per cent fall over more than a year. Exporters will find the new target modest. The pre-excitement level of 2006, adjusted for slower Swiss inflation, is SFr1.43.
Still, the SNB’s move was enough to cause one sort of instability right away. The franc dropped 8 per cent against the euro in 15 minutes. Currency traders could not recall anything like it. Exchange rate calm should now return, though, if the SNB keeps its word.
However, the intervention is potentially destabilising to domestic prices, if the SNB has to use an uncomfortably large quantity of francs to defend the SFr1.20 target and too much of the new money floods the domestic economy. The risk is substantial, since the Swiss franc is still attractive. Switzerland does not suffer from the eurozone’s political problems or face the US’s trade and fiscal challenges. Besides, the SNB will end up holding substantial quantities of euros and perhaps dollars. Those have to be invested somewhere, distorting markets far from Bern. But the psychological effect of the unlimited Swiss effort could be more significant than the monetary.
While Switzerland accounts for only 0.8 per cent of the world’s gross domestic product, the SNB is a globally respected institution. It has now provided intellectual cover for self-interested policies elsewhere. And few things would make the global economy less stable than a currency war of all against all.
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