Apparently You Can't Just Surrender In a Currency War
Two weeks ago Switzerland abruptly decided that it couldn't keep buying billions of euros every month just to maintain a somewhat arbitrary peg with that currency. It stopped trying, allowed the Swiss franc to trade according to market forces, and watched it soar.
At the time there was some question about whether an export-centric economy like Switzerland could handle a soaring currency's impact on its major industries. In other words, is it even possible to surrender in a currency war?
This week we got an answer. At least for Switzerland, it is not possible. From Bloomberg:
Two weeks after Switzerland stunned currency traders by abandoning the franc's peg to the euro, it seems that the central bank is quietly getting back in the market. With central banks from Denmark to Singapore to Canada easing monetary policy in recent weeks, the Swiss authorities face an even bigger battle trying to restrain their strengthening currency.
The Schweiz am Sonntag newspaper said during the weekend that the Swiss National Bank is now targeting a corridor rate for the franc of 1.05 to 1.10 per euro, compared with the 1.20 level it abandoned Jan. 15. The bank is declining to comment; but if it is trying to keep the franc from becoming stronger than that level against the euro, it seems to be struggling to drive the currency into the desired range:
The aftershocks of the peg abandonment, which triggered squeals of horror from Swiss exporters, are still rumbling through the nation's economy. Figures released yesterday showed that a benchmark index of manufacturing activity slumped to 48.2 in January, down from 53.6 a month earlier and undershooting economists' expectations for a 50.6 reading. A number below 50 signals contraction, and every component from order pipelines to stocks of goods to employment declined. The manufacturing survey was taken just after the currency defense was abandoned, according to Martina von Terzi, an economist at Unicredit in Munich. She expects the Swiss economy to grow by just 0.1 percent this year, with quarter-on-quarter contractions of 0.7 percent in the first three months and 0.3 percent in the second. So it's clear why Switzerland doesn't want an appreciating currency to trash its economy.
Having retired once with a bloody nose, however, it isn't clear why the Swiss central bank thinks it can rejoin the fray without taking another beating. Maybe it hopes that the currency traders who lost millions of dollars when the peg was dropped won't dare to speculate again on the franc. Maybe it considers 1.05 francs per euro defensible in a way that the old peg of 1.20 wasn't. Maybe it anticipates less pressure now that the European Central Bank has finally conceded to the need for quantitative easing.
Bloomberg nails the two main points here. First, allowing one's currency to soar is the same thing as importing the rest of the world's deflation. As a consequence, your exports plunge, manufacturing slows, the economy dips into recession and leaders get tossed out in the next election.
Second, keeping a currency weak enough to be "stable" in an aggressively devaluing world depends, in part, on the markets believing that you'll follow through. Everyone is pretty certain that the eurozone and Japan, for instance, are going to flood the world with their currencies in 2015, regardless of the consequences. But the Swiss, having burned foreign exchange traders big-time just two weeks ago, have a lot less inflationary credibility. So now, as they try to maintain their new peg (calling it a "corridor" doesn't change the reality of the policy), foreign exchange traders are happily buying up all the new francs that the Swiss National Bank creates, assuming the same pressures that caused the last surrender will cause the next one. They're probably right, making the franc a really good bet for another 20% pop in the year ahead.
So now the question becomes, once you've tried to surrender in a currency war, is it possible to rejoin the fray? We'll see. Either way, the Swiss are earning their own chapter in future economics textbooks.