Archive for January 18th, 2015

The Connection Between The Swiss Franc And The Bolívar

January 18, 2015


Last week, the Swiss National Bank (SNB) a truly independent Central Bank, made the surprising decision to stop the “peg” it had with the euro at 1.2 euros per Swiss Franc. Essentially, in 2011, the Swiss Franc was appreciating very fast with respect to other currencies, which makes Swiss industry less competitive, and the SNB decided to establish a form of exchange control. In some sense, Switzerland “joined” the European Monetary Union by agreeing to have its currency pegged to the euro.

Except that it did not work very well. As everyone expects some form of quantitative easing in the weeks ahead and some European may leave the Monetary Union, the Euro has been getting weaker against most currencies and in order to keep the peg, the SNB has been buying more and more euros, as nervous Europeans sought the safety of the Swiss Franc, as well as took advantage of the cheap interest rates for borrowing Swiss Francs. The topic also became a political issue, as a referendum was proposed (and defeated) by which the SNB would have had to increase the percentage of reserves it held in gold to 20%, as a way of protecting the value of the Swiss currency.

Additionally, the Swiss economy was healthier than the European ones, growing faster and attracting even more money to Switzerland. There was little room to use interest rates to influence this, as interest rates were already negative (and are more negative now). Thus, the peg was removed and this rattled a lot of things, as the Swiss Franc exchange rate went from 1.2 to the euro to one to one with the Euro overnight, as the Swiss Franc revalued 16.7% with respect to the Euro…in minutes.

First, it rattled speculators that were betting that the Swiss Franc would remain at the peg. It also rattled those that had borrowed in Swiss Francs and now owe more money due to its revaluation. And it rattled Swiss banks, many of which have property and investments outside of Switzerland, all of which will now have to register these properties and investments at the lower rate of exchange. But more importantly, it rattled Swiss industry, which will now find it harder to export (its main market) as well as seeing tourism diminished as it will be much more expensive for tourists to go to Switzerland.

And what is the connection between this and the Bolívar?

Simple, what the Swiss did was impose an artificial control on its foreign exchange markets in order to stop the revaluation of its currency, because it was bad for its industry. Except that the policy failed and the distortions became worse and worse as time went by. But rather than be afraid by not solving the problem and removing the control, the Swiss decided to swallow the bitter pill and let the currency float again. There will be pain now, but it will be eased in time. It would have been worse to keep the artificial policy on and wait a few years. This would have actually been bad for the Swiss Franc as it would have had even more euros in its balance sheet, some of which it would have had to invest in a currency that would be weaker and even in bonds that would change in currency in the future.

It is the reverse problem Venezuela has: It imposed controls to stop the currency from devaluing, but the effects are the same, distortions and future problems when and if the controls are removed. The point and the connection is that these type of controls have never worked and even the Swiss Central Bank made the mistake of imposing them with known consequences.

Some day the controls will be lifted in Venezuela and everything will be rattled for years to come. It used to be that a devaluation like that which will be necessary would benefit local production. Unfortunately, the destruction of local producers and manufacturers will make it difficult to have an impact right away. Years of distortions will take years of rebuilding, proving once again that such controls don’t work anywhere even in the short term. They did not work in Switzerland and do not work here.

And as a famous Venezuelan politician said (Gonzalo Barrios?): No somos suizos (We are not Swiss) implying we don’t do most things well. But in this case, both Central Banks erred, the Swiss were just capable of correcting their mistake.