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.

38 Responses to “The Connection Between The Swiss Franc And The Bolívar”

  1. Vitor Says:

    Swiss finally woke up and stopped with this stupid race to the bottom. The idea of devaluing a currency will make people prosper is so absurdo. All those mainstrem economists with their fancy equations and little understanding of human action. Austrian School FTW.

  2. jsb Says:

    What DID happen to the three Iranian dairies?

  3. Roger Says:

    As long as Venezuela produces only oil at low prices and has to import almost everything else at world prices, its screwed. Domestic production that does not require much foreign imports can survive inflation but, with globalization, such products are few. You can bet that even the Cubans present their Facturas to Venezuela in USD! Just like the commissions, paid in USD but I bet calculated at the Bolivar inflation rate!

  4. ce h Says:

    Consequences for me ? Happy 2015..ceh

  5. PM Says:

    I have a doubt that may be slightly OT:

    It’s been said many times that if the government of Vzla decides to lift currency controls, the BCV will quickly run out of foreign reserves. Why is this?

    • moctavio Says:

      Well, there are reserves and there are liquid reserves. Of the US$ 20 billion in reserves about US$ 18 billion plus (I haven’t checked the numbers recently) is in things like gold (US$ 15 billion) IMF drawing rights and the like.

      There are 2,002,068,323,000 bolivars.

      If all these Bs. want to leave and you only have 2 billion $ liquid, then you would have to sell them at Bs. 1,000 per $

      If you sold the gold and had about US$ 20 billion liquid you would have to sell it at Bs. 100.

      Get the problem?

      • PM Says:

        Sure, but my question is: Can’t the central bank simply not sell any of its dollars? will the exchange rate go to infty?

      • concerned Says:

        Does anyone know for sure if there is actually a gold reserve left, or where it may be? After that shell game they played a few years ago after the repatriation of the gold reserves, I wouldn’t be surprised if it wasn’t parked in cuba, or was used to pay off debt to the Chinese, Russians, etc.

      • But they could lift currency controls and avoid participation. This would take the exchange rate to 100 to 200 per dollar.

  6. Alex (el de California( Says:

    Miguel, ¿me permitirías traducir y publicar este excelente artículo en Noticiero Digital? Obviamente con el crédito y enlace correspondiente. Gracias!

  7. Island Canuck Says:

    I can’t get my head around the talk of devaluation & how it will help the country.
    Long before the fall of oil prices it has been obvious that government was without sufficient dollars to meet the demands of the country.

    Now with almost no income coming in how is changing the exchange rate of the Bolivar to 100, or 200 for that matter, going to help increase imports into the country when they have no dollars to sell at any price.

    I know the higher exchange rate will help them fiscally for local costs like salaries & pensions but it sure isn’t going to help with imports.

    • halfempty Says:

      AH, you see, it will be profitable to grow it, build it in country again. Are any small gardens popping up in odd spaces? A sure sign,

      • halfempty Says:

        Of course ther’s this gap between in-country production and imports which could last months. It will be a bad time.

        • Roy Says:

          Years, not “months”. But, restoring large-scale domestic production will also require capital. Investment requires stability and confidence in future stability. The current government cannot provide this.

    • Dr. Faustus Says:

      I am of THAT opinion as well. The Bolivar has no standing/credibility in the international banking community. A simple devaluation, again – my opinion, will not solve the overall problem. It’s just ONE STEP that is needed. In 1923 the Germans were printing money as fast as would go through the printing presses. In November of 1923 a new “currency czar” was appointed. His name was Hjalmar ‘Horace Greeley’ Schacht. His first step was to introduce a new currency, the Rentenmark, which was to be exchanged for the Reichsmark at one trillion Reichsmarks to one. Really. Now that’s a devaluation! But, …but, what he did to support it was just as important. He tied German assets and gold to the new Rentenmark to give it credibility among the other international bankers. Now, you still couldn’t exchange your Rentenmark for real gold, but it had a calming effect among the speculators. It did the trick. Inflation quickly decelerated and Schacht became a national hero. In my opinion Venezuela needs to do the same, (1) a new currency, (2) a respected economist as head of the national bank, and (3) the currency to be marginally backed by hard assets and gold. Having credibility is so very important here. Or, plan B. Ditch the Bolivar and make the US Dollar the primary currency. That would work too…

      • concerned Says:

        Please don’t spark the idea of a new currency that they would certainly want to call “the Chávez”, and be just as worthless.

        Pick an established currency. Any one that is exchanged, traded and received anywhere outside Venezuela, and adopt it as the national currency. It may be a far stretch to adopt the evil U.S. dollar, so go with the euro.

      • There is very little probability that Venezuela would opt for dollarization of the economy. In Ecuador, which was the last country to opt for such a tact, it was done before the advent of the current Correa regime. Has it worked in Ecuador? Yes (I was in Ecuador earlier this month) but only to a point. It did cure inflation but relative to Colombia and Peru I found Ecuador expensive.

  8. Ira Says:

    I’m too stupid to understand the financial stuff–my brain isn’t wired for it. So to go OT:

    Is there a possibility that Cuba will push or demand pegging to the Sucre for any new business dealings with the U.S.?

  9. Noel Says:

    With low oil prices offering no relief in sight, the magnitude of the adjustments to be made to prices, exchange rates, etc. is so huge (plus as you point out a hollowed private sector) that the government is probably paralyzed in fear: they prefer to let the situation rot away than trigger an explosion which would engulf them all.

  10. plob500 Says:

    Thank you for this clear and interesting analysis.

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