The Swiss National Bank’s dismantling of its ceiling on the value of the Swiss franc yesterday stunned the financial world. Jim Armitage and Russell Lynch of the Independent called the ensuing jump up in the value of the Swiss franc an earthquake; Social media called it “Francogeddon;” while the CEO of Swatch, Nick Hayek, called it “a tsunami for the export industry and for tourism, and finally for the entire country.” Thomas Jordan, the head of the Swiss National Bank, explained, “If you decide to exit such a policy, you have to take the markets by surprise.”
At points during the day yesterday, the Swiss franc was as much as 39% more expensive relative to the euro and the US dollar than it had been the day before. Exchange rate movements have yet to settle down, but seem to be headed for something closer to a 15%-25% increase in the value of the Swiss franc.
In my Dec. 19, 2014 column “The Swiss are now at a negative interest rate due to the Russian ruble collapse” I made three predictions. On one, I was spectacularly wrong. On the second, I was exactly on target. As for the third, its time has not yet come, but will.
When I wrote “no one should underestimate the Swiss National Bank when it says that it will do whatever it takes to keep its exchange rate at 0.833 euros per Swiss franc” I badly underestimated the speed of events. On top of the continuing crisis of the Russian ruble, the financial markets’ belief that the ECB will soon begin serious quantitative easing to lower yields in the eurozone is now also steering investors toward Swiss assets. And buying Swiss assets requires buying Swiss francs. So there is a scramble to get hold of Swiss francs, even at a premium.
The Swiss National Bank decided it was a fool’s game to fight this: keeping the ceiling on the Swiss franc’s price longer would have meant the Swiss National Bank taking bigger losses. As it is, the Swiss National Bank lost on the order of 60 billion Swiss francs (equivalent to about $68 billion in US dollars) when yesterday’s exchange rate movements made its foreign asset holdings worth that much less in terms of Swiss francs.
But events have borne out my second prediction: that the Swiss National Bank would move toward deeper negative interest rates. The SNB’s new interest rate for banks keeping money in an account at the SNB is now down to -0.75 % per year. That is three-quarters of a percent below zero. By comparison, the European Central Bank is still at -0.2% per year, or only a fifth of a percent below zero.
My third prediction was that the Swiss National Bank is prepared, if needed, to push interest rates lower still—beyond the -0.75% they are at now. In a bit of hyperbole, Hans Guenther-Redeker said in a Bloomberg interview that if the Swiss National Bank pushed interest rates down to -2%, “You have to make a bank depositor to pay for the services of the bank—or for the luxury of having a deposit with the bank. That is going to turn capitalism upside down.” Swiss National Bank interest rates at -2% now look much more likely to happen. If the Swiss National Bank does lower interest rates to -2%, capitalism will adjust, and the Swiss economy will get stimulus it badly needs.
Besides lowering interest rates, the other main option the Swiss National Bank has to keep the Swiss economy from sputtering is to push the Swiss franc down relative to the US dollar, now that the SNB has given up pushing the Swiss franc down so hard relative to the euro. But it will have to buy huge amounts of dollar assets to have much of an effect on the Swiss franc/dollar exchange rate if it doesn’t use interest rate cuts to help make the Swiss franc cheaper relative to the US dollar.
I am betting that, going forward, interest rate policy will be the linchpin for the Swiss National Bank rather than exchange rate interventions. What the Swiss National Bank knows that many financial market observers have not yet figured out is this: other than an economy that starts to boom and risk overheating from lower interest rates, there is no limit to how far a central bank can cut interest rates, as long as it cuts the interest rate on paper currency along with other interest rates.
As I explained to an attentive audience at the Swiss National Bank on July 15, 2014, in a negative interest rate environment, all that is needed to bring the rate of return on paper currency down in line with the other interest rates a central bank controls is to introduce, and for a time gradually increase, the size of a paper currency deposit fee when private banks come to deposit paper currency at the cash window of the central bank. Then, once a robust economy leads to positive interest rates again, the paper currency deposit fee at the central bank’s cash window can be gradually reduced back to zero, until the next time that negative interest rates are needed to keep the economy on track. (You can find all the details here.)
Although lowering the paper currency interest rate in tandem with other interest rates avoids the massive paper currency storage that would otherwise be a serious side effect of deep negative rates, there is no question that negative interest rates will require many detailed adjustments in how banks and other financial firms conduct their business. Like it or not, Swiss banks and the rest of the Swiss financial industry may be forced to lead the way in figuring out these adjustments, just as the Swiss National Bank is leading the way in figuring out how to conduct negative interest rate policy. The Swiss are eminently qualified for that pioneering role. The rest of the world would be well-advised to watch closely.