Rhett … if you go, where shall I go, what shall I do?
Frankly, my dear, I don’t give a damn.
Gone with the Wind
So at long last the world’s reputedly most stable central bank, the Swiss National Bank, blinked yesterday by agreeing to stop supporting the de-facto peg of the Swiss Franc to the Euro. Immediately the Swiss Franc rose sharply against the Euro and the US Dollar, even though these currencies recovered ground later in the day (on January 15 when all this happened), with a 15% move for the day. Correct – that’s a one day move so it doesn’t bear thinking how many people out there got wiped out by this bout of volatility.
How did this state of affairs come to be? Well technically, it wasn’t a peg but a price target that the venerable central bank had promised to defend its currency against. In other words, the Swiss Franc wasn’t allowed to strengthen beyond 1.2 against the Euro; this had the effect of making the small Alpine nation a little lake of stability amidst the turbulent ocean that was the blustering, blundering economic bloc around it – the EU.
As with all currency market interventions, this one was ostensibly aimed at restoring a semblance of stability to the Swiss industrial complex (makers of fine watches, superb machine tools, expensive pharmaceuticals and delicious chocolates even if their cheese doesn’t taste as good as its reputation suggests) as the European sovereign crisis got more severe over time. You see, people fleeing the sovereign debt volatility in Europe had hit upon the idea of staying inside Europe by buying Swiss government bonds or failing that, put money denominated in Swiss Francs in a little bank somewhere in the country.
That rapid rise of the Swiss Franc against the Euro made a lot of these companies lose their competitive edge against the folks sitting in Germany (for watches and machine tools), France (for chocolates and cheese) and everywhere (for pharmaceuticals). Only the bankers were happy, and post 2008, the Swiss didn’t want that either. Thus, in a pure Keynesian response, the central bank decided to peg its currency the Swiss Franc to the Euro, in effect by not allowing it to cross the 1.20 mark as of September 2011.
What did this entail? Very easy really – someone wants to sell a few billion Euro to buy Swiss Franc, as a central bank you take the other side of the trade, i.e. sell the Swiss Franc and buy all the Euros they want to sell you. What do you then do with the Euros you have bought: well, you go and buy some Euro-denominated government bonds.
Yes, you aren’t reading this wrong – the very bonds that had caused the crisis in Europe which led to capital flight, would now be purchased by the SNB to protect the value of the Swiss Franc so that its citizens could export more stuff, make money that they saved in their little banks : and that would then be used to purchase toxic European sovereign bonds. Even the world’s best comedy writers couldn’t have thought up a situation comedy like that one; but trust me this is what the central bankers of the world (fondly now referred to as “bonkers” for their mental state) concocted.
What made them stop? Well, the size of the balance sheet for one thing. The SNB had by the end of November 2014, grossed nearly Swiss Franc 500bn of foreign exchange reserves (a nice euphemism for other’s people’s toxic debt that will never be repaid from cash generation in our lifetimes, but that’s a bedtime story for another day) from around Swiss Franc 260bn at the end of 2011 when the intervention began.
In terms of timing, this move to stop defending the peg came one week before the European Central Bank (ECB) meeting, where bank president Mario Draghi is widely expected to announce the beginning of open market operations to purchase European sovereign bonds directly. That would have flooded the market with more Euros, which then would have pushed up against the Swiss Franc and made defending the 1.20 level that much more difficult – or at least caused an exponential increase in the Swiss central bank’s balance sheet for the next few months.
There are two broad issues that arise from this story; perhaps as lessons for future generations of “bonkers” but at least as useful lessons for the rest of us:
1. The market is always right;
2. Poachers shouldn’t be gamekeepers.
These are examined below.
Value destruction without punishment
Central bank interventions are doomed to fail in the long run because they go against the grain of the free market. If instead of allowing market participants to find the right levels for various assets, one assumes that authority figures in governments and central banks can somehow stick their divining rods into the ground and figure out the future, well the SNB experience should count as a rude shock over time.
It is however not just the SNB experience that bears watching. Look elsewhere as well:
a. Despite hundreds of billions in quantitative easing from the US Federal Reserve, core investments in the US economy have remained low; limiting wage growth as new jobs have been largely in menial jobs;
b. The Bank of Japan’s QE policies, as part of the government’s “three arrows” strategy, have failed to reverse the recession in Japan;
c. The less said about the ECB’s policy efficacy, better: macro numbers have done nothing but crater downwards for the past 3 years;
d. The Chinese banking system faces the effect of hundreds of billions in dud loans made to infrastructure companies.
All this adds up to a spectacular misallocation of capital globally by government employees (well, those working for the central banks anyway). If you worked at an investment firm and made mistakes like that, you job would be gone pretty quickly. However, the patina of “public service” and the old fib about “following orders” allows these epic value destroyers to continue their maniacal ways without any fear of being held accountable.
Do as I say, not as I do
The moral questions aren’t to be sneezed at either. All the policies highlighted above had one thing in common – they involved like most things in government and central bank policies these days, oodles of intervention into the free markets. But if you read the financial press, there is nary a report on the actual manipulators; search for the term and you are likely to encounter small fry like LIBOR fixers and foreign exchange traders.
You know, those “manipulators” sitting out there among the commercial banks, destroying livelihoods of common people. No wait, you have the wrong men (and a few women) – these people are simply trying to make a living out of making sense of the myriad central bank interventions around the world. From the quantitative easing policies of the US Federal Reserve, Bank of Japan and Bank of England to the “whatever it takes” approach of the European Central Bank, which is not to mention the outright currency manipulation practiced by the People’s Bank of China and other lesser central banks around the world; the free markets had become merely vectors of conflicting national and central bank interests over the past five years.
It’s a funny world when the biggest manipulators out there also get to be your regulators, and even funnier when they get to charge your traders making a couple of thousand dollars on some attempted currency manipulation with their drinking buddies in the bank across the street.
Well, it may not be funny for the people who get docked obviously, but for market observers like me, it provides unlimited entertainment.
Does anything change?
So the bigger question is whether central banks around the world learn any lessons from this episode of the SNB. The answer is likely to be that, but for a bit of clucking and disapproving noises, it will be business as usual amongst these folk. If you don’t believe me, just see what happens next week in Davos when the world’s rich and mighty descend to take about the future course of the world economy.
They will grandstand, they will make policy announcements, suggest prescriptions for fixing the world economy that will involve more intervention not less. It’s a small consolation though for free-market believers like me that these idiots will pay a good 20% more for their Davos jaunts. Pity that money they lose won’t be coming into my pocket though.
In any event, I don’t give a damn – and neither should you.