Jan 23, 2015

The Economics of Swiss Franc's Float

A Swiss watch or vacation in Zurich is going to cost you much much more.. The more I read, more I feel like I should have taken a Swiss trip before the this float decision
Much has been written about this. For a good introductory read, you can check the Mint article . Most of the literature of this decision has focused on the macro underpinnings. While it is true that the macro factors forced SNB to take this decision, I think it is important to understand the micro-economic implications of currency pegging & its aftermath
Switzerland is a country known for its political stability. It stood insulated from even the world-wars. Such a place , coupled with its banking laws naturally has an appeal for black & white money from risk averse people across the world.
The currency pegging was introduced by SNB to protect the economy from the global financial crisis. For a country, preventing appreciation of currency is quite easy -- Just print more money. The effect of this can be quickly assessed by checking a few numbers in SNB Balance sheet
If you look at period from 2010 - 2014, the total balance sheet size has approximately doubled ( CHF 269 billion to 525 billion ). If you look at where this has gone into, you would notice that bulk of it is  foreign currency investments ( 204 to 475 billion ) .  This is not accompanied by a proportional increase in economic activity or growth irrespective of which indicator you use to assess it ( GDP growth / consumer price / inflation ) .  This is best illustrated another two numbers in the same PDF. Bank notes ( value ) in circulation over the same time period has increased only by about 6%, whereas the deposits in domestic banks have grown about 9 times .  So, where this money has gone into ?  The obvious answer in all such economies is Real Estate
In such a situation, currency pegging ( i.e, capping appreciation ) makes matters worse for the local population.  Since the local economy has not really picked up, an average coffee-shop owner / farmer still sees his inflows largely the same in value ( CHF terms ). And when he goes to buy a home , he's kicked out of market by investors ( or, rather, risk-averse people ) who bring in Euros ( where, economic activity is much higher than CHF ) & convert it at a fixed rate to CHF.
The impact of this is lack of availability of affordable housing .Though the intention of currency peg was to keep the industry competitive, encourage investment, it ends up sidelining the local population.   At a micro-level, this drives huge resentment . Given the fact that ECB was about to take a cue from US Fed, currency peg would have left SNB with a very risky balance sheet - something which looks like a hedge fund betting on property & currency - and a disgruntled local population.   
In an increasingly connected economy, it is never a prudent decision to peg the appreciating exchange rate. Adam Smith's "Invisible Hand" or market forces would catch up with you sooner or later. 

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