Super QE, or beggar-thy-neighbour

Published on Friday, 09 September 2011 19:56

Elle

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The Swiss National Bank has managed something rather unusual today when it managed to move the currency by as much as 7-8% in a single day. The bank made a statement wherein it set an exchange rate target of 1.20 francs per euro which it claimed was the minimum exchange rate.

However, this does not signify the bottom and is more like the upper limit as the Swiss are looking to maintain the franc at no more than 83.33 euro cents.

Gold which is currently the largest safe haven in the current economic crisis has only the Swiss franc as a competitor as hence there have been concerns about the deflation of the value of the threat following large scale purchases. The announcement by the Swiss National Bank looks like an indicative that they will create an unlimited reserve to allow surplus foreign exchange and as the primary focus of the statement was the euro, it is most likely that they would be making purchase of the euro.

Traditionally, we think of central banks as pursuing the opposite policy; using its foreign exchange reserves to buy the domestic currency. But the SNB is doing the opposite, creating Swiss francs to accumulate reserves. And, in theory the scope is unlimited as the SNB can create francs without number.

Any strategy as aggressive as this is certain to have some repercussions, both internationally and domestically. The Swiss had been attempting to weaken their currency by a more roundabout route, repurchasing Treasury bills and diverting the money into bank deposits.

This policy had already had the effect of making interest rates negative, in the very practical sense that UBS was charging institutional customers who held excess deposits in their accounts. The trouble with this plan is that most currencies are currently paying little or nothing; investors might not mind paying 1% to hold a deposit if they felt the Swiss franc was set to rise 5% a year against the dollar or euro.

Other countries have used QE without explicitly aiming to drive down their exchange rates, although the Bank of England has broadly welcomed the decline in the pound and QE enthusiasts cite the decline in the dollar as an example of the success of the Fed’s policy. But this is shock-and-awe stuff and makes one wonder whether other countries will follow suit.

The current move marks a major round in the ongoing currency war.