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FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

The Swiss National Bank Goes "Nuclear"

Currencies / Fiat Currency Sep 07, 2011 - 03:22 PM GMT

By: Justice_Litle

Currencies

Best Financial Markets Analysis ArticleThe Swiss National Bank (SNB) rocked the forex market this week with a "nuclear" level currency intervention. The biggest net winner? Probably gold.

It was the press release that shook the forex market to the core.


On Sept. 6, the Swiss National Bank issued the following statement (emphasis mine):

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures.

In plain English, the SNB (Swiss National Bank) has committed to a price ceiling for its overstrong currency. Against the euro, the Swiss franc will be allowed a certain level and no higher. One could also consider this a "peg," as the franc is now pegged to a maximum value (in terms of euros).

When the news hit the market, the Swiss franc plunged 8.7%, its largest drop ever against the euro. Traders took the intervention threat seriously: When the SNB says they are "prepared to buy foreign currency in unlimited quantities," that is full-on nuclear talk.

The problem, as we have written about before in these pages, is that an overstrong currency can cripple an economy by making exports uncompetitive.

Because the Swiss franc is seen as a safe haven in times of turmoil (alongside gold and Treasury bonds), investors, traders and savers have rushed to convert their dodgy euros (and dollars) into stable Swiss francs.

This safe haven demand sends the franc even higher, in turn making Swiss products more expensive. Tourism then declines as travelers find Switzerland unaffordable, and Swiss exporters see sales and profits drop.

There is a sense of déjà vu here. The last time the Swiss tried to cap their currency, it was more than three decades ago (against the deutschmark in 1978). The problem back then was the same as today's: Too much safe haven buying creating pain for the Swiss economy.

So what next? "The currency wars are heating up," says Kit Juckes of Societe Generale.

"The SNB has just drawn the ultimate weapon," opines Alexander Koch at UniCredit Group.

The open question is whether the SNB will succeed in keeping down the franc, and how much it will cost them. Currency interventions can be incredibly expensive, and historically they are prone to failure. (Just look at how Japan has struggled with the yen.) It is conceivable the SNB could throw hundreds of billions at the problem, and still fall short.

In further bad news for the Swiss, the odds of a successful intervention depend on coordinated action. If you can get other central banks to go along, your chances of success are better. In this instance, though, the SNB appears to be acting alone.

Last but not least, there is long-run inflation risk in pegging the Swiss franc to the euro. By declaring a price ceiling, the SNB has made sure that, if the euro drops in value, the Swiss franc does too (to keep the ratio intact).

This exposes Switzerland as a country to the threat of rapid currency depreciation and possible surprise inflation. If the euro falls swiftly and sharply -- as it well could in true crisis mode -- the franc goes with it.

Good News for Gold?

As we know, Swiss franc strength has largely been a mirror image of eurozone weakness. Many European savers with bank deposits in euros have been looking to diversify their nest eggs.

The drumbeat of crisis in Europe only intensifies that desire, as Reuters noted yesterday:

The euro zone's debt crisis appeared at risk of spiraling out of control on Tuesday amid doubts about Italy and Greece's willingness to push through austerity demanded by their partners, and hardening opposition to further aid in paymaster Germany.

Safe havens are needed as sorely as ever. Now, though, the SNB has shown the determination to take a popular safe haven away (in the form of deliberate currency debasement).

Perhaps this goes to show that no government -- even a Swiss one -- with access to a printing press can be trusted.

The net winner as a result of all this? Probably gold.

It remains possible that the "nuclear" intervention fails, and the Swiss franc continues to strengthen against the SNB's wishes. Realistically, though, savers have to see that the franc is now at risk. If their fear is a booby-trapped euro, the franc is similarly booby-trapped by design.

With one less place to go -- and the reminder of central bank threats writ large -- the one true "neutral" currency, gold, becomes that much more compelling.

Publisher's Note: This strange discovery could save Europe's economy... Two geologists recently discovered a buried treasure under a farm in southern Sweden. Over 60,000 tons -- or $30 billion worth -- of a rare material not found anywhere else in Europe. Learn more about this investment opportunity.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

Source :http://www.taipanpublishinggroup.com/tpg/taipan-daily/taipan-daily-090711.html

By Justice Litle
http://www.taipanpublishinggroup.com/

Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor to the free investing and trading e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.

Aside from his career in the financial industry, Justice enjoys playing chess and poker; he enjoys scuba diving, snowboarding, hiking and traveling. The Cliffs of Moher in Ireland and Fox Glacier in New Zealand are two of his favorite places in the world, especially for hiking. What he loves most about traveling is the scenery and the friendly locals.

Copyright © 2011, Taipan Publishing Group

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