Swiss tactics expose Euro fragility

The fragility of global economies, as well as their inter-reliance, has been exposed in recent weeks, with the latest examples delivered courtesy of the Swiss Franc and the Euro.

After several years of managing a cap of Swiss Franc (CHF) 1.20 per Euro, the Swiss National Bank unilaterally and immediately removed the cap, causing the Swiss Franc to appreciate by around 20% almost instantly.

As the Euro zone entered its sovereign debt crisis (think of Greece, Portugal and Spain in particular), the CHF became a safe haven currency. Funds flowed into the CHF driving the currency’s value rapidly up. This made the countries’ very large volume of exports (in 2013, more than 72% of Switzerland’s GDP was derived from exports) more expensive.

After the CHF spiked in September 2011, the Swiss National Bank applied an effective cap of CHF1.2/Euro. It did this by spending Swiss Francs to buy Euros (and some other currencies). In so doing, it acquired a vast portfolio. The problem is that much of the currency the Swiss National Bank acquired was of dubious and variable value. Eventually, that can lead to large losses, reduced liquidity and the decline of a tool available to the Swiss economy to defend itself in the future.

That is especially important because unlike similar programs (think of the US quantitative easing program that has recently ended), the Swiss have been holding foreign currencies equivalent to the value of something close to 75% of their annual GDP.

So finally, on January 15th, the Swiss National Bank pulled the pin on its currency support. The result, which clearly caught the global economy unawares, saw the CHF instantly leap in value by around 20%, to the point where the exchange rate with the Euro is approximately one for one.

The implications in Europe are enormous. Loans taken out in CHF in poorly performing European countries now cost 20% more to repay. The International Monetary Fund and others have warned of a renewed bout of currency shocks and economic woes.

Further afield, the Swiss affair has jammed the Euro lower against the US Dollar and the Australian Dollar, among other currencies. Commentators now expect the European Central Bank to begin its own program of currency control to defend the value of the Euro.

What this house of cards is exposing is that private sector demand and growth, driven by consumption, is stagnant in major economies. The artificial sustenance of some currencies may help hide the situation, but it isn’t addressing it.

The repercussions of the Swiss move have been felt around the world, in varying degrees. At least one hedge fund went bust and speculators have fared variously, but the main implications for those involved in trading is the weakness of the Euro. Its exports, many of them already cheap, may well continue to be cheaper.