The news of the day was the Swiss National Bank removing its FX peg to the Euro. There’s been a lot of speculation about why this was done and after having spent today talking to a lot of people in Europe about what’s going on I think the most plausible reasoning is politics. A source of mine at a large European bank says that he thinks the move was the result of “untenable” politics. In essence, the SNB has been expanding its balance sheet to try to maintain the peg, but politics surrounding the situation make this politically risky. In other words, while a Central Bank shouldn’t be able to go “bankrupt” Central Bankers have to operate within certain political constraints that could actually render it “bankrupt”. Ie, unable to act. Laws and politics trumps the printing press….
A report from JP Morgan via FT Alphaville confirms the thinking and the timing of the move:
“The SNB’s decision to abandon the floor for EUR/CHF is remarkable but not unwarranted. As we have long argued and indeed positioned for, the SNB was losing the ability to prevent an increasingly justified depreciation in the euro against the franc. The pressure was bought to a head by the prospects for ECB QE and the SNB’s inability to substantially expand its balance sheet from an already bloated 85% of GDP.
The timing of the move may have had part to do with the release last week of the SNB’s massive profits for 2014 (CHF 38bn) which provide a sizeable cushion against the mark-to-market losses the SNB will suffer on its reserve portfolio (the SNB would have been bankrupted by this de-pegging had it not made such a large profit last year).”
This is all pretty interesting from the perspective of monetary theory since the ultimate constraint on Central Bank operations are ultimately guided by politics. If the politicians threaten to force the Central Bank into a corner then the Central Bank has to respond even though it theoretically has huge amounts of unchecked power. Pretty interesting stuff for a monetary theorizing nerd like myself.
But really, there’s only one message that matters from all of this. The SNB will still manage their exchange rate. It will just be looser. I seriously doubt they’re going to just let the Franc cruise back to its old levels without responding at all. More importantly, the ECB is on the verge of QE and it’s scaring the pants off some people. Of course, we all know that feeling…in this case I have to wonder if the SNB wasn’t worried about inflation and currency devaluation and all the other things that QE doesn’t really do, but people think “money printing” does. So many interesting moving parts here….Anyhow, QE is coming to Europe. Not that it will have much of an impact, but it’s sure causing the usual stir in financial market….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.