Thursday, 15 January 2015

The true meaning of the revaluation of the Swiss Franc

This morning the Swiss Central Bank threw in the towel.  
It said it could no longer maintain and defend the floor of CHF1.20 for 1 EUR.  In spite of charging negative interest rates, capital continued to flow into the Swiss Franc forcing the Central Bank to accumulate an undesirable level of foreign currency reserves as it sold the Swiss Franc to defend the floor.  This would set up the Bank for huge losses on exchange when eventually market forces had to be respected and the Swiss Franc allowed to revalue.

So this morning we have seen the Swiss franc swing from 1.20 to the Euro down to 0.74 to the Euro and then finding some stability at just above par around 1.03 at the time of writing.

Even at this level it means a revaluation of 15% overnight.    What does this mean?

Switzerland, Germany, Austria and the Netherlands are economies that are deeply integrated.   Suddenly Switzerland, which is out of the Euro, had to revalue their currency and lose 15% instantly in their export competitiveness.   Why the same does not apply to Germany, Austria and Netherlands?   Simply because these are in the Euro and investors do not want to buy the Euro as it is weakened by the state of play in other Euro countries in the periphery like Greece, Italy, Spain and Portugal.

Which means the Germany Austria and Netherlands are making a feast out of the misery of Italy Spain and Portugal.  They are avoiding the pain, that Switzerland has been forced to face, through a free ride on the back of Euro countries in distress.

The Swiss lesson today is that reality can be delayed but cannot be avoided.   Similarly the Euro will at some stage have to face reality i.e. that convergence of competitiveness among the various member countries cannot be achieved through austerity on the deficit countries and feasting of the surplus countries.   Ultimately the Euro area will have to break into two distinct  Hard Euro and Soft Euro areas and then gradually arrange a re-docking into one Euro Version 2 under new terms and conditions which will include substantial integration at fiscal and debt levels.

When?   When the alternative would be seeing the whole Euro structure blow up either through market forces ( like the Swiss experience) or through political turmoil following election of poltical demagogues who promise easy solutions that do not exist.

How can one justify that a two super-competitive economies like Switzerland and Germany share so different fortunes with their rate of exchange? The Swiss Franc hardening and the Euro falling!!!   This is artificial to the point of being laughable; and artificial things do not last.

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