Swiss time was running out

The reviews are in on the Swiss National Bank (SNB) abandoning its CHF 1.2 per Euro minimum peg and they are unfavourable. It seems people are shocked that Switzerland might act in a unilateral fashion and without seeing the need to coordinate with other countries.

Anyway, the departure point for many analyses seems to be an assumption that nothing was especially wrong with the peg. Sure, the SNB was committed to buying unlimited quantities of foreign currency, and thus unlimited growth in its balance sheet, but what exactly was the constraint on that? Well, for one thing, it was producing some economic outcomes that Swiss voters — remember those people? — didn’t seem to especially like, not least rapid growth in asset prices such as housing and questions about huge holdings of foreign currency assets.

But let’s take the liquidity trap diagnosis at face value. Switzerland has been at risk of deflation, and the tendency of investors to pile into its currency at the same time forces it to appreciate, making the deflation problem even worse. The peg was supposed to solve that, but the domestic politics around that was turning sour. One way to break the deflationary cycle: get people thinking that the SNB might be just a little crazy and liable to do things at short notice which make investing in the currency not such a good idea. And furthermore, realizing that your peg is going to crack at some point in the future, acting abruptly now in a way that causes the exchange rate to, er, “overshoot” its true higher long run value so that investors expect it to depreciate over the foreseeable future, meaning rising prices and … more incentive to spend today!

Yes. it sounds crazy. But the liquidity trap is itself crazy. This particular exit option just might fit the times.

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