“The road to hell is paved with good intentions”
Well meaning efforts by the Swiss National Bank have backfired, sending shock waves through international markets.
In 2011, the Swiss central bank took dramatic steps to keep 1 euro worth 1.20 Swiss francs.
Then, last week, it reversed that 3-year-old policy, and the Swiss franc has soared about 20 percent against the Euro.
The problem is that fixed exchange rates of currencies do not work in the long run as well as letting the market determine exchange rates.
The Swiss decision put further pressure on the European Central Bank to begin an economic stimulus program known as quantitative easing.
Under quantitative easing, the European Central Bank would buy hundreds of billions of euro-denominated government bonds in order to both stimulate the region’s economy and beat back deflation. Reuters reported Wednesday that the bank’s executive board had proposed buying 50 billion euros (about $57.9 billion) in bonds per month starting in March.
America is going in the opposite direction, because its economy has been boosted by low energy prices and increased consumer spending. The U.S. Federal Reserve is going to institute a tighter monetary policy at the same time Europe is going to embark on an ambitious loosening policy.
With unemployment falling, many professionals expect Fed policymakers to raise rates after their June meeting. Our central bank remains committed to this policy amid worries about a low inflation rate, slow global growth and falling oil prices. Excluding volatile food and energy items, our core prices rose 1.6 percent on the year.
The world has not seen an economic divergence like this since the mid-1990s, when Europe was grappling with the fallout of the Soviet Union’s collapse and we were benefitting from a technology boom.
Why did the Swiss central bank reverse course?
It wanted to stop the expansion of its balance sheet, which had grown about fivefold since 2011 as it bought billions of euros to keep the Swiss franc-euro exchange rate the same.
The bank also was concerned about the country’s growing real estate bubble, which was being fueled by cheap money. Bank lending had increased by 25 percent as a share of gross domestic product and was now 170 percent of GDP.
Switzerland now confronts three problems.
The appreciation of the Swiss franc will increase the possibililty of deflation.
The bank initially will book large losses in its assets. About half are denominated in francs.
Christian Levrat, president of the left-wing Social Democrat party, called the exchange-rate decision “a serious threat for tens of thousands of Swiss jobs.” With more than 40 percent of Swiss exports going to the euro zone, Swiss companies’ profits will plunge.
Their hugely important luxury and tourism industries are most exposed.
The abrupt move by Switzerland’s central bank to remove the cap on the franc-euro exchange rates has created turmoil from Europe to Wall Street.
The U.S. economy has been boosted by low energy prices and increased consumer spending.
But overseas problems can reverberate back to us.
Japan is in a funk, China’s growth rate is slowing significantly and Europe could even experience a recession.
Will the Swiss move be a trigger for another global crisis? If the world catches a cold, will the U.S. sneeze?
Originally published in the Sarasota Herald-Tribune
