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Can You Just Surrender In A Currency War?

Switzerland, as everyone knows by now, has slipped out the back door of the drunken orgy that is the modern financial system. And the other revelers are wondering if it’s time to find their own clothes and start tiptoeing towards the exit.

Because the Swiss have such a big “mind share” in the world of finance, it’s easy to forget how tiny their country actually is: Eight million people, a landmass of 40,000 square kilometers (less than half that of Virginia, for instance), and a few interesting but by no means essential exports like watches, chocolate, and pharmaceuticals. But in banking it’s a behemoth. Traditionally the place where money ran to hide, whether gold stolen by Nazis, tax revenues stolen by kleptocrats or personal wealth stashed by reasonable individuals living in unreasonable countries, it has for centuries been as reassuringly — and purposefully — boring as an aging accountant.

In other words, the Swiss are purveyors of financial stability, which requires a rock-solid currency and predictable behavior. The franc, as a result, has for long stretches been the only fiat currency to hold its value versus gold.

But this attractiveness became a liability a few years back, when the euro’s fatal flaws emerged and capital from the rest of the Continent started fleeing to Switzerland, spiking the value of the franc and threatening to price Swiss exporters out of global markets. What happened next is so well known that there’s no need to repeat it here. But for those who would like a primer, see Absolutely everything you need to understand about what happened to the Swiss franc this week.

Now, with the Swiss having cut their (considerable) losses and retaken control of their monetary policy, citizens of the rest of the world are left to deal with the consequences of 1) their own stupid financial policies and 2) their equally-stupid (in retrospect) decision to bet on the Swiss abandoning centuries of tradition by allowing their currency to evaporate along with the other pieces of confetti that now pass for money. Among the victims:

And remember, the Swiss franc saga is just one of three major sucker punches to strike the world in the past few months, the other two being the dollar’s spike and oil’s collapse. Banks, hedge funds, governments and individuals around the world are on the hook for what might cumulatively amount to trillions of dollars of bad paper, with the interplay between these three pieces of volatility making a true accounting impossible until well after the fact.

Anyhow, some thoughts and questions re Switzerland:

Is it even possible to just surrender in a currency war?
That’s effectively what the Swiss have done. From now on they’ll run their monetary policy old-school, with stability once again the main goal. But what happens to their exporters, which make up a bigger part of their economy than almost any other country’s? Will the result of keeping a strong currency in a weak currency world be an epic recession in which big swaths of its society cease to function because they’re priced out of global markets? Or will Switzerland, after a period of adjustment, become an island of well-run tranquility in a sea of monetary chaos? This is a serious question and the answer isn’t at all clear.

Does the eurozone need QE now that the euro has cratered?
The point of a central bank buying bonds with newly-created currency is to make money easier to borrow for its citizens. But a depreciating currency does the same thing and the euro is already down by about 20% in the past year. Everyone who has borrowed euros now gets to pay back their loans in cheaper currency and European exports are now far more attractive on the global market than in 2013. So once again it’s possible that ECB chief Mario Draghi has gotten what he wanted just by talking, without actually having to do anything dangerous.

Or…is the euro beyond saving and about to collapse under the weight of its own contradictions, with upcoming Greek elections marking the end of the dream? And then what happens to the franc in the face of the resulting tidal wave of capital fleeing the imminent return of drachmas, lira and pesetas?

Will anyone ever trust a central bank again?
This of course is the big one because the entire global financial system, from governments managing unfunded liabilities by borrowing effectively unlimited amounts of money, to corporations obscuring deteriorating fundamentals by repurchasing stock with borrowed funds, to leveraged speculators hiding trillions of dollars of derivatives exposure in plain sight because of a perceived central bank backstop, depends on the myth of central bank omnipotence. If the willingness and/or ability of the Fed, ECB or BoJ to step in and keep the party going is questioned, then it all stops just as quickly as did the Swiss franc carry trade. The difference being one of scale.

42 thoughts on "Can You Just Surrender In A Currency War?"

  1. I haven’t trusted the Central Banks for years…..don’t plan on ever trusting them for the remainder of my life either. It’s the cynic in me, or the BS detector. Mine works really well, not that it takes a highly tuned one to detect the stench of this mess.

  2. Swiss government holdings of foreign currencies rose from 10% of Swiss GDP in 2008 to 80% of Swiss GDP this year which is why the SNB could no longer continue creating Swiss francs to buy foreign currencies to keep the foreign exchange rate of the Swiss franc at their desired targets.

    The biggest implications of allowing the Swiss franc to float in FOREX is that the prices of Swiss exports will go up dramatically as started to be the case last week with jumps of around 20%. That creates a massive problem for the economy of Switzerland as its GDP is almost entirely EXPORT BASED with exports accounting for more than 72% of Swiss GDP.

  3. NO WONDER WHY THE LOSSES OCCURRED:

    “Shorting the franc was a popular trade and most firms would leverage their positions some 20 times or more, said Williams, who consults for hedge funds. With such leverage a 5 percent move against the position wipes out all the value, yet the trades were seen as relatively low-risk by models used by financial institutions because volatility of the franc was reduced by the SNB’s cap, he said. ”

    http://www.bloomberg.com/news/2015-01-19/bank-losses-from-snb-surprise-seen-mounting.html

  4. One context to keep in mind is currency devaluations don’t just happen in a vacuum, they occur because the various economies are not doing well. But “money printing” to try to lower interest rates and weaken a currency to “spur demand” doesn’t work so other countries need not worry about losing “market share” for their exports because those sick countries wouldn’t be able to buy them anyway. Lower import prices, just like lower interest rates, don’t necessarily mean people will buy or borrow more. Switzerland will be fine. In fact, probably better off – all things considered.

    1. Switzerland is no in a HEAP OF BIG TROUBLE ECONOMICALLY as more than 72% of its GDP is based on exports which have skyrocketed 20% in price overnight, and another big part of its GDP is tourism which is now 20% more expensive for foreigners coming to visit Switzerland.

      1. That may seem “logical” but I don’t think it works that way. Remember, most of the countries that Switzerland exports to couldn’t afford their products anyway, under the circumstances. Besides that, the import/export business is flexible. Distributors can choose to make nothing – their call – or just relatively little, as to how much markup they charge. Furthermore, if Swiss products are unique and of high quality then people will pay up for that. As far as tourism, I don’t know any one who travels to Europe because of the exchange rate. “Locals” maybe, but I doubt that’s the majority of travelers given how crappy the Eurozone economies are.

        But beyond all of that, the idea that a country that has its shit together is somehow at a disadvantage to profligate ones that thinks they have to devalue their currencies to stay alive is absurd.

        1. Obviously, it works exactly the way I stated. A lot of the Swiss goods that they export which constitute more than 72% of their economy (GDP) are not price inelastic goods and will be hurt very substantially in the markets at much higher prices. Many of those goods are food goods including cheese and chocolate for which there are substitutes of high quality and that is true even in their renowned watch industry.

          Switzerland doesn’t price much in the way of price inelastic goods such as Germany with BMW and Mercedes-Benz vehicles, for instance, for which there are no comparable products. As to its pharmaceutical industry, I don’t know how much they have that is unique and protected by patents, and that is a wildcard.

          Switzerland doesn’t have much together at all, and will be rapidly disintegrating as a result of the huge 20% jump in the value of their franc and its enormous adverse impact on their exports which are essentially three-quarters of the entire Swiss economy.

          1. Well, we shall see how things play out. Frankly, I could care less about the Swiss, especially since they started down this road to begin with. My comment about a country “having its shit together” was to make a point of contrast. That said, any country that is responsible will always prevail over the less so.

        2. Tourism will be hit for sure. People will flock to the skiing resorts of neighbour Austria, the Zillertal being located right next to Switzerland. Such holidays are expensive enough as it is and with a substantial hike of the value of the Swiss Franc, the Germans, Dutch, Belgians etc will be quick to relocate. This is going to hurt the Swiss, because in this case there are alternatives.

          1. Of course, bankrupting the country trying to hang on to a peg that was never sustainable would not have been a good choice either. If they had hung on another year through ECB QE how much worse would SNB’s losses have been? No good choices, I think. They take an economic hit no matter what.

            Anecdotally, there is no alternative to Kuhn-Rikon cookware in my book. Anything that needs replacing in the kitchen, I will try to replace with Kuhn-Rikon even if the prices double from here, because then I know I’ll never have to replace it again.

          2. I actually think the Swiss made the right decision here, but that decision will inevitably come at a cost. I’m sure the SNB will have carefully considered the pros and cons beforehand. The fact that they decided to go ahead with this anyway, does not bode well for the global economy IMO. Plus, we still haven’t felt the full impact of the move because – just like the lower oil prices – this will take some time to work its way through the global economy.

          3. “… does not bode well for the global economy” ? How about the euro? That is what the SNB thinks of it at this point. The rat hole was getting too deep. Why willingly tether oneself to a losing cause? Everybody in the eurozone wants out, they just don’t know it yet, not just Greece and Portugal and Spain and Italy and Ireland. What kind of crazy wants in now? What kind of loon would want to assume the downsides without any of the “upsides”?

            I will thank the Swiss if I have the opportunity for representing the monetarily sane (sort of) in this world.

          4. If this affects the political and economic cohesion of the EU, it will affect the global economy, because we’re all far too interconnected by now and the Eurozone still is a very powerful economic block. The 2008 meltdown could not be contained either. One central bank returning to sanity might be laudable from a moral point of view, but it also comes desperately late. The world is chock full of debt, this is our main predicament, it can only be serviced at low and in many cases even negative rates, while a lot of the liabilities beneath the surface are of epic proportions. We’re stuck and no conventional medecine can cure the patient, only some kind of reset will do.

            We’re starting to witness all the unintended consequences of QE, yet again proving that there is no free lunch. And at this point we can only hope someone can step on the fuse before it reaches the derivatives warehouse. Although given the fact that the bank lobbies succeeded in loading even these risks on the back of the US taxpayer, I’m not very hopeful at what lies ahead.

          5. There’s no arguing with that logic. Of course, if important enough entities would publicly admit this sobering fact and act upon it, the ensuing loss of confidence will truly be a spectacle to behold. Let’s see which “not on my watch”-team will get to eat his words. Unless they’ll succeed in stealthily inflating away trillions and trillions of dollars.

          6. There is no way to stop or even slow down the rapidly intensifying GLOBAL DEFLATIONARY SPIRAL.

          7. Germany doesn’t want out of the Euro and once they purge the EuroZone of the really bad applies in the South of Europe, they may propose to rename it the Deutschmark and live happily ever after.

        1. Gold is one of the MOST DANGEROUS AND MOST TOXIC little assets out there and is on its way to its mean of $456 per ounce and then headed lower.

  5. The Markets today live off fiat lies, damn derivative lies, & central bankers. The head of the Swiss central bank said the following, “If you decide to exit such a policy, you have to take the markets by surprise.” In other words, “Shut up and enjoy a 25% intraday swing in the value of your nation’s currency.” Nothing these people say should be listened to. Just watch their cunning actions to know these people are arrogant. reckless liars ( quote source: http://reut.rs/1IBNVXd ).

    1. Something must be up for them to jump ship. I read somewhere they just recently said they would stay pegged and now they don’t. I really don’t know what to make of it.
      He who bails first bails best???
      Way too much funny business going on these days.

      I seen another story similar to SoKalbeachdude, where its speculators, another was to help the Euro to devalue, kind of a cover.
      Probably in a month or so the diversion smoke will clear and we will see whats up.
      Hopefully it stays over there. But it is fun to watch!

  6. FXCM Lobbied Against Leverage Limit Before Trades Went Bad (Bloomberg)

    “FXCM, the brokerage facing a shortfall of nearly a quarter-billion
    dollars after highly-leveraged investors made losing bets on the Swiss
    franc, pushed back against U.S. regulatory efforts that likely would
    have left it less vulnerable. In 2010, the Commodity Futures Trading
    Commission sought to force individual investors trading currencies to
    give their broker 10 cents in capital to back every $1 in positions. The
    regulator failed to accomplish that amid pressure from New York -based
    FXCM and other brokers, meaning only 2 cents must be pledged. The
    agency’s proposal would “have a devastating impact on the retail FOREX
    industry,” Drew Niv, FXCM’s chief executive officer, wrote in a March
    2010 letter to the CFTC that was signed by eight other executives at
    currency dealers.”

    http://www.bloomberg.com/news/2015-01-16/fxcm-lobbied-against-leverage-limit-before-franc-trades-went-bad.html

  7. The Swiss currency was PREPOSTEROUS OVERVALUED DUE TO MANIC SPECULATION and is now EVEN MORE PREPOSTEROUSLY OVERVALUED TO TO EVEN MORE MANIC SPECULATION IN IT NOW. The issue is that the Swiss National Bank got fed up with the costs of keeping those IDIOTIC DEAD WRONG MANIC SPECULATORS AT BAY and decided to stop trying to maintain reasonable valuation for the Swiss Franc last week.

  8. And Now, The Consequences – By Karl Denninger

    Gee, you think?

    Casualties mounted from the Swiss currency shock as the largest U.S. retail foreign-exchange brokerage said client losses threatened its compliance with capital rules and a New Zealand-based dealer went out of business.

    FXCM Inc., which handled a record $1.4 trillion of trades by individuals last quarter, said clients owe $225 million on their accounts after the Swiss National Bank’s decision to abandon the franc’s cap against the euro roiled global markets. Global Brokers NZ Ltd. said the impact on its business is forcing it to shut down.

    So who thought it was a good idea to allow 50 or 100:1 leverage in FX accounts?

    Nobody, except these brokers.

    http://market-ticker.org/akcs-www?post=229743

  9. Switzerland’s population of around 8 million people is about half the size of the population of the Greater Los Angeles, California area of 16.7 million people, and Switzerland’s economy is tiny amounting to only $365 billion GDP. Switzerland’s government debt of $128 billion is 35% of its GDP.

    The big issue for Switzerland with the rise of the Swiss franc in exchange value is that Switzler is a net exporter and now the prices of Swiss that that were already very high in the world markets has been pushed up about 20%. Switzerland is also heavily dependent on tourism and the costs for anyone going to Switzerland suddenly rose about 20% last week.

      1. Personally I don’t “short” anything, but for those who do, the best ways to short gold are with the ultra-short ETFs DZZ and GLL and in the past 4 years they have had SPECTACULAR RETURNS with their best return being in 2013 with 66% gains each, and in 2015 they may top that as gold rapidly accelerates it plunge towards its mean of $456 per ounce.

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