The Swiss Central Bank has revealed that it has been creating, or printing if you like, we call it quantitative easing these days, billions of Swiss Francs, exchanging them into Euros, and then purchasing Eurozone government bonds. In other words they have been engaging in a mixture of quantitative easing and currency intervention.
From the Financial Times: "To put the figures in perspective, there have been only two months when China, the world’s largest holder of forex reserves with $2,249bn in assets, saw its reserves increase more than Switzerland’s $73.2bn rise in May, says Beat Siegenthalter, currency analyst at UBS."
I know nothing about Switzerland, so take this idea with a pinch of salt. But it seems to me that the Swiss Franc has detached from the domestic economy and become a plaything of financial markets. Whereas the Swiss Franc was once about life in Switzerland, now life in Switzerland has more in common with the level of the Euro than their own currency. Life in Switzerland would improve if all the shops charged in Euros and all the workers were paid in Euros, and the Swiss Franc was kept for the benefit of banks and speculators. Really the Swiss Franc is an example of how national currencies don't work for small countries, they end up being tossed around by ocean waves. If a foreign power invaded Switzerland and auctioned off everything they could find the total value would come to fraction of the outstanding stock of Swiss Francs. So the Swiss Franc is a sort of monopoly money that has detached from domestic fundamentals. In a sense it's like Gold, which once had economic fundamentals, but now is just monopoly money.
In theory if the Swiss Central Bank start printing money and switching it into euros people who hold their money would value it less, and the Swiss exchange rate would drop. The currency markets, however, are hardly rational creatures. Safe haven demand for the Swiss Franc persists and the currency yesterday rose to a fresh record high of 1.37 SFr per € (compared to a price of around 1.57 in 2006). Now the Bank can keep on printing, keep on selling their increasingly worthless currency until the speculators realise their mistake. Meanwhile, life in Switzerland remains quite untouched, those extra francs are bought by speculators and remain offshore in money market accounts, so they don't destabilize the domestic Swiss economy and you don't see goods or asset price appreciation. When the Franc eventually falls to a sensible level, the bank can reverse the whole process for a massive profit (assuming the bonds don't drop too much in price!).
It is ironic that whilst many blame the economic crisis on financial engineering, the move looks not only right from the Swiss point of view, it is also great news for the Eurozone. It is supporting the European currency and bond market at a time when others have taken flight. Stemming the rise of the Franc is not just a priority for Swiss exporters such as Rolex. In Hungary, 60 per cent of all mortgages are denominated in Swiss Francs, yet the Hungarian forint has lost more than 25 per cent against the Swiss franc since the crisis erupted. Many Swiss and European banks have given loans in Swiss Francs, the impact of continued appreciation on European Banks would be dreadful.
Imagine you ran a little country that had an economy based on the gold standard, but one day someone in the government invented a machine that turned lead into gold. You swear everyone to secrecy and then you hold down the value of gold by selling gold to foreigners and investing in the euro. As the years go by you develop this enormous portfolio of euro assets making nice returns. One day the gold bubble start softening under the weigh of all the supply you have added, and then you quickly covert your people over to the Euro and kiss goodbye to the gold standard forever. Or, if for some reason you really want to stay on the gold standard, you buy back all the gold you sold for a profit and throw it into the sea.
Three things come to mind - how we are moving toward a more interventionist world, how inefficient markets appear (both in selling Swiss Franc mortgages to Hungarians and in the bizarre movements of foreign exchange markets), and how much more important global co-operation looks. Foreign Exchange reserves have hurt fast growing China because it has fixed itself to a slower growing potential enemy, but Switzerland is even more European than Austria, so they can go on pilling up free money forever and they are laughing all the way to the bank. Once upon a time Swiss Banking Secrecy laws gave it an advantage in financial services that justified being more detached from Europe, but that has gone, and now it's just another European country. So all it takes is a no turning back decision and secrecy.
Finally this intervention news might signal that the Euro's recent run of bad luck is running out of steam, at least for now, making both EURUSD and especially EURJPY look attractive. It's a tough call, but arguably the Eurozone is in better shape than both the US and Japan. One important thing to bear in mind is that both America and Japan have disastrous political leadership, the Eurozone has, by contrast, the Germans.
Update: The Swiss lost their nerve almost as soon as this news reached the newspapers. I think central banking operations should be kept secret as they are in China. Perhaps the Central Bank could use some sort of opaque special purpose vehicle that doesn't create headlines.