resilience, not stability

SNB’s Swiss Franc Dilemma: A Solution

with 12 comments

As I highlighted in my previous post, the honeymoon period for the SNB in its enforcement of the 1.20 floor on the EURCHF exchange rate is well and truly over. In May, the SNB needed to intervene to the tune of CHF 66 bn to defend the floor. There’s even speculation that the SNB may be forced to implement capital controls or negative interest rates on offshore deposits in the event of a disorderly Greek exit from the Eurozone.

Increasingly, the SNB is caught between a rock and a hard place. Either it can continue to defend the peg and accumulate increasing amounts of foreign exchange reserves on which it faces the prospect of correspondingly increasing losses. Or it can abandon the peg, allow the CHF to appreciate 20-25% and risk deflation and a collapse in exports and GDP. It is not difficult to see why the SNB is being forced to defend the peg – the EUR in the current environment is a risky asset and the CHF is a safe asset. By committing to sell a safe asset at a below-market price, the SNB is subsidising the price of safety. It is no wonder then that this offer finds so many takers when there is a flight to safety.

Some argue that the continued deflation in the Swiss economy allows the SNB to maintain its peg but this argument ignores the fact that it is the continued deflation that also maintains the safe status of the Swiss Franc. Deflation provides the impetus for the safe-haven flows due to which the required intervention by the SNB and the SNB’s risk exposure are that much greater in magnitude. Therefore, if the SNB is eventually forced to abandon the floor, the earlier the better. A prolonged period of deflation punctuated by occasional flights to safety will compel the SNB to accumulate an unsustainable level of foreign exchange reserves to defend the floor. By the same logic, the SNB would obviously prefer that the Eurozone not implode but if it does implode, then it would rather that the Euro implodes sooner rather than later.

So what does the SNB need to do? It needs to engineer an outcome where the market price of the EURCHF moves up and the CHF devalues by itself. The only sustainable way to achieve this is to provide a significant dose of inflation to the Swiss economy and it needs to do so in a manner that does not provide an even larger subsidy to those running away from risk. For example, raising the EURCHF floor by itself only increases the temptation to buy the Franc and at best provides a one-time dose of inflation. The SNB could decide to buy CHF private sector assets but the safe-haven inflows and relatively strong performance of the Swiss economy mean that asset markets, especially housing, are already frothy.

The more sustainable and equitable solution is to simply make the safe asset unsafe by generating the requisite inflation for which money-financed helicopter drops are the best solution. Money-financed fiscal transfers will create inflation, deter the safe-haven inflow and shore up the balance sheet of the Swiss household sector. The robustness of this solution in creating sustainable inflation will not come as a shock to any emerging market central banker or finance minister. The crucial difference between this plan and that implemented by banana republics around the world is that instead of printing money and funnelling it to corrupt government officials we will distribute the money to the masses.

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Written by Ashwin Parameswaran

June 12th, 2012 at 11:21 am

12 Responses to 'SNB’s Swiss Franc Dilemma: A Solution'

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  1. Man, you got nearly everything wrong. Look on my site. e.g
    The Swiss problem is the inflation caused by massive inflows and a huge real estate bubble. Switzerland has Inflation despite a currency that continues to appreciate and tames inflation a bit. Switzerland is not Japan.

    George Dorgan

    12 Jun 12 at 4:53 pm

  2. George – latest CPI data was flat MoM and -1.0% YoY.

    I have already noted that there is asset price inflation and a possible real estate bubble hence my preference for helicopter drops combined with letting go of the peg.


    12 Jun 12 at 5:56 pm

  3. Read this
    carefully, then you see that the YoY deflation will finish soon and go up 1.5% in August.

    George Dorgan

    12 Jun 12 at 6:57 pm

  4. Read this
    carefully, then you see that the YoY deflation will finish soon and go up 1.5% in August. Year to data inflation is already +0.5%

    George Dorgan

    12 Jun 12 at 7:34 pm

  5. George – the SNB has an inflation target that allows 2% inflation and even in the year that the EURCHF floor has been instituted, we have a possible inflation of 1.5% at the peak which will wash out when the currency effect on imports washes out (like the VAT increase in the UK). I hardly call this an inflation problem.


    13 Jun 12 at 9:06 am

  6. You are perfectly right. But even without printing 2013 inflation is expected at 1.4% after the wash-out fueling further the real estate bubble.

    The official SECO is its forecast always sustaining the SNB floor policy. With 1.4% inflation a sudden solution of the Euro zone crisis, or a scenario like the German Euro exit, will mean suddenly a cheaper franc and lot more expensive imports for Switzerland (from Germany). The SNB won’t be able to sterilize the money as quickly as they wish.

    This money printing/ real estate bust scenario has happened several times in Swiss history. See at the end here:

    George Dorgan

    13 Jun 12 at 9:19 am

  7. George – my fundamental proposition is that the SNB should abandon the floor. If nothing changes in the Eurozone my guess is that we’ll see an appreciation to 0.90 or so.

    To the extent that the SNB wants to prevent this appreciation, it should do so via direct money transfers to Swiss citizens rather than currency floors which subsidise safe-haven seekers as well as foreign buyers of Swiss real estate. The current policy is simply a subsidy from the Swiss taxpayers to safe-haven seekers the cost of which will keep increasing the longer the SNB maintains its floor. Direct transfers will have a much less stimulative effect on asset markets than the current floor.

    Of course if the Eurozone crisis is solved or safe haven flows stop then the SNB can simply do nothing.

    Thanks for the comments.


    13 Jun 12 at 10:02 am

  8. The SNB is just one example of the recent central bank “corridor” dynamic:

    -above the corridor lies reducing economy-wide debt through inflation.

    -inside the corridor, the central bank transfers risk from private actors to taxpayers in an effort to create a wealth effect.

    -below the corridor lies reducing economy-wide debt through deflation (i.e. loss recognition).

    Balance sheet expansion is merely fiscal policy in disguise. It creates a contingent tax liability on a one-for-one basis. This is the Swiss dilemma you paint: keep increasing that contingent tax liability, or finally migrate above the corridor.

    No central bank seriously considers going below the corridor. This would only happen as a result of an unintended policy “error” (as happened in 2008).

    FWIW, I suspect the corridor system finally dies this year, and is replaced with some form of “above the corridor” NGDP targeting regime.

    Diego Espinosa

    18 Jun 12 at 4:50 pm

  9. Diego – Thanks for the comment. My point is just that if the new regime is implemented via an asset purchase commitment then it still ends up being a wealth transfer exercise.


    19 Jun 12 at 9:34 am

  10. Jezz Ben

    2 Aug 12 at 10:54 am

  11. @Jezz Ben
    Could you please indicate the sources of your data. It does not look professional without sources.

    Why do you think that Switzerland is in a liquidity trap when retail sales rise 3.7% YoY and unemployment is at record low of 2.9% ?

    Or like Reuters said: A small country, a big hedge fund.

    Concerning inflation and referencing sources see this one:


    2 Aug 12 at 3:53 pm

  12. @Mark

    SNB Monthly Statistical Bulletin May, June, July etc. 2012
    SNB Money market debt register claims
    SNB Quarterly Bulletin 1/2012 and 2/2012
    SNB Speech: Thomas Jordan: Introductory Remarks, Media News Conference

    Jezz Ben

    22 Aug 12 at 7:19 am

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