SNB Deval A Bank Rescue Plan, Not About CHF Overvaluation

Generally speaking I give a central banker the benefit of the doubt. But today's SNB pork pie is so over the top that I can only say who do they think they are kidding?

When global trade is collapsing, benefits to competitiveness from a decline in a currency are relatively mute... they need to be huge on a nominal basis to do anything to help exporters outside of translation effects. And with G20 agreement this weekend on one principle assured - oppose protectionism and beggar thy neighbor currency policy - seeing unilateral intervention from the SNB today (okay telegraphed in talking points by the central bank for better part of the last 6 months) being billed as an integral part of QE and stimulating economic activity is laughable.

Moreover, I think it is a very safe assumption that heavy buying (several yards) of euros and US dollars for Swiss francs today was previewed and approved by US and European officials, and especially so in the current environment. Remember FX is best left to markets to determine is the cornerstone of central bank think on currency policy full stop. So why would the likes of the ECB and US Treasury sign off on unilateral Swiss intervention if not for pumping up the money supply now that Swiss rates are at zero bound?

To save the banking system of Europe... well to add to the bailing system on the flooded European banking system. Eastern and Central European banks were large lenders of CHF, at a lower interest rate, in local mortgage markets and some business loans. They are getting crushed in the typical BOP crisis (capital account) by having to service debt in CHF with crumbling local currencies and a boycott of foreign capital in light of the global recession and banking crisis. And we all know that Western European banks have large stakes in many of these East Europe institutions that took to lending in CHF (carry trade as a way of life). Weakening the CHF allows the flooded European banking system to plug pump out water from another hole in the hull without sinking.

However, it remains to be seen if the SNB approach (with surely G7 backing) has pulled the lid off of Pandora's box and will bring more into the devaluation game - Japan comes to mind in G7. If it is good for the goose should be good for the gander. However, Japan's monetary authorities seem to have made a science of very indiscreet currency manipulation in a don't ask don't tell agreement with G7 and may not need to follow the Swiss example.

But it is also a world of never say never... a large government encouraged US dollar decline could do lots for US firms with overseas sales and if large enough, but so large that the Wylie Coyote outcome is assured, could do at least as much for US growth as tax cuts. Arguably an orderly dollar deval would be one tough task to carry out and would demand a high degree of market confidence in the competence of US officials and we know that well is tainted if not poisoned in the last 18 months.

Today's SNB action tells me more about the fragility of the European banking system than any press conference by JC Trichet or quarterly bank statement from a major European bank.

Roughly top to bottom in EURCHF since 2007 high to 2009 low is about 13%...big but not unprecedented for a major currency (EURUSD did more than that in July-Nov 2008) and what will 5-8% reversal achieve? Good news is there is no inflation so some of the negative externalities of a deval are mitigated.

It seems to me the rise in the CHF is all about a bank funding problem - like all those carry trades funded in CHF or Hungarian mortgages funded in CHF are forcing a massive short covering in the currency, just as we saw with the USD and JPY. Addressing imbalances via currency policy is never a good sign, not even in the current environment of benign inflation.

David Gilmore

Foreign Exchange Analytics
http://www.fxa.com

Disclaimer: The opinions expressed herein are those of the author and not a recommendation to buy or sell specific securities.