Swiss National Bank (SNB) may fail to stem the rise of the Swiss Franc by monetary expansion and a currency peg if drivers are geopolitical. Extraordinary measures like selective capital controls may be necessary.
By Christian Takushi, Waltalingen-Switzerland, 10 August 2011
Swiss exporters should weather the strong Franc better than expected. Japan’s exporters survived similar or stronger appreciations. Strong Franc offers unique opportunities to Switzerland (M&A, sovereign fund for strategic purchases in EU etc)
Those of you who follow my research know that I have been trying to convince investors that the CHF is not overvalued as they are told by most economists, and that they need to prepare for a stronger CHF still.
The SNB – under pressure by political Bern and exporters – is trying to counter the Swiss Franc strength with monetary measures; that could work if the forces behind the recent acceleration were mainly monetary and economic. Their idea is to make the Franc less attractive.
Understanding investors
Apart from the speculation by traders, investors all over the world are fleeing into the Swiss Franc and Gold not for investment allocation reasons (i.e. higher returns), but rather for preserving the value of their savings from imminent or potential loss. Investors have seen the world going from crisis to crisis in the past 10-15 years and most of them were neither forewarned nor prepared by their bankers and consultants. Investors have seen the crises – to mention just a few – in Asia, Japan, Russia, Argentina, LTCM, IT-bubble, 9-11/London/Madrid terror attacks, sub-prime crisis, energy and food shortages, then the Middle-East, Euro-debt crisis and US spiraling deficits. At the same time investors have seen their elected leaders postponing unpopular measures to address structural problems, because central banks were able to stimulate by printing ever more paper-money after every new shock. Much has been said about this moral hazard. I talk to many private and institutional investors that tell me privately that visibility is low and uncertainty elevated, thus they feel uneasy about the future.
The SNB’s challenge
A powerful mix of speculation and growing fear – while speculation can be arrested by setting a cost higher than the potential gain. Arresting fear will be much more difficult, because in a global crisis, many people have a desire to protect their savings or preserve the purchasing power thereof – like at the onset of a war. For that reason: making it “simply more expensive” or less attractive by lowering the interest rate from 0.25% to 0% or even -1% will ultimately fail to stem the demand for the currency of one of the most politically stable, neutral and competitive nations in the world. This type of protection-seeking investors will not be deterred by even a 5% cost. In their distress they may prefer to save 90% of their savings rather than losing half of it in a currency reform or fiscal union. Blocking them from accessing the Franc may help stem some of these accelerated panic-driven demand waves. And we should brace for more of them in the future – my private geopolitical research points at geopolitical tensions rising to new highs between 2015 and 2018. Nevertheless, such a trend is not linear and the SNB may be overreacting at a temporary “high”.
Resisting exporters’ pressure
Being Switzerland a small-open economy, any temporary capital restriction would have to be smartly tailored. It will be controversial, because of the widespread yet flawed view of financial markets that a stronger currency is simply bad for competitiveness. Financial markets make little distinction between Terms of Trade and Competitiveness. In fact it has an initial negative effect on corporate profits, but it unleashes innovation and stronger competitiveness over time. From a macroeconomic perspective Swiss Policy Makers should avoid throwing money at currency markets – they should rather focus monetary resources and fiscal spending at directly supporting real economic activity. Should the SNB give in to political pressure and try to fight currency markets head-on to defend an artificial currency peg; it will ultimately fail and create an array of new problems. Chief among them the monetary conditions that raise systemic instability or vulnerability of the economy. It would also set a dangerous precedent for Swiss manufacturers to rely on lobbying the central bank and government to support them. Something that has led to chronically uncompetitive economies elsewhere. Public listed companies are unfortunately under more pressure to deliver quarterly results than boosting their long term competitiveness. Short term profits at publicly listed firms are “by design” defended at the cost of costly externalities to society and future competitiveness, yes even future profits.
There is no doubt, that a sharp rise in the value of a nation’s currency causes pressure and pain. But Policy Makers should have all options on the table and not treat capital restrictions as a “taboo”. Too often, “free capital flows” are seen as an “unthinkable option”. Taiwan and South Korea are thriving economies without the complete free capital flow of Western nations. Completely free capital flows are somehow rather the exception than the rule in this world. I believe that unprecedented challenges call for unprecedented solutions. While Swiss manufacturers deserve a certain degree of protection, giving in to the demands of public-listed exporters would somehow be like bailing out UBS for a second time. As shameful a chapter in Swiss history like the demise of the Swiss national carrier. Globally active firms have the duty to commit resources to understand the global risks they are exposed to – they cannot simply focus on maximizing short-term profits until the next global systemic event occurs. The risk of a sharp CHF appreciation is one of the most well-known macro risks for any Switzerland-based multinational – it is not a matter of if, but when it will occur. Governments should focus on helping with events that were totally unpredictable. Otherwise the role of the government will dramatically grow in Switzerland as has already in so many other nations. Globally active firms have to take care of that Swiss Franc risk by themselves – having in place strategic teams analysing long-term macroeconomic & geopolitical risks and taking all necessary measures. Unfortunately many large Swiss firms delegate or externalize this strategic issue: They don’t have their own teams assessing those risks, they rely on external opinions and on lobbying the government to shield them. The advice they seek is often post-event and therefore biased towards the short-term and financial aggregates. They often miss the more complex macroeconomic and geopolitical trends behind the events. That is like wanting to benefit from globalized markets without having to embrace the complex interactive macro risks of such a globalized world economy. The SNB should stand its course. It enjoys still a high degree of credibility; of a level that other central banks envy. That in itself is a precious asset.
I believe Switzerland should apply a 3-staged approach:
- The primary line of defense should be selective temporary capital controls & restrictions
- The secondary line of defense should be regulatory & fiscal measures along broad capital restrictions
- The tertiary line of defense should be the whole arsenal of monetary & policy tools including the threat of a temporary peg. A peg is the potentially costliest one with the biggest macro risks though.
That way the SNB could spare its resources and tools for later. This is not a sprint, but a marathon.
Global crises are on the rise, not behind us
Because of the history of my family and what they went through before, during and after WW2, I have followed global geopolitical trends since my youth – and according to my research and proprietary methodology the world is facing at least 10 powerful geopolitical sources of systemic risk. Altogether we expect 10 of 20 major geopolitical and macroeconomic trends to overlap during 2015 to 2018. Leading to unprecedented frictions, tensions and recurring crises. They are gathering pace and increasingly converging. And those who follow science may want to add geophysical & gravitational instability of our planet that may be feeding climate instability. We can close our eyes to them of course, but taking action now will decide whether we are ready. The following sources of tension are being augmented by the rise of new nations, their appetite for resources and aggressive reach for global power and hegemony – they will make sure that at one point the demand for Swiss Francs and eventually Gold will see new highs:
a) Geopolitical balance of power tilting east
b) Massive debt-burdens
c) Rapidly aging populations and shrinking labor forces in industrialized nations soon to be joined by large emerging nations (GDP growth rates set to decline globally)
d) De-basing of central bank paper-money- money printing creating boom-bust cycles that call for more of it
e) Massive & unprecedented global arms race (defense spending in Middle East & Asia-Pacific alone to exceed USD 2’700 bn this decade)
f) Middle East conflicts; emerging nations are aggressively projecting their new power there, supplying weapons unchecked. Iran is winning the battle for ideological supremacy in the Muslim world. After Egypt’s fall only Saudi Arabia can stand up to it. A futile effort as the USA allies herself with Islamic states in Turkey and Iran.
g) Radicalization of Islam and spreading of dirty weapons of mass destruction
h) Recurring energy, resources and food scarcities
i) Clean sweet water scarcity – but 80% of sweet water is needed in agriculture
j) Manufacturing shifted to anti-democratic nations with hegemony ambitions – the West in the trap
Climate instability is adding to unpredictability of crops, tensions & natural disasters
=> these are all part of the transitioning from the Cold War Equilibrium .. most probably to a world where nations will give way to regional super-governments formed along shared geopolitical interests. Weakened individual nations won’t be able to cope with the magnitude of the coming crises. More important than the crises is the fact that major changes lie ahead at political and economic level that shall impact every society on the face of our planet. Neither “fear” nor “denial” helps.
Because of these sources of tension (also sources of opportunities) and their intermittent rising momentum, high uncertainty will remain. Thus all Swiss households (govt, companies, banks and even families) should prepare for possible waves of Swiss Franc strength. And take advantage of it, where possible. The world is simply in a transition period and vulnerable. Switzerland should consider selective capital restrictions or other protective measures that should help make the rise of the Franc managable; To believe we can fully contain it, is unrealistic and risky.
In recent months I have seen many people – among them some working in the financial industry – deeply shaken. If even bankers and economists cannot hide their fear, why should the man on the street? This is not an external-unpredictable-temporary shock; most crises in the past 10 years are connected and part of this historic transition.
What awaits us in the future makes a strong case for both SNB and Bern to prepare for more geopolitical friction, risk events and upward pressure on the Swiss Franc.
With information and analysis currently available I see this as the most likely scenario over 10-20 years :
(Trying to look far into the future we may see the following picture taking shape, to a lesser or greater extent)
- Only a few centers of government power worldwide – many nations will exist only on paper; their sovereign powers transferred to super-governments. I don’t believe the EU will disappear, but rather rise again as nations transfer more powers to Brussels or whatever a new capital should be (Rome?). For sovereign nations to voluntarily transfer their powers to Brussels though, more and bigger crises are needed. This temporary equilibrium with powerful super-governments could set the stage for a future unified Global Government (one of the visions of the UN and many world leaders).
- Currency reforms are needed to fix the debased paper-money systems. There have been high-level talks to form major currency blocks and even for a Global Currency. People that spread conspiracy theories speak of a One-World Currency, but although this is the final goal of many world leaders and the UN, that is premature for now. I encourage readers to avoid conspiracy theories and to chose sound analysis instead. Such supranational or global currencies need a much higher level of systemic crisis and distress to become reality, we aren’t there yet. All talks so far have shown big differences. I believe Currency Reforms will be concerted and coordinated. Thus large currency reforms and monetary blocks will come first, paving the way for a possibly global currency, but they will be primarily a response to major economic-political crises.
- Tensions will escalate in the Middle East, where old and new powers are aggressively projecting their influence – unchecked. Brazil, China, Pakistan, Turkey are already supplying intelligence, banned materials and weapons to the region. The arrival of so many new powers to the Middle East conflict is destabilizing the region. Western nations look away from fear of losing big business contracts in emerging nations. To regain its influence, Russia has begun to sell strategic weapons to Iran-Syria. Saudi Arabia and its neighbors in return are buying huge amounts of weapons from the USA to contain Iran and its allies. Meanwhile Turkey rallys behind Iran. The destabilization has passed the point of no-return. It is possible that the economic, military and geopolitical crises in the Middle East will ultimately force Europe, Russia, China and the USA to accept a sweeping Peace Treaty for the Middle East. One advanced by Turkey? In 2017 Turkey celebrates the 500th anniversary of the capture of Jerusalem by the Ottoman Empire. If you know Oriental people’s circular & religious thinking, you should keep an eye on Turkey’s rise. The unsustainability of such a peace may one day lead to more powers for the U.N. in key parts of the world (Middle East) and the de-facto rise of a World Government. Given the trend of UN activity shift from New York to Geneva, a possibly unified World Government could be headquartered in Geneva. One thing is for sure – governments will get much bigger and powerful in controlling every area of human life in the foreseeable future. All major nations are converging in unprecedented surveillance of their citizens already. They are using the “terror threat” to achieve this.
- Aggressions and Wars are very likely and only a matter of time. The world looked away when Hitler spoke of genocide and built weapons, today the world looks away when rising powers bully their neighbors and when Iran’s president denies the holocaust and promises a genocide. Well-meaning people believed Mr Hitler wanted sincere talks and peace; he used it to buy time. Passivity & tolerance (of imminent aggression) are a risky combination in times like this. Had the world stopped Hitler early the world would not have lamented 60 Mio lost lives. When the EU played along with years of endless peace talks in former Yugoslavia, a series of massacres unfolded. Ironically only the US intervention helped contain a greater tragedy. Ironically, pacifists are at times the greatest allies of ruthless aggressors. Thus, even peace-loving people have to keep an eye on the big picture and avoid being instrumentalized.
- Global crises are the cathalyst for Power Centralization & Concentration: according to my research geopolitical and economic crises may reach their climax before 2020; forcing overwhelmed nations to give up their sovereignty. I would not underestimate the EU and Russia despite all their policy errors and limitations. Russia is forging already a greater union and will try to expand it south into the Middle East. The EU is seen by many nations de-facto as the most “expansionist” power, but one that cannot defend herself. Is your business ready for such power concentration?
- These possible scenarios suggest for Bern and the SNB to prepare for a long-haul marathon or “conflicts” for the survival of the nation as a sovereign state. Without financial health we won’t overcome the super-crisis independently. Apart from capital controls, we need to prepare strategically, considering different potential scenarios, strategies and tools.
Disclaimer: This text represents solely my personal opinion, flowing out of my personal macro-geopolitical research and network. No person should understand this analysis as a buy or sell recommendation of any mentioned asset. Macroeconomic analysis is complex and subject to changing factors and regular review.
Christian Takushi, Macro Economist MA UZH, In Zurich-Waltalingen, 10 August 2011