I dedicate this blog primarily to real estate headlines and news. But on occasion there are non-real estate issues in the global financial system that deserve exposure, and the Swiss Franc Currency Shock is one of them. If you don't fully understand the issue, you're reading the right blog.
The currency shock happened when the Swiss National Bank (or SNB, similar to our Federal Reserve) announced that they would lift the "cap" on the Swiss franc's value.
Why did the SNB create a "cap"?
When countries in the Eurozone (countries that use the Euro) began to have problems (think Greece, Spain, Portugal and Ireland), firms began trading their Euros for Swiss francs (the Swiss have a long-held reputation for having a strong financial system). However, Switzerland is an exporter. They sell goods and services primarily to other European countries. When the Swiss franc increased in demand and the Euro fell in demand, the Swiss franc became more expensive, and it became harder for Swiss firms to sell their goods and services to other European countries. The SNB created a cap in 2011 to protect their exporting firms.
How did the SNB create a "cap"?
A country can peg its currency to another currency by buying and holding large sums of a particular currency. SNB did just that: bought and held various, depreciating European currencies like the Euro. Makes sense, right? If you bought and held a large stake in a foreign currency, your net worth would be tied to that currency. This is not entirely uncommon, and is the same mechanism Tim Geithner accused China of using when he said China is "manipulating its currency". If you don't remember, click here.
Ultimately, this cap means that as the value of the Euro decreased, so did the value of the Swiss franc.
Why did the SNB lift the "cap"?
In a way, the US and the Eurozone have been dealing with the same global recession, but in two different ways. In Europe, nations have imposed "austerity" measures. This is particularly evident in Greece, where the Eurozone has been requiring the country to impose higher taxes and cut spending. In the US, the Federal Reserve has taken to several rounds of "quantitative easing." The Federal Reserve has spent billions nearly every month on bonds in recent years to prop up the financial system. (The Fed spends money on financial firms' assets. Financial firms can sell their assets for more money. This means that financial companies have more cash. If competing financial firms have excess cash, they can't charge borrowers as much to lend that money, and interest rates go down. Ultimately, it's cheaper for borrowers to make investments.)
The American method appears to be attractive to the Eurozone. But another thing happens when you have excess cash in your financial system; the value of your cash depreciates.
It looks like the Swiss National Bank is afraid of quantitative easing in the Eurozone. If quantitative easing proceeds, AND the SNB is committed to pegging the exchange rate, the easing would further depreciate the Swiss franc. While this may sound like good news because the Swiss watch you've been eyeing is getting cheaper and cheaper, this may not be so good for the Swiss. In real terms, letting the currency become worth less and less, means that the country is becoming increasingly disenfranchised. Get it? The value of the country's holdings (i.e. money, assets, everything denominated in Swiss francs) become worth less and less. This is why they removed the cap.
How did the SNB lift the "cap"?
They will stop their practice of buying and holding weaker currencies.
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