The Swiss National Bank’s Loss of Nerve Will Cost It Dearly

It’s a news that many Americans have probably missed in the chaos of what is happening here in America. But the news is important. It marks a new step in the development of the world recession caused by governments’ reckless borrowing and spending based on Keynesian interpretation of events. It also gives us the opportunity to see clearly the failure of two anti-Biblical economic theories that have proven, and will prove very soon, to be failures: mercantilism and Keynesianism.

The news – given in a short press release on September 6 – is that the Swiss National Bank declared that it would no longer tolerate the ever strengthening position of the Swiss Franc to the rest of the world’s currencies, and would put a cap on its rise. The Bank will refuse to exchange the franc for rates lower than 1.20 francs per euro. The language of the press release is very strong:

The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

In other words, the Bank promises to print as much money as necessary to buy as much foreign currencies as necessary to keep the value of the franc down. Why? What makes this necessary?

Because the strong franc is threatening the exports. The higher the value of the franc is, the more expensive the Swiss products become for buyers in other countries. They will buy less, and therefore the Swiss exporters will have to produce less, and have less profits, and their employees will have to go with lower incomes. Or some of them may have to be laid off, until the situation improves. This is the thinking of mercantilism: A nation’s wealth is produced by its exports, by the influx of money from other nations. With only one difference: When mercantilism was at its height as a practice in England, “money” meant “bullion.” In our present times, “money” means “worthless paper notes or computer blips whose quantity is controlled by governments who create more and more of it, bringing its value down.” And this is Keynesianism, the belief that the manipulation of the money supply by the government creates wealth. When the two, mercantilism and Keynesianism, combine, they produce a deadly mix that can easily destroy even a strong economy like Switzerland’s.

Now, the first obvious thing is that the franc is not getting stronger, it is the rest of the currencies and their economies that are getting weaker. Both Europe and the United States, the two main trading partners of Switzerland, are ravaged by recessions and high levels of government and private debt. It is this weakening of the economies in the industrialized world that leads to decreased exports. The growth has been negative in both regions for a couple of years now. Unemployment is reaching new highs, and the risk of government default in both the US and Europe makes investors unwilling to invest. The creation of new money by the central banks doesn’t help the economy anymore because most of it doesn’t even reach the economy, it only covers the ever growing government debt. Even if all things in terms of currencies were equal and there was no relative movement between the franc and the other currencies, the Swiss exporter will export less simply because the French, the German, the British, and the American producer have a smaller market, are forced to produce less, and therefore will buy less from a Swiss exporter. And the average European or American consumer has less money to buy, and therefore will buy less. A manipulation of exchange rates and money supply won’t solve this problem, except may be for just a short time, and with dubious effects.

But all things aren’t equal. Contrary to the mercantilist theory, there is more involved in the wealth of a nation than simply the exporters. There are the average people on the streets who have Swiss francs in their bank accounts. There are also the importers. In the final account, given the characteristics of the Swiss economy, the very exporters are very often also importers. And what the export loses, is gained in other areas of the economy, just as important as the exports.

In a world of economic recession and devaluation of all other currencies in the last two years, the Swiss saw their own wealth increase just by the sheer fact that their currency remained stable. Just a year ago 1 franc was exchangeable for 1 dollar. A little over a month ago, a person with Swiss francs in his hand had to pay only .72 francs for one dollar. This increase in relative value by almost 35% made the Swiss citizen able to buy 35% more American and European goods with the money he had. Given the fact that most of the goods traded around the world are denominated in either euro or dollars, this made the Swiss the richest people in the world. Oil, for example, while increasing in price for everyone else in the last one year, remained stable when denominated in Swiss francs (in fact, the price of crude oil dropped 6 per cent measured in Swiss francs between September 2010 and September 2011).

In addition to it, the Swiss whose savings and retirement funds are in Swiss francs, saw their future value rise, compared to the retirement funds and the savings of the world around them. A Swiss retiree now can afford much more than their French or German counterpart.

And let’s not forget, foreign trade has two parts: export and import. And if exports become more expensive because of the strength of the currency, imports become cheaper for the same reason. And Switzerland is not a nation that has too much of its own. Imports are an important part of its economy.

In such situation, the free market could have dealt easily with the decrease in exports due to the world’s economic recession, provided it was backed by a stable currency that is as good as gold (as the franc was). First, of course, exports can’t be kept at the previous levels no matter what. But they could be kept at a satisfactory level as exporters reduce their prices. When the buyers are poorer than before, the seller must be willing to profit less from them. The decrease of import prices would have helped in this. A relative decrease in wages would have contributed to it too. As long as the franc remained stable, the economy could rely on the fact that any calculations based on it are realistic and therefore a new level of export prices could be established that still produces profits and yet accounts for the new realities in the world economy.

The decreased exports, combined with a strong franc and cheaper imports could help the Swiss industry do something other economies do not have the luxury to afford now: retool and invest in new technologies. Also, using the lower world prices for building reserves of raw materials – something the Swiss used to do in the past – is much more possible when your economy is strong and everyone else’s is weak. The gold reserves of the nation could be used as a cushion against the short-term problems that could arise, with a view of a longer term benefits.

And what is most important, there is no short-term threat to the Swiss economy. Unlike the governments of the EU and the United States, the Swiss government hasn’t lived from-hand-to-mouth, hasn’t run big deficits, and has no large debts it needs to pay back. There is no rush. All that was needed was business as usual, with small incremental steps, taking advantage of the lower prices and adjusting for some unfavorable factors in the world economy. And in the long-term, Switzerland would have emerged even stronger and better prepared to meet future economic challenges, as she has always done.

In the final account, it all boils down to this: short-term vs. long-term. In a free economy and with sound money, the Swiss would have taken in some short-term loss; but would have positioned themselves for long-term supergains once the world’s economy stabilizes.

The Swiss National Bank decided it couldn’t stomach the short-term loss and would try to manipulate the currency to avoid it. Therefore it decided to print an indefinite amount of Swiss francs to buy out as much foreign currency as necessary to keep the franc down and the exports up.

Provided this keeps the exports at the previous levels, and the economy working, the Swiss citizens will still get poorer. May be they will have the same amount of francs in their bank accounts; but these francs will be worth less. As the Bank buys out more foreign currencies, more foreign nationals will have Swiss francs in their hands and will use them to compete for Swiss goods. This will drive the prices in Swiss francs up, and Swiss citizens will see themselves poorer as the purchasing power of their francs declines. Their savings and retirement funds will decrease in value too. Since the effect of the newly printed francs won’t be known or predictable, no one will know what the future value of those savings and retirement funds will be. This will drive more people to convert their savings from francs into others, less liquid but more stable assets, like precious metals or real estate. This will inject additional amounts of francs on the market, driving the value even further down.

When this happens – as we in the US very well know – any market calculations would become extremely difficult and unreliable. A currency that jumps up and down, its value driven by government manipulations and the panic of the investors and the public, is not a good foundation for solid economic assessments and predictions. Everyone is a loser in such situation: the public, the importers, the banks, and the exporters. Especially the exporters since they depend so much on the exchange value of the franc; and a constantly shifting value won’t allow them to even calculate their profits and losses, let alone tell them if they need or can retool or invest in new technologies. A currency’s most foundational function is to allow comparisons of value and economic calculation. When this is destroyed because a central bank has tampered with it, the currency is as good as nothing, and the economy suffers.

In short, the SNB lost its nerve and decided to act to solve a short-term problem, sacrificing the wealth of Switzerland and its citizens in the long-term. But that loss of nerve will cost dearly. And the markets know it: hedge funds are already plotting to take advantage of it. The markets are not easily fooled by the theories of mercantilism and Keynesianism; unlike the central bankers, they have learned the lessons of the last two centuries and they know those two theories produce failures when applied in practice. Ideas have consequences, and bad ideas have bad consequences. And those who can tell bad ideas for what they are, can take advantage of them. And Switzerland will pay dearly in the long-term, unless it makes a quick turn and returns to the principles of free markets and sound money that have kept it economically stable and prosperous for centuries.