News Monday, August 13, 2012 Page 1

Anatole Kaletsky Daily Comment [email protected] : Not A Peg For All Seasons

!e has constrained the appreciation of the franc, but incurred spill-over e"ects. !e result of liquid funds pouring into safe- haven Switzerland has been rapid credit growth and a surge in property prices. But the question we increasingly hear asked is whether the SNB will stick with the de facto peg since the cost of doing so keeps increasing.

While markets almost always win when an authority seeks to protect its The SNB’s reserve currency from devaluation, the opposite usually applies in the case of an accumulation has been huge authority repressing the value of its currency. In practice, however, the Swiss story may turn out di"erently for four key reasons: Firstly, the SNB's reserve accumulation has been enormous. Reserves are

at about 71% of GDP (in China that would be $5 trillion and in the US $10.5 trillion!) and the pace of accumulation shows no sign of dwindling. !e increase in July alone was CHF41b.

!e problem with this sort of reserve accumulation is not just the potential in#ationary e"ect, which has so far been mild. !e bigger problem is the potential loss incurred by the SNB when the peg

eventually breaks or is abandoned. Central banks cannot go bust, but If the peg was to go then they must publish accounts. When the peg policy is $nally ended the paper losses could run into paper losses could run into hundreds of billions. hundreds of billions Secondly, Switzerland has seen the development of a strong populist movement led by 's Swiss People's Party which vili$es

bankers in general and the SNB in particular. Blocher's party orchestrated the campaign that helped oust Philipp Hildebrand as head of the SNB.

Checking The Boxes Our short take on the latest news

Fact Consensus belief GK Research reaction

China new loans declined New loans lower than Recent rate cuts will help A potent new force in Swiss from RMB 920bn to 540bn in expected RMB 700bn; M2 profit margins, but its impact Jul; M2 growth up +13.9% slightly above exp. +13.8% on demand is not obvious politics have been the anti- Japan 2Q GDP growth Rebuild spending wanes; 2H banker Swiss People’s Party weakened to +1.4% YoY Worse than expected +2.3% growth at risk lacking global following +4.7% in 1Q demand and weaker ¥ Eurozone growth problems French IP fell by –2.3% YoY Worse than the expected are intensifying and we in June, up from –3.7% –1.8% YoY decline remain underweight the

Canadian employment fell Disappointing and lowers the Much worse than the by –30,400 in July, down likelihood of a tightening by expected +6,000 gain from +7,300 the BoC in the near term HK GDP dropped –0.1% s.a. Lower than expected 0.6%; All external-orientated Asian QoQ in Q2, vs revised 0.6% in FY estimate was reduced countries suffered; limited Q1; YoY, Q2 GDP up 1.1% from 1-3% to 1-2% sign of turnaround so far

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!is success has whetted the populist appetite for more attacks. !e paper Swiss Franc: Not a Peg For All losses on Switzerland's reserves a%er a 2010 attempt to hold down the Seasons exchange rate have featured heavily in the anti-SNB campaign. !e problem for the SNB’s new president, !omas Jordan, is that future losses could be far higher. And thirdly this brings us to the issue of the personalities involved. Hildebrand used to work as a hedge fund analyst (Moore Capital) and understood foreign exchange markets. He also believed in his own abilities and had the temperament to take big risks. Jordan is a lifelong Thomas Jordan has been far central banker/academic, who is as di"erent from Hildebrand as could be more predictable than imagined (while still remaining Swiss!) !is has three implications: Hildebrand in his daily i) Jordan is much more likely to blink than Hildebrand; dealings with currency traders ii) If Jordan does blink, he will be able to blame the losses on Hildebrand - and Swiss public opinion will back him on this (since everybody hates hedgies these days, even in Switzerland);

iii) Jordan seems to have no regard for market tactics. Under Hildebrand the SNB intervened unpredictably and skilfully to keep EUR comfortable

above CHF 1.2. He o%en in#icted sharp losses on traders who tried to challenge the peg by weakening CHF much more than "required" by the 1.2 policy, if only for a few hours or days. Once Jordan took over, this

tactical trading quickly stopped. !e EUR fell straight to the #oor of CHF 1.2010 and has remained virtually motionless at that level, with the SNB simply standing there and taking all bids. !is is about the most ine"ective way of defending a peg that can be imagined and it casts doubt

on the SNB's ability e"ectively to manage through a genuine crisis. And $nally, there is the global currency environment. Should the euro

Should the euro stay together break up then the CHF peg will clearly need to be adjusted. One but maintain a gradual possibility would be re-pegging to a new DM. But what if the eurozone manages to muddle through as a unit? In this eventuality, there is a strong depreciation path, then the chance that the euro will weaken leading to the obvious question; why CHF peg can be unwound bother preserving the peg. A%er all, the CHF has fallen by 25% from its without much fuss high against the dollar and yen. If the euro depreciated by a further 10- 15% against the dollar (which is exactly what it has done in the past 12 months), CHF/USD would move back into the CHF1- 1.20 range where it has long traded. In this eventuality abandoning the peg would not be major deal.

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