It’s interesting to read stories on the Swiss Franc today because it’s not the case study we’re all used to hearing. Normally a country is forced to devalue in order to save its economy from higher interest rates elsewhere. The Swiss National Bank is instead saying it is forced to RE-value because it can’t, what exactly? It can’t stop people from loving the Franc, especially as the ECB is closer to its own money-printing program.
First of all, this is BS because all the Swiss National Bank has to do is promise to print francs and buy Euros at 1.20 francs / euro to keep the peg. They don’t actually have to print all those francs, the threat is enough if made credibly. It is unfortunate for the Swiss economy that their central bank has taken such a deflationary approach. If the ECB isn’t doing enough to combat “lowflation”, then the Swiss bank is actively severing itself from a fairly tight monetary policy to pursue an ultra-tight monetary policy.
But don’t feel too sorry for Switzerland. It seems like political pressure is to blame for it’s about face. It’s as if the Swiss all decided to listen to Ron Paul and worry about following a supposedly loose ECB monetary policy.
What I have trouble understanding is why global markets are freaking out that one small country is committing monetary suicide. To answer that question requires us to think in terms of expectations and market psychology. The American economy seems strong recently, but treasury rates have been falling ever since the taper. Conservatives in the US are hopping mad about QE while liberals don’t seem to care. Liberals want to use a sinking economy to enact expensive social programs that will be impossible to get rid of 50 years from now.
The markets are perceptively seeing the Swiss turnaround play out elsewhere. The Federal Reserve’s extraordinary measures to combat deflation have somewhat reset our expectations, but not enough to be considered “loose”. Yet the media, political pundits of all stripes, and a lot of macro-economists describe monetary policy as very loose. Conservatives blast the debasing of our currency, even while commodities prices tank.
Swiss perceptions of their central bank aren’t that far from our own. A central bank’s power to debase it’s currency and cause inflation is unlimited by math, but there are political limits. The SNB’s move today is a stark reminder of that fact. Thus expectations have suddenly become more deflationary, and monetary policy in Europe and the US has tightened (with 0 actions taken on the part of the ECB or Federal Reserve).
How will stock markets continue to react? Tight monetary policy is a strange thing. In the short term, there could be a gnashing of teeth in stock markets as asset prices follow commodities downwards. But stocks earn a return just like other securities. The hallmark of long-term, tight monetary policy is LOW interest rates. And low interest rates usually mean higher prices for those securities earning a steady stream of income. So again, buy value-oriented, high-yield stocks, because higher interest rates are still a long way off.