Bloomberg reports Franc Weakens Against Dollar, Euro After Report Currency Target Discussed

The franc weakened after SonntagsZeitung reported over the weekend that the Swiss government and the central bank are in “intense” talks over setting a possible target for the currency, citing unidentified people close to the situation.

Talk is Cheap

OK, once you decide a target, how do you get it there? I addressed that question previously in Swiss Central Bank Ponders “Temporary” Peg to Euro; Franc Trades Sharply Lower; This a Bluff? What Does it Take to Maintain a Peg?

Is the Threat a Bluff?

Just because someone discusses something does not mean the discussion was serious. We cannot tell.

However, we do know what a currency peg requires: To maintain a currency peg, one must buy (or sell) virtually unlimited quantities of a foreign currency, as much as the market supplies, to maintain the desired conversion rate.

Interest rate policy works the same way. To maintain an interest rate target, the Fed (or any central bank in general) must supply or subtract unlimited amounts of currency to maintain its target interest rate. This happens continually.

If the rate is targeted lower than what the market thinks, the Fed or Central Bank must print enough money to keep the target. Likewise, if the Fed sets a rate higher than the market dictates, it must drain as much money as necessary to keep rates to the peg.

Does anyone really think this continual micro-manipulation of currency to maintain an arbitrary interest rate (set by central planners who do not know what they are doing) is a good idea?

Currency Peg Risks

Back to the Swiss Franc: A currency peg is much riskier, because the defense is not in relation to its own currency as it is with interest rates. Moreover, one might expect wild swings and an immediate snap-back once the peg is removed. Thus “temporary” might mean for as long as the Euro crisis continues, and that might be a very long “temporary”.

Finally, note the relative size of Switzerland vs. all the Eurozone countries. Buying “unlimited” Euros could rapidly get out of hand.

China goes through the same setup to maintain its “widening” peg to the US dollar. However, China does not allow much external trade of the Yuan.

The above discussion does not answer the bluff question, but it does state what the parameters of the defense must be. All things considered, I do believe it is a bluff.

Let’s return to the question: Is it a Bluff? I still don’t know but now I think it’s more likely than I previously thought.

Bear in mind, setting a target and hoping the market reacts to it, and officially setting a peg are different things. However, once bureaucrats start marching down a certain path it is hard to get them to stop, no matter how futile the march.

I have never seen currency intervention work. It’s hard enough if you are a large country, but the size difference in economies and forex trading says the idea cannot work unless the target just happens to be at or near where the market thinks it should be.

Mike “Mish” Shedlock

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