Eploiting the EUR/CHF 1.2 minimum exchange rate

[new_trader]

The German government ends up with the cash. You tell me whether those profligate, inflation-loving Germans are gonna cause a problem.

The SNB creates CHF to buy EURO’s...then uses those EUROS to buy German Bonds....where have the CHF ended up and where did the Euros come from in the first place?

Let me ask it like this instead.

Let’s suppose that a person living and working in the Euro zone doesn’t want to save in Euro’s. They open a Swiss Account and every month they deposit 1000 Euros that they have honestly earned into the account. Now, within the Euro zone there might easily be 1 million people who want to get rid of their Euro’s (and easily as many in the US who want to get rid of their dollars), but let’s stick with Euro’s for the moment. So that is 1 billion Euro’s/month that the SNB is buying...and the exchange equivalent that is being deposited in CHF accounts that the SNB is creating out of thin air.

The SNB now sells it’s Euros and buys German Bonds, so now it’s the Germans who hold the Euros instead of the SNB and they do absolutely nothing with them at all, the just keep them in The Deutsche Bundesbank?

In the meantime, there are Billions of CHF sitting in Swiss Bank accounts waiting to be spent at the same time they are being devalued and debased. According to you, no extra money ends up circulating in the economy throughout this process because it is nothing more than transfers between Central Banks and Governments...is that correct?

Therefore, according to you, the Swiss are not inflating, correct? Their currency is magically being devalued against the Euro without any consequence whatsoever? wasn't the whole idea to help exporters? The money must be circulating somewhere.

 

[scose-no-doubt]

The euros don't come from anywhere, the SNB is buying up German government bonds... they're financing German government operations and the Germans benefit from lower (possibly depressed) borrowing costs. As with any government bond, the bond is repaid (from tax income or treasury returns or whatever - just government income) at par on maturity and the SNB has received the coupon in the meanwhile. Then, the whole cycle beings again when the cash is re-invested in government bonds.

 

[Martinghoul]

Therefore, according to you, the Swiss are not inflating, correct? Their currency is magically being devalued against the Euro without any consequence whatsoever? wasn't the whole idea to help exporters? The money must be circulating somewhere.

Well, the Swiss ARE inflating, but they're really only counteracting the deflation that is naturally occurring within the Swiss economy. So there are certainly consequences...

As to the Euros, yes, the money goes to the German government. Now, the German government then decides what to do with it. For instance, it might decide to cut everyone's taxes, which would obviously cause this money to circulate within the German economy. However, the German government chooses (at least for the moment) to not cut taxes, but rather pay off debts (i.e. reduce budget deficit). For example, in 2011 German budget deficit as a %age of GDP went from 4% to 1%. So I guess you can interpret this as the SNB helping with the ongoing European deleveraging.

 

[rsh01]

Interesting that they've actually been going down since Q3 2011. Not sure why that would be.

"anybody who has hoped on a hike of the EUR/CHF was trading not with but against the SNB"

"On the other side the SNB has increased its firepower and its reputation: breaking the floor will be very difficult for the next 2 years"

georgedorgan - SNB buys Swiss Francs and sells Euro: Welcome to the EUR/CHF peg

re its increase in firepower.....

"But if we look at current prices for these assets it becomes clear that the SNB will have a very positive quarter in Q2/2012, if current market conditions do not change.
1) 10 year German Bunds have risen from 138 to 141 since the end of March.
2) The CHF/JPY has fallen from 92 to 89.
3) The GBP/CHF continues to appreciate from 1.4444 to 1.47 since the first quarter."

hmm theres not much comment re 'if current market conditions do change'.

 

[new_trader]

Well, the Swiss ARE inflating, but they're really only counteracting the deflation that is naturally occurring within the Swiss economy. So there are certainly consequences.

Ok, so at least you have highlighted my my point. They are counteracting a natural, free market deflation with artificial inflation. History has shown time and again that Central Banks have an appalling track record of getting this right. The Euro might be saved by weaker members dropping out but I think the SNB will one day face the choice of high or even hyper inflation at some point or continuing their operation. Unless of course things are different this time.

 

[Martinghoul]

"anybody who has hoped on a hike of the EUR/CHF was trading not with but against the SNB"

"On the other side the SNB has increased its firepower and its reputation: breaking the floor will be very difficult for the next 2 years"

georgedorgan - SNB buys Swiss Francs and sells Euro: Welcome to the EUR/CHF peg

re its increase in firepower.....

"But if we look at current prices for these assets it becomes clear that the SNB will have a very positive quarter in Q2/2012, if current market conditions do not change.
1) 10 year German Bunds have risen from 138 to 141 since the end of March.
2) The CHF/JPY has fallen from 92 to 89.
3) The GBP/CHF continues to appreciate from 1.4444 to 1.47 since the first quarter."

hmm theres not much comment re 'if current market conditions do change'.

This is a rather superficial analysis. Contrary to what the George Dorgan feller says, there is actually no indication that the SNB has been selling EUR.

 

[Martinghoul]

Ok, so at least you have highlighted my my point. They are counteracting a natural, free market deflation with artificial inflation. History has shown time and again that Central Banks have an appalling track record of getting this right. The Euro might be saved by weaker members dropping out but I think the SNB will one day face the choice of high or even hyper inflation at some point or continuing their operation. Unless of course things are different this time.

Well, anything and everything is possible one day... Who knows, the world might end on the 21st of December this year.

Can you offer me some specific cases that you're alluding to? Specifically, the Central Banks getting it wrong, time and again. Also, if you have an example of high or hyper inflation as a result of the Central Bank measures?

Needless to say, I am in disagreement with you regarding the SNB's measures.

 

[new_trader]

Well, anything and everything is possible one day... Who knows, the world might end on the 21st of December this year.

Can you offer me some specific cases that you're alluding to? Specifically, the Central Banks getting it wrong, time and again. Also, if you have an example of high or hyper inflation as a result of the Central Bank measures?

Needless to say, I am in disagreement with you regarding the SNB's measures.

I know you disagree because like other PhD Economists you think that a bureaucrat knows exactly what they are doing better than the market does. The SNB has chosen 1.20 for what reason exactly? Why not 1.25 or 1.15 or 1.30? How do they know that 1.20 is precisely the correct rate to produce the results they want? These are rhetorical questions although I’m sure you can tell me exactly why 1.200000000000000000000 and not 1.200000000000000000001 is the correct and precise rate.

In another thread you implied that Governments in the Euro zone were not inflating yet this appears to be nothing more than a Rube Goldberg method of debt monetization by proxy. The Germans are paying off debt with Euros the Swiss used to buy German bonds using CHF that they printed to buy the Euros they are selling back to the Germans. This seems to be the economic equivalent of “There was an old lady who swallowed a cow, I don't know how she swallowed a cow; She swallowed the cow to catch the dog, She swallowed the dog to catch the cat, She swallowed the cat to catch the bird...”

We all know what eventually happened to her...

"There was a Swiss bank that bought German Bonds....

 

[Arbu]

"anybody who has hoped on a hike of the EUR/CHF was trading not with but against the SNB"

"On the other side the SNB has increased its firepower and its reputation: breaking the floor will be very difficult for the next 2 years"

georgedorgan - SNB buys Swiss Francs and sells Euro: Welcome to the EUR/CHF peg

re its increase in firepower.....

"But if we look at current prices for these assets it becomes clear that the SNB will have a very positive quarter in Q2/2012, if current market conditions do not change.
1) 10 year German Bunds have risen from 138 to 141 since the end of March.
2) The CHF/JPY has fallen from 92 to 89.
3) The GBP/CHF continues to appreciate from 1.4444 to 1.47 since the first quarter."

hmm theres not much comment re 'if current market conditions do change'.

That's a good article. My estimation of the chance of the SNB abandoning the peg in the next couple of months has gone down from 40% to more like 15%.

 

[Martinghoul]

I know you disagree because like other PhD Economists you think that a bureaucrat knows exactly what they are doing better than the market does. The SNB has chosen 1.20 for what reason exactly? Why not 1.25 or 1.15 or 1.30? How do they know that 1.20 is precisely the correct rate to produce the results they want? These are rhetorical questions although I’m sure you can tell me exactly why 1.200000000000000000000 and not 1.200000000000000000001 is the correct and precise rate.

In another thread you implied that Governments in the Euro zone were not inflating yet this appears to be nothing more than a Rube Goldberg method of debt monetization by proxy. The Germans are paying off debt with Euros the Swiss used to buy German bonds using CHF that they printed to buy the Euros they are selling back to the Germans. This seems to be the economic equivalent of “There was an old lady who swallowed a cow, I don't know how she swallowed a cow; She swallowed the cow to catch the dog, She swallowed the dog to catch the cat, She swallowed the cat to catch the bird...”

We all know what eventually happened to her...

"There was a Swiss bank that bought German Bonds....

Well, sire, see here... It's very difficult to have a meaningful discussion like this. I have asked you a couple of specific questions, but you don't respond. Instead, you talk about something completely different. I can certainly respond to your points above, but it's gonna make for a very disorderly discussion indeed.

 

[rsh01]

This is a rather superficial analysis. Contrary to what the George Dorgan feller says, there is actually no indication that the SNB has been selling EUR.

sorry for being a bit slow on this subject, its late, i am tired & i do not know a great deal about CBs accts. i agree the article is not forthcoming in key stats, but there are some key balance sheet quarter movements which contrary what you say wld indicate that the eur has been used to buy chf...

major movements in the bal sheet:
~Eur & Cad foreign ccy investments according to the link below page 13 (same as one you posted) are only ccy's investments (in trans ccy) which have reduced in last quarter: by circa EUR17bn & CAD3bn.
~total foreign ccy investments have reduced CHF257bn to CHF245bn so there has been a net outflow of CHF12bn somewhere & its not (all) to pnl.
~ the balance sheet has shrunk circa CHF6bn- as per the article the money supply has reduced.

unknowns:
you 'guessed' that the Eur reduction cld be from selling german bonds - so we would expect an increase in Eur, and perhaps this was swapped out into another ccy along with the other eur17bn, but its pure speculation, & largely irrelevant cos there was a net outflow & eur / cad were only ccy's which reduced.

conclusion:
a foreign ccy flowed out to reduce the balance sheet & it cld only have been the eur or cad (indirectly or directly).

alternative conclusion:
we dont really know what the hell they are doing cos they have myriad of funky acctg rules for on bal sheet & off bal sheet accts.

http://www.snb.ch/ext/stats/balsnb/pdf/deen/Bilanz_der_SNB.book.pdf

(one note on there i did laugh at was that they only get audited at year end)

 

[new_trader]

Well, sire, see here... It's very difficult to have a meaningful discussion like this. I have asked you a couple of specific questions, but you don't respond. Instead, you talk about something completely different. I can certainly respond to your points above, but it's gonna make for a very disorderly discussion indeed.

I didn't answer because History is there for you to research and form your own conclusions.

I have one question for you, which you don't have to answer: Can you please rank in order of importance the conditions that you think need to exist before the SNB should end completely its currency manipulation with respect to the EUR.

 

[Martinghoul]

I didn't answer because History is there for you to research and form your own conclusions.

I have one question for you, which you don't have to answer: Can you please rank in order of importance the conditions that you think need to exist before the SNB should end completely its currency manipulation with respect to the EUR.

Well, firstly, consider me a total eeejit with no knowledge of history. Can you provide me with some examples?

As to your other point, the answer is simple. Universal consensus, among the various stakeholders in the Swiss society, that the EURCHF floor is wrong for Switzerland. What causes this to actually come about? I dunno... Maybe it's the expectations of high inflation that tip the scales. Or maybe it's the realization that a speculative property bubble is in the making and the various regulators are incapable of curbing it using macroprudential tools. At the moment, while concerns exist, there are no tangible signs of any such issues. On the other hand, there are tangible signs that the current valuation of CHF is causing the Swiss economy to lose industrial capacity and become over-financialized. The Swiss have seen this happen in countries like the US and they perceive this as a much more dangerous "slippery slope". So, for the moment, they unanimously choose the lesser evil.

 

[Martinghoul]

sorry for being a bit slow on this subject, its late, i am tired & i do not know a great deal about CBs accts. i agree the article is not forthcoming in key stats, but there are some key balance sheet quarter movements which contrary what you say wld indicate that the eur has been used to buy chf...

major movements in the bal sheet:
~Eur & Cad foreign ccy investments according to the link below page 13 (same as one you posted) are only ccy's investments (in trans ccy) which have reduced in last quarter: by circa EUR17bn & CAD3bn.
~total foreign ccy investments have reduced CHF257bn to CHF245bn so there has been a net outflow of CHF12bn somewhere & its not (all) to pnl.
~ the balance sheet has shrunk circa CHF6bn- as per the article the money supply has reduced.

unknowns:
you 'guessed' that the Eur reduction cld be from selling german bonds - so we would expect an increase in Eur, and perhaps this was swapped out into another ccy along with the other eur17bn, but its pure speculation, & largely irrelevant cos there was a net outflow & eur / cad were only ccy's which reduced.

conclusion:
a foreign ccy flowed out to reduce the balance sheet & it cld only have been the eur or cad (indirectly or directly).

alternative conclusion:
we dont really know what the hell they are doing cos they have myriad of funky acctg rules for on bal sheet & off bal sheet accts.

http://www.snb.ch/ext/stats/balsnb/pdf/deen/Bilanz_der_SNB.book.pdf

(one note on there i did laugh at was that they only get audited at year end)

Yeah, so you're right, it's difficult to understand what's where... However, if you look at the exact breakdown of the foreign ccy investments, you will notice that the EUR holdings have gone down by a lot as a % of all holdings, but that's excluding FX derivatives. If you look at the number including FX derivatives, on the other hand, there's virtually no change (<1%). That's, to me, a sign of the fact that they have had some cashflows, rather than actually selling EUR bonds outright. Same for CAD.

 

[rsh01]

Yeah, so you're right, it's difficult to understand what's where... However, if you look at the exact breakdown of the foreign ccy investments, you will notice that the EUR holdings have gone down by a lot as a % of all holdings, but that's excluding FX derivatives. If you look at the number including FX derivatives, on the other hand, there's virtually no change (<1%). That's, to me, a sign of the fact that they have had some cashflows, rather than actually selling EUR bonds outright. Same for CAD.

you are talking about the last table on the last page 13?
~ Currency breakdown of foreign currency investments, including derivatives, excluding investments and liabilities in connection with foreign exchange swaps - yes its a small % change, but this is derivs not inc swaps which isnt a key balance from what i can see. What is key is....

The 2nd from bottom table:
~ Currency breakdown of foreign currency investments, excluding foreign exchange derivatives - for Eur is a 6.5% reduction. This includes securities (for all ccy assets = chf237bn of which chf221bn = securities see p8 "securities") & cash & forms large part of the ccy investment balance of the Eur bal of CHF124bn (as per top table on p13 Excluding foreign exchange derivatives)

So you can infer there is a 6.5% reduction on chf124bn Eur ccy investment asset bal (which is largely securities) over the quarter....

..if i am reading it correctly.

http://www.snb.ch/ext/stats/balsnb/pdf/deen/Bilanz_der_SNB.book.pdf

 

[Martinghoul]

you are talking about the last table on the last page 13?
~ Currency breakdown of foreign currency investments, including derivatives, excluding investments and liabilities in connection with foreign exchange swaps - yes its a small % change, but this is derivs not inc swaps which isnt a key balance from what i can see. What is key is....

The 2nd from bottom table:
~ Currency breakdown of foreign currency investments, excluding foreign exchange derivatives - for Eur is a 6.5% reduction. This includes securities (for all ccy assets = chf237bn of which chf221bn = securities see p8 "securities") & cash & forms large part of the ccy investment balance of the Eur bal of CHF124bn (as per top table on p13 Excluding foreign exchange derivatives)

So you can infer there is a 6.5% reduction on chf124bn Eur ccy investment asset bal (which is largely securities) over the quarter....

..if i am reading it correctly.

http://www.snb.ch/ext/stats/balsnb/pdf/deen/Bilanz_der_SNB.book.pdf

This is the specific bit I am referring to:
http://www.snb.ch/ext/stats/balsnb/pdf/deen/A3_2_Devisenanlagen_der_SNB.pdf

 

[new_trader]

Well, firstly, consider me a total eeejit with no knowledge of history. Can you provide me with some examples?

Financial Stability Paper No. 13 – December 2011

Reform of the International Monetary and Financial System

By: Oliver Bush, Katie Farrant and Michelle Wright
Bank of England

Summary:

The financial crisis has imposed large costs on the global economy and revealed deficiencies in policy frameworks around the world. While the ongoing reforms to financial regulation aim to make the financial system more resilient, they cannot eliminate all the risks associated with large global capital flows. This paper argues that broader reforms to the International Monetary and Financial System (IMFS) are also required. The paper sets out three objectives for a well-functioning IMFS:

i) internal balance,
ii) allocative efficiency and
iii) financial stability.

The IMFS has functioned under a number of different regimes over the past 150 years and each has placed different weights on these three objectives. Overall, the evidence is that today’s system has performed poorly against each of its three objectives, at least compared with the Bretton Woods System, with the key failure being the system’s inability to maintain financial stability and minimise the incidence of disruptive sudden changes in global capital flows.

There is little consensus in the academic literature, or among policymakers, on what are the underlying problems in the global economy which allow excessive imbalances to build in today’s IMFS and/or which impede the IMFS from adjusting smoothly to counteract these imbalances. This paper attempts to provide a framework for thinking about these underlying problems, and thus a means for discriminating among the reform solutions.

Finally, the paper proposes a number of reforms to today’s IMFS. Measures that countries could implement themselves to reduce the underlying frictions include greater flexibility in nominal exchange rates; reforms to make national balance sheets more resilient; and measures to improve financial market participants’ understanding of the risks on countries’ balance sheets. Policy initiatives that require some degree of international co-operation to be effective include improvements to global financial safety nets; international initiatives to close data gaps; co-ordination on financial regulatory reform; and possibly revisiting the application of WTO rules. But the paper also notes that it may be impossible to remove the frictions entirely, and so there may be a need for a more fundamental overhaul of the IMFS in which a rules-based system would prevail, to force countries to internalise the externalities that result from their policies.

3 The performance of today’s IMFS

Since the breakdown of the BWS, international monetary arrangements have evolved into a decentralised system, in which countries have chosen to make independent choices about their monetary, exchange rate and financial stability policies. Capital has become increasingly mobile between countries.

Against a range of metrics, today’s system has performed poorly, at least relative to the BWS. Table A shows that the current system has coexisted, on average, with: slower, more volatile, global growth; more frequent economic downturns; higher inflation and inflation volatility; larger current account imbalances; and more frequent banking crises, currency crises and external defaults.

To some extent these period-average metrics obscure significant improvements over the current period. Inflation fell sharply over the 1990s (Chart 2), most likely reflecting greater recognition of the economic costs of high and volatile inflation in the 1970s and early 1980s.

Given the freedom that countries have in today’s IMFS, they have chosen to adopt independent domestic monetary policy regimes, often with explicit inflation-targeting mandates. Nevertheless, with the (important) exception of inflation, the outcomes achieved during the BWS period were still better than those attained since 1990.

 

[Martinghoul]

Financial Stability Paper No. 13 – December 2011
Reform of the International Monetary and Financial System

By: Oliver Bush, Katie Farrant and Michelle Wright
Bank of England

Summary:

The financial crisis has imposed large costs on the global economy and revealed deficiencies in policy frameworks around the world. While the ongoing reforms to financial regulation aim to make the financial system more resilient, they cannot eliminate all the risks associated with large global capital flows. This paper argues that broader reforms to the International Monetary and Financial System (IMFS) are also required. The paper sets out three objectives for a well-functioning IMFS:
...

Wait, so I ask you for a specific concrete example and you offer me an academic paper that is all about the theory and Bretton Woods? I am not going to discuss the theoretical conclusions of the article in this thread, since it really has nothing to do with my questions. I have asked you for specific cases where central banks "got it wrong" and/or caused hyperinflation, which is what you have asserted. Unless you can provide specific examples and thus prove your assertion, I would have to conclude that you're just making stuff up randomly as you go along. In that case, there's really no point in us having a discussion.

 

[new_trader]

Wait, so I ask you for a specific concrete example and you offer me an academic paper that is all about the theory and Bretton Woods? I am not going to discuss the theoretical conclusions of the article in this thread, since it really has nothing to do with my questions. I have asked you for specific cases where central banks "got it wrong" and/or caused hyperinflation, which is what you have asserted. Unless you can provide specific examples and thus prove your assertion, I would have to conclude that you're just making stuff up randomly as you go along. In that case, there's really no point in us having a discussion.

You're putting words in my mouth. I said: "They are counteracting a natural, free market deflation with artificial inflation. History has shown time and again that Central Banks have an appalling track record of getting this right."

The academic article backs this up. Other than that, it's a case of "If you have to ask, no answer will suffice".

 

[Martinghoul]

You're putting words in my mouth. I said: "They are counteracting a natural, free market deflation with artificial inflation. History has shown time and again that Central Banks have an appalling track record of getting this right."

The academic article backs this up. Other than that, it's a case of "If you have to ask, no answer will suffice".

The academic article doesn't back anything up. It makes an argument, like all academic papers do. There are many other papers that make the opposing argument. This is pretty basic.

You have used the phrase "track record", which implies that you have knowledge of specific cases. That is what I would like you to provide. If you can't provide that and instead are offering academic theory, your assertion, as you have stated it, is false. So let me ask you yet again, can you offer any specific instances of "central banks not getting it right"?