Trends Journal Special Report - The Swiss Franc

Posted 8/15/11

Trends Journal Special Report

15 August 2011

As Trends Journal subscribers know, while we make public my investment strategies, we do not provide financial advice. For well over a year I have been primarily invested in Swiss francs …

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Trends Journal Special Report - The Swiss Franc

Trends Journal Special Report
15 August 2011 As Trends Journal subscribers know, while we make public my investment strategies, we do not provide financial advice. For well over a year I have been primarily invested in Swiss francs and gold. This year, the franc has gained 32 percent vs. the dollar and 24 percent on the Euro. In attempts to stop its rise, the Swiss government has recently taken measures to weaken the franc. Where is the franc going, will they be successful in keeping it weak, who will it help, who will it hurt? The following Trends Journal Special Report is written by Dr. Paul Craig Roberts, former Assistant Treasury Secretary under Ronald Reagan, university professor of economics and noted author.* Sincerely, Gerald Celente

THE SWISS FRANC AND THE DEVELOPING CRISIS Why Switzerland Is Inflating by Paul Craig Roberts
The vast sum of money being printed by the Federal Reserve in order to finance the huge US budget deficit, keep banks afloat, shore up the stock market, and stimulate the economy is causing enormous problems for other countries. The European Central Bank has broken its own rules and is following the Fed’s practice of creating new money in order to purchase debt in order to protect private banks. The ECB is creating new money with which to purchase the troubled sovereign debt of European Union countries, such as Italy and Spain, in order to protect the solvency of private German, French, and Dutch banks. Fearing both an inflated dollar and an inflated euro, people seeking a safe haven have been selling dollars and euros and buying Swiss francs. Speculators have joined the fray. In the five months from March 10 until August 10, the Swiss franc rose 22% against the US dollar and 21% against the euro in the four months from April 8 to August 12. The Swiss have a strong monetary constitution and have experienced little inflation relative to the US and UK. Over the decades the franc has risen dramatically against the dollar and British pound. In the 1960s one US dollar would buy 4.1 Swiss francs. On August 11, 2011, one US dollar would buy 0.74 Swiss franc. The Swiss economy and currency are small in size in relation to the US and EU. Movement out of much larger currencies into a small one drives up the value of the smaller currency. The franc has been driven so high that Switzerland is concerned about its exports, which comprise 52.7% of its economy. If Swiss products are priced out of markets, the Swiss will be thrown into recession. On August 10 the Swiss company, Nestle, the world’s largest food company, announced that the rise in the franc had reduced its sales growth over the first 6 months of the year by 14 percentage points. During the first week of August the Swiss National Bank (SNB) declared the franc “massively overvalued” and said that the currency’s strength “is threatening the development of the economy.” The SNB stated that the bank “will not tolerate a continual tightening of monetary conditions and is therefore taking measures against the strong Swiss franc.” The SNB put policy where its mouth was and more than doubled the Swiss monetary base. The bank said that it will take further measures if necessary, including intervention in currency markets. What this means is that the Swiss monetary constitution notwithstanding, the SNB is going to print francs in order to absorb the currency inflows that are driving up the value of the Swiss currency. The bank suggested that the franc could be pegged to the euro. This would mean that euro inflows into Switzerland would not be permitted to drive up the exchange rate between francs and euros. To maintain the peg would require the Swiss central bank to print money to absorb the inflows of euros. The consequences for the Swiss could be inflation instead of recession. In other words, the monetary policy of the US and EU is forcing Switzerland to choose between inflating its own currency in order to prevent its rise or to be forced into recession from the loss of export markets. This is an example of what Russian prime minister Putin meant when he said that the US “is a parasite on the world economy.” There is some doubt that the Swiss could print enough francs to absorb the inflows. Others say that a peg would require constitutional and legal changes. However, law was impotent to prevent the IMF and European Central Bank (ECB) from violating their charters in order to bail out private banks and their shareholders. If Switzerland is faced with a collapse in exports and employment, law is likely to be shoved aside. The vice-chairman of the SNB, Thomas Jordan, said on August 11 that “measures that influence the exchange rate are within our mandate” and are thereby legal. Moreover, the SNB can operate a peg informally without a law permitting it simply by printing enough new francs to prevent foreign currency inflows from driving up the franc’s value. The problem with printing francs is that although most of them might go into the safe haven hoards of Europeans and Americans, some multiple of the Swiss money supply would be created, and unless the SNB repurchases the francs that are printed, inflation would result from the francs eventually finding their way into the Swiss economy. A better route for the Swiss to take would be exchange controls that would prevent the inflow of foreign currencies except for investment in new businesses, plant, equipment, and employment. When Swiss authorities declare that the franc has risen “to levels that are menacing Switzerland’s economy” and that in the range of policy responses “nothing is excluded,” it is likely that the Swiss are going to prevent their currency from being driven to extraordinary heights by American and European demand for a safe haven from the irresponsible monetary policies of their own central banks. The Swiss might also have to address foreign flight into Swiss equities, which would drive up price/earnings ratios, and into Swiss bonds, which could produce negative interest rates. The picture is further complicated by the fact that mortgage holders in Poland, Hungary, and Central Europe took loans in Swiss francs in order to gain the low interest rates of the strong currency prior to the franc being driven up by flight from dollars and euros seeking safe haven and by speculators. In Hungary alone, 700,000 home owners ignored the currency risk in order to benefit up front from lower interest rates. Now the mortgage payments have risen with the Swiss franc. Thus, Americans and Europeans (and speculators) are making life hard for Eastern and Central Europeans who hold home mortgages in Swiss francs. The same flight from dollars and euros has forced Japan to print yen to absorb the inflows. Despite the Japanese intervention, the yen has risen strongly since April 8 when one dollar was worth 85 yen. As of August 12, one dollar is worth only 76 yen. Without the intervention, the dollar might be even lower. Obviously, US policymakers are not concerned with the welfare of US citizens. The extent of the US dollar’s depreciation against the Japanese yen is extraordinary since January, 2007, when one dollar was worth 120.6 yen. In January, 1972, a dollar was worth 308 yen. Today the yen is stronger in relation to the US dollar than ever, despite the Japanese having the highest ratio of public debt to GNP. The Japanese ratio is twice the US ratio, but the yen continues to rise against the dollar despite the intervention of the Japanese central bank. Oil producers such as Qatar and Saudi Arabia, which peg their currencies to the dollar, protect themselves from dollar devaluation by raising the price of oil, their main export. Thus, a devaluing dollar means a higher oil price, which pushes up prices in all countries in the world. If the Swiss franc ceases to be a profitable safe haven for those fearful of US and EU inflation, other countries not afflicted with debt problems, such as Canada and Australia, will find their currencies kept strong by inflows of dollars and euros that have been going into Swiss francs. As those currencies are larger, the inflows will not result in such a rapid rise in exchange value unless the flight from dollars and euros intensifies. European and American officials are hoping that the purchase of government debt by the central banks will subdue the sovereign debt crisis and calm the markets. However, the money creation necessary to calm the debt markets can rile the currency markets. The money creation that is the response to the developing financial crisis, which now afflicts Western governments as well as private financial institutions, is forcing the world into inflation. This impetus toward inflation is one aspect of the developing crisis. Simultaneously, another aspect of the developing crisis is high and rising unemployment. The US has now had several years of fiscal stimulus from large federal deficits and monetary stimulus from very low interest rates. Yet, economic growth, employment, and consumer spending have not responded. In Europe, fiscal austerity is being imposed on Portugal, Ireland, Italy, Greece and Spain (PIIGS) simultaneously as euros are being created by the ECB. Even Switzerland is being forced into inflation by US and EU monetary policies. In the US austerity is the policy of the most aggressive political party. Austerity and money creation add up to what appears to be a contradiction--an inflationary depression. Such a development would be a new kind of crisis for which economic policy has no solution. This potential mother of all crises has two independent origins. One is the years of jobs offshoring which moved US GDP, tax base, consumer income, and consumer demand offshore with the jobs that were relocated in China, India, Indonesia and elsewhere. This is why the current recession is unlike any other. The recessions of the last half of the 20th century resulted from the Federal Reserve “taking away the punch bowl.” As the economy heated up, inflation would rise. The Fed would respond by cooling off the economy with higher interest rates. Consumer demand would fall, inventories would mount and layoffs would result. Slack would appear in the economy, and the Fed would reverse course. Easier money would result in more spending. Manufacturers would call their workforces back to work, and the cycle would begin anew. The current recession is different. There are no jobs to which to recall the workforce. The jobs have been moved offshore. This is why stimulus programs haven’t worked. The financial crisis resulted from another great mistake--financial deregulation. Deregulation allowed greed to run wild and debt to be leveraged to previously unimaginable levels. Financial claims on wealth exceed the size of the real economy. When the bubble burst, instead of allowing the unpayable claims to unwind, the US Treasury and Federal Reserve have been trying to underwrite the excessive claims with money creation. This policy is forcing the rest of the affected world to inflate also. The loss of tax revenues and the expensive wars have made issues of the unprecedented federal budget deficits and the rising US public debt and added them to the mix. The outpourings of dollars and debt are undermining the US dollar’s role as world reserve currency. Consequently, the international monetary system is threatened with collapse. As the realization of the complexity of the crisis spreads, the search for safe harbors will intensify. The prices of gold and silver could reach extraordinary heights. Unlike Swiss francs, gold and silver cannot be printed. * About the author: Former associate editor of The Wall Street Journal and columnist for Business Week, Dr. Paul Craig Roberts served on personal and committee staffs in the House and Senate, and served as Assistant Secretary of the Treasury for Economic Policy during the Reagan Administration.
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