Markets Insight
May 29, 2013 9:56 am
Markets Insight: Swiss example questions need for QE unwinding
By Robert Jenkins
The SNB has laid the foundation for a sovereign fund
It would appear that capitalism is no longer capable of saving itself. Central bank policies, which rightly supplied liquidity when confidence was lacking, continue to shape capital flows when it is not.
When and how this will end is the source of market-moving speculation. But in sifting through the scenarios, market participants might like to think a bit out of the box. Take for example the case of the Swiss central bank’s foreign exchange intervention.
In September 2011, the Swiss National Bank embraced a bold policy of currency capping. Such was the demand for the haven currency that its appreciation threatened both the country’s price stability internally and export competitiveness externally.
The solution was to supply Swiss francs to the foreign exchange markets sufficient to prevent the euro/SFr exchange rate from falling below SFr1.20 per euro. The SNB would, it said, buy the euro using an unlimited amount of its domestic currency.
The policy had an initial calming effect. But in 2012 the troubles in Europe resurfaced; demand for Swiss francs returned. In that year alone, the SNB “spent” some SFr188bn to enforce the cap. This was equivalent to nearly one-third of Swiss GDP. Central bank reserves swelled to $500bn. After a short respite in early 2013, purchases resumed and reserves rose further – exceeding $550bn by the end of the first quarter.
When will the SNB halt its policy? When will it reverse its purchases? In April Thomas Jordan, SNB president, said the exit from the franc cap was still far away. But perhaps a full reversal need never take place. Perhaps, albeit unconsciously, the Swiss authorities have laid the foundation for a “Swiss sovereign wealth fund”.
Sovereign wealth funds come in many shapes and sizes. The International Monetary Fund defines SWFs as “government-owned investment funds set up for a variety of macroeconomic purposes. They are commonly funded by the transfer of foreign exchange assets that are invested long term overseas.”
SWF’s can provide commodity-producing countries with a stable level of income in the face of volatile commodity prices (for example, Chile and copper). Alternatively, a fund can diversify trade-generated foreign exchange reserves (for example, the China Investment Corporation). The largest SWF today is that of Norway, founded in 1990 to convert the income from a non-renewable resource (oil) into a permanent national endowment that will offer benefits to future generations.
The Norwegians were not obliged to follow this strategy. They could have spent all the money as it rolled in. But doing so would have courted a form of resource curse known as the “Dutch disease”. The term was coined in 1977 to describe the decline in the manufacturing base of the Netherlands following its discovery of natural gas in the 1960s. Gas revenue-fuelled spending drove up domestic prices and drove out manufacturing competitiveness.
Now back to Switzerland. It too possesses a scarce resource – its haven status. This has been built over generations of fiscal prudence, domestic stability, and political neutrality. Though a leading wealth manager, the Swiss wish to preserve balance in their economy through a viable industrial and services sector. An excessive rise in the Swiss franc is a threat to economic equilibrium in the short term and the people’s wellbeing in the long term.
Allowing the franc to strengthen to a free market clearing price would raise Swiss global purchasing power temporarily, but would come at the cost of industry competitiveness, jobs and income in the long run. Cherished stability would be replaced by unpredictable volatility. Speaking to the IMF in April, Mr Jordan declared: “[The cap] is the only option to avoid a deflation spiral and a destruction of the economy.”
The cap is not only expedient, it is clever. The policy exchanges printed Swiss paper for a diversified portfolio of global purchasing power. Equities may join the traditional central bank holdings of sovereign debt and gold. So is it a given that this state of affairs need be reversed by the Swiss state – in full or in part? Global investors take note.
Viewed as FX reserves, the SNB ranks fifth in the world. Viewed as a sovereign wealth fund, the holdings approximate those of China Investment Corporation. The Financial Times’ front page recently reported Beijing’s search for a new head of that wealth fund. Will a future edition announce the search for a chief investment officer of a newly created Swiss SWF?
Markets are mesmerised by how and when central bank policies will be unwound. But they should also consider the possibility that such policies may not be unwound at all.
Robert Jenkins is adjunct professor, finance at London Business School and a former member of the Financial Policy Committee of the Bank of England
Copyright The Financial Times Limited 2013
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