You know the world is crazy when banks charge negative interest on deposits. This is exactly what is happening in Switzerland as the small nation tries to fend of the monetary policy of the euro zone.
Good luck with that.
Switzerland has its own currency, the Swiss franc. In 2011 the PIIGS of the euro zone (Portugal, Italy, Ireland, Greece and Spain) were in tough shape. The integrity of the euro was in question as the Greek economy showed signs of collapse. Investors large and small fled the euro, rushing into other currencies like the Swiss franc.
As large pools of money sold euros and bought Swiss francs, the value of the franc soared against the euro. While the lofty currency allowed the Swiss consumers to buy more foreign goods, it meant that foreigners had to spend more on Swiss items, like Swatch watches and Swiss vacations.
Apparently the Swiss weren’t comfortable standing idly by as exports fell and tourism dropped off, so the Swiss National Bank (SNB) put in place a downside limit of 1.20 on how many Swiss francs one euro can purchase. If the exchange rate fell lower (meaning the franc was stronger), the SNB would print new francs and use them to buy euros, keeping the exchange rate at 1.2.
This action calmed the markets somewhat, but only for a while.
Over the last 12 months inflation in the euro zone has dropped near zero, while GDP growth is tepid at best. The unemployment rate is stuck above 10%, and Greece is about to hold an election in which a far-left party that favors repudiating debt is polling ahead of other parties.
Citing weakness across the euro zone, ECB policy makers announced they could soon start their own quantitative easing (QE) program. All of these things have combined to push the euro to decade lows, causing other currencies to soar… except for the Swiss franc.
As long as the SNB keeps its exchange rate pegged at 1.20 or higher, the euro can’t lose more value against the franc, which gives investors a free pass to exchange their falling euros into nice, strong francs at the artificially high level of 1.2.
Not being stupid, money managers, pension fund managers, and everyone else who handles large amounts of euros are rushing to exchange euros for francs. In an effort to shrink the amount of money coming in, the SNB has instituted negative interest rates on deposits.
The hope is that if investors have to pay a penalty in negative interest rates once they exchange euros for francs, they might be less inclined to make the trade in the first place. This is a great theory, but it misses the bigger point.
The euro zone is stuck in a low inflation or even deflationary environment, so funds stuck in that currency are going to suffer in the weeks and months ahead. Paying a small price, such as a negative interest rate on deposits, to hold funds in a different currency is worth it, especially if the exchange rate is artificially high in the first place.
The best thing the Swiss can do is get rid of the limit on the exchange rate and let the valuation float with the market. This will cause some pain in the short run, but it’s much better than continually printing new francs to buy euros as they flood the small country.
In the larger picture, the fact that Switzerland has to resort to such measures in the first place indicates how difficult the situation in the euro zone has become. For years we’ve pointed out the two big problems in Europe – an overhang of debt and aging populations.
Monetary policy and exchange rates won’t make these problems go away. The good news is that anyone living outside of the euro zone should be able to take a cheaper European vacation in the years to come.