Uh Oh, by Robert Gore

Yesterday the Swiss National Bank (SNB) announced that it was abandoning the Swiss franc’s peg to the euro at 1.2 Swiss francs to the euro. The peg had been maintained to keep the franc artificially cheap to the euro, thus aiding Swiss exporters. However, the SNB’s euro reserves had ballooned as it created francs to buy the euro. When it abandoned the peg all hell broke loose. Trading in the franc was virtually impossible for several hours as markets groped for a new price (it eventually settled in at just above parity with the euro, about a 16 percent gain for the franc, or about a 20 percent loss for the euro against the franc). Foreign exchange shops in Switzerland were jammed. Several currency brokers went belly up because their customers where short francs and could not meet their margin calls. Hedge funds, massively short the franc, are looking at substantial losses, although the extent of those losses won’t be known for several months. The Swiss central bank has a huge loss on the euro stockpile it has accumulated. Jim Grant, publisher of the Grant’s Interest Rate Observer, looks like a prophet. Several months ago he recommended purchase of long-dated franc call options and those who acted on his recommendation (only a select group of institutions had access to this trade, so don’t feel bad that you missed it) are counting their rather substantial profits today. The market turmoil reveals two lessons that investors and speculators must keep in mind going forward. The size of the move in the franc after the announcement shows just how much central banks can distort markets. A 20 percent move is almost unprecedented in the foreign exchange market, except when a banana republic somewhere announces a currency devaluation. The second lesson is that central banks can’t fight markets forever. The Swiss had tied the franc to the euro. European economic policymakers are hell-bent on weakening the euro, and on January 22 the ECB intends to announce the extent of its exercise in debt monetization. Some speculated that it will be larger than market expectations, and that the Swiss, if they wished to retain a weak currency, would have to further ramp up their unsustainable franc-creation and euro-buying. The precipitous fall in oil and other commodities was the first shot across the bow of the notion that central banks can make markets dance to their tune. The SNB franc revaluation is a direct hit. How long will it be before the guns of market forces are trained on the remaining bulwarks of central bank interventionism—equity markets and sovereign debt—sending the money-printing, interest-rate-repressing central bankers and the financial markets and economies they thought they were piloting to a watery grave? Man the lifeboats (see “Be Prepared,” SLL, 1/15/15, and the links at the end of that article).