Swiss Central Bank Ponders "Temporary" Peg to Euro; Franc Trades Sharply Lower; This a Bluff? What Does it Take to Maintain a Peg? "Temporary" Defined

The Swiss Franc is trading sharply lower this morning as Swiss National Bank Discusses Possible Euro Peg

“Any temporary measures to influence the exchange rate are permissible under our mandate as long as these are consistent with long-term price stability,” Jordan said in an interview with Tages-Anzeiger today, when asked about a general currency peg.

“It’s certainly not the easiest measure to introduce neither in political nor legal terms,” SNB Governing Board member Jean-Pierre Danthine told Le Temps newspaper in an interview published today. The SNB’s mandate is “to conduct an independent monetary policy.”

Swiss Franc Daily Chart vs. US Dollar



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Swiss Franc 30 Minute Chart vs. US Dollar



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That last spike up has the look and feel of and end gasp of a parabolic rise. However, one cannot be certain at this time. Note that the discussed peg is a Swiss Franc peg to the Euro, not to the US dollar.

Is the Threat a Bluff?

Just because someone discusses something does not mean the discussion was serious. We cannot tell.

However, we do know what a currency peg requires: To maintain a currency peg, one must buy (or sell) virtually unlimited quantities of a foreign currency, as much as the market supplies, to maintain the desired conversion rate.

Interest rate policy works the same way. To maintain an interest rate target, the Fed (or any central bank in general) must supply or subtract unlimited amounts of currency to maintain its target interest rate. This happens continually.

If the rate is targeted lower than what the market thinks, the Fed or Central Bank must print enough money to keep the target. Likewise, if the Fed sets a rate higher than the market dictates, it must drain as much money as necessary to keep rates to the peg.

Does anyone really think this continual micro-manipulation of currency to maintain an arbitrary interest rate (set by central planners who do not know what they are doing) is a good idea?

Currency Peg Risks

Back to the Swiss Franc: A currency peg is much riskier, because the defense is not in relation to its own currency as it is with interest rates. Moreover, one might expect wild swings and an immediate snap-back once the peg is removed. Thus "temporary" might mean for as long as the Euro crisis continues, and that might be a very long "temporary".

Finally, note the relative size of Switzerland vs. all the Eurozone countries. Buying "unlimited" Euros could rapidly get out of hand.

China goes through the same setup to maintain its "widening" peg to the US dollar. However, China does not allow much external trade of the Yuan.

The above discussion does not answer the bluff question, but it does state what the parameters of the defense must be. All things considered, I do believe it is a bluff.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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