For central banks few things are tougher than a successful currency intervention. Just ask the Bank of England. On September 16, 1992, Britain withdrew the pound sterling from the European Exchange Rate Mechanism after spending weeks intervening to defend the currency’s peg to the deutsche mark. That move cost U.K. taxpayers $4 billion and earned hedge fund manager George Soros, who had made a huge short bet on the pound, a $1 billion profit.
Pity the Bank of Japan. This year it’s sold trillions of yen trying to keep the currency from appreciating against the dollar and the euro. That has briefly worked, but the yen keeps rising. Since April 1 it’s gained 6 percent on the greenback.
If intervention has a mixed record at best, how did Switzerland turn the tide against its franc? The Swiss have been trying to drive their currency lower since the fall of 2009, when it started climbing from about 1.50 francs to the euro.
After the Greek crisis cast a pall over European banks in July, the franc soared to 1.10. So on September 6 the Swiss National Bank announced that it was putting a floor under its currency of 1.20 to the euro. To hold the line, the SNB promised to buy no end of euros; so far it’s shelled out the equivalent of $9 billion, Nomura Securities International estimates. But the plan has worked brilliantly.
Ray Farris, head of FX strategy for Credit Suisse in Singapore, says the Swiss had several unique advantages. First, the franc was hugely overvalued — by 35 percent, according to the Organization for Economic Cooperation and Development.
Marc Chandler, who heads currency strategy at Brown Brothers Harriman & Co. in New York, says market size also matters. Japan’s $5.5 trillion economy is ten times bigger than Switzerland’s, and trading in the franc is much less feverish than buying and selling of the yen; speculators can overwhelm the Japanese central bank.
So far no hedge funds or other traders have tried to scuttle the Swiss strategy by offering a higher exchange rate. The franc hasn’t traded below 1.20 since September 6. Farris notes that because the currency has a floor, not a peg — which means it could drop further — traders are using it as a proxy for the euro when they go long the dollar or short the euro. The SNB guarantees the Swiss franc won’t appreciate above 1.20, so there’s no downside risk to shorting it.
Also, it’s much easier to stop a currency from appreciating than from declining, Farris says. “You can always sell your own currency because you can print it,” he explains. “You cannot always sell a foreign currency because you have a limited stock of it.”
Lack of inflation helps Switzerland too. Fearing inflation, the Swiss public has opposed previous intervention on behalf of the franc. Switzerland also put a floor under its currency in 1978, but sharply rising prices forced it to back off three years later. This time around, low inflation has created political support for the SNB’s efforts.
Switzerland is not alone in taking extraordinary measures to contain its currency. Brazil has tried to stop the rise of the real with taxes and threats to intervene in the derivatives market. Those moves flopped, but the currency has fallen anyway as a result of the global flight from riskier assets. Turkey has been more successful. In August the Central Bank of the Republic of Turkey cut its one-week repo rate by 50 basis points, to 5.75 percent, despite an inflation rate of 6.3 percent and a 9 percent current-account deficit. Between November 2010 and last month, the Turkish lira fell 36 percent against the dollar.
“To win the currency war, you either need to be like Switzerland and defend a specific level and throw your entire credibility behind it,” says Manik Narain, an emerging-markets currency strategist at UBS in London, “or you can try what Turkey did, which is to be extremely unorthodox — institute policies that make the markets think you have lost your senses.” • •
