Switzerland exposes the central bankers
It's been a week now since the Swiss National Bank job, a clever heist in which a pack of central bankers in Bern decided to steal from the rich and give to the super-rich. It's a time-honored tradition in the Alps, apparently; they're Robin Hood with a German accent.
To help us understand the deeper meaning of the Switzerland's decision to ditch its currency peg, I rang up Satyajit Das in Sydney, Australia. Longtime readers of my columns at MSN Money will remember Das as the ex-banker who first explained to us the massive problem facing investors in September 2007 as a result of the subprime credit mess (link to TheStreet.com version of the article).
He explained then in shocking detail how $1 in real money had come to support $20 of derivatives in the super-leveraged market for collateralized mortgages. When that $1 of real money failed because of a default on a house, he said it would causes the entire stack of fake money to tumble. I asked him at that time if we were in the third inning of the game at that time, and he laughed with pity -- saying that we are not yet past the singing of the national anthem. How right he was.
Since then, Das has been my go-to source for understanding all manner of arcana relating to banking. So when the Swiss National Bank pulled the kill switch on its peg to the euro, he was the first person I knew I needed to hear from.
Das noted first of all that the peg was put in place in 2011 to keep the value of the Swiss franc down after it had risen sharply due to large capital inflows into Switzerland in the aftermath of the 2008 global credit crisis and the 2009 European sovereign debt crisis. In large part, he said, the goal was to protect Swiss exports like chocolate, cuckoo clocks and drugs. To maintain that 1.20 peg to the euro, the central bank had to buy euros every time the franc went up -- typically by issuing more francs. They had been doing that for years, and it had become extremely expensive. The bank's balance sheet had become 80% of Swiss GDP and their money supply had quintupled.
This started to create problems for the Swiss National Bank, and also the economy, as shown in a rapid rise in house prices. It's important to recognize that the SNB is unusual among central banks in that it is not owned entirely by the government; it's a listed company owned by a mixture of private shareholders, including individuals and the country's cantons. They were increasingly uncomfortable being short Swiss francs and long euros at a time when the European Central Bank was expected to launch a round of quantitative easing that would have the effect of pushing down the euro.
As a result, Das argues, the bankers came to realize there would be no end in sight for their losses unless they acted quickly and decisively. They had to unwind their position even if it led to near-term pain. But did they know how much pain they would have to endure? It's unknown. Das, shown below, notes the bank had recently announced a profit of 38 billion francs. But the mark to market losses on the currency position was estimated at 75 billion francs, or around 13% of GDP.
The repercussions are interesting. First, the SNB has taken a massive loss on its short-franc position and will need a recapitalization - which in turn means that other banks and individuals will have to give it money. And it is now in the position of importing deflation on a massive scale as the SNB dropped its interest rate to -0.75%, which means people will lose three quarters of a percentage point by putting money in Swiss banks. Presumably that is still better than potentially losing 20% or more on euros.
Of course everyone knows now that many small and large currency traders who were shot francs were bankrupted overnight by the SNB move, which seems terribly unsporting but it seems they had to do what they had to do -- even if it meant crushing some punters, as well as anyone who was using the franc as a "funding currency" for carry trades.
The SNB figured the short term mayhem would be "small potatoes," Das says, compared to what would happen if it continued on with the unsustainable peg.
Looking more broadly, he argues that the SNB has given us a" laboratory or test case" for the real problem of the world today, which is the fact that central banks have rigged every market in the world with their monetarist policies. They have tried to manipulate asset prices in different ways, and it has worked only to the extent of pushing up the value of paper assets. They have not been able to figure out how to flow all that paper wealth back into the real economy. Growth is anemic in the eurozone and Japan, and just barely good enough in the United States.
The SNB is showing us that there are limits to this policy, in short. They looked into the abyss and determined that if they were to keep going they would end up in an untenable place. So they withdrew. Now the question is what that means for other central banks.
Das senses that the SNB action will undermine the "blind faith" investors and government policy makers have had that central banks are all-powerful. "The SNB case shows that central bankers are not supermen. There are limits. This puts doubts into investors' and politicians' minds," he said. "It shows they can make large, costly policy mistakes. It shows that their attempt to stage manage everything can fail, and that they can change their minds abruptly with no concern about fall-out elsewhere."
Now the analyst believes other central banks are not happy because the SNB move may be a harbinger of trouble to come. "Now there will be doubt about the bankers' omnipotence, this belief that they are perfect policy makers who don’t make mistakes. Now attention will turn to an examination of what other policy errors may follow."
I asked if there are any new measures in the central banker's toolkits similar to QE or zero-interest rate policy, which were fresh ideas when launched in 2008-2010. Das answered that the Japanese have already talked about their new idea, which was to have the government buy stuff like foreign companies' shares and other governments' bonds. But that is really socialism if your plan is just to have the government own everything, and that has never worked well.
"Basically," he said, "we are trapped. There is no growth now, and none on the horizon. There has been very little innovation along the lines of the steam engine, computer or air travel that has the potential to open up new vistas of employment growth and business opportunity."
Gazing a little further out, Das said he sense that conditions are becoming ripe for a crisis as pressures build that are reminiscent of the 1997-98 Asian contagion: strong dollar, weakening yen, crashing oil prices, plunging high-yield debt tied to weakened energy producers, increasingly worthless collateral for that debt, and monetary policy in disarray. We could look back and say this was the crisis of "subprime oil" instead of "subprime mortgages," he quipped.
Along those same lines, Das does not buy the idea that low oil prices will be good for growth. "You might save $500 a year on gasoline, but you don't have a well-paying job, so how much good is that going to do you?"
In short, Das sees "victims starting to pile up in an interesting way" following the SNB action, and now you have the sense of infallibility starting to be stripped away from the central bankers. That will make it harder than ever for some other sainted policy makers to step in as rescuers next time.
"The major difference between 2011 and now is we still had some ammo left. But now we have spent a lot of capital and the strategies have not produced the desired results of stronger economic growth. So what are we going to do now that major emerging markets like Russia, South Africa and Brazil -- the commodity dependent countries, with too much debt and too much inflation -- start to really falter? You have to wonder."
Well that was a pretty depressing interview, but enlightening and provocative as always. If you want to check out his books on Amazon.com, visit this link. My favorite book of his was "Traders, Guns and Money," which is paperback, and "Extreme Money," which is only in hardcover. He also wrote a cool book on wildlife tourism with his partner, Jade Novakovic; it's called "In Search of the Pangolin."
Source: Markman Capital Insight
