Fisher Investments Editorial Staff
Currencies, Media Hype/Myths

The Swiss Miss: Media’s Take on the Franc’s Fallout

By, 01/20/2015
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Headlines globally remained stuck on Switzerland Friday, spouting nonstop warnings, lessons and overall hype. To us, it all seems fairly out of proportion. Switzerland is tiny, and the franc’s wild ride is a textbook case of a currency peg gone bust. The writing was on the wall, and the global implications here are miniscule—this is nowhere near enough to end the bull market. Nor is it evidence of festering global weakness.

Here’s a roundup of the major stories, which we read and analyzed so you don’t have to.

Francs, Fear and Folly
Paul Krugman, The New York Times

Is the franc’s sudden spike a deflationary pressure for Switzerland, as this piece claims? You betcha. Is this a sign problematic deflation lurks the world over? No, because it is largely a byproduct of falling energy prices, which are due to a massive surge in production. Is this a sign the 2008 crisis fundamentally changed the rules of central banking and economics? No. Currency pegs and floors have never been stable when combined with free capital flows and independent monetary policy. There is a name for this in economics. It’s “The Impossible Trinity,” and it didn’t just become impossible. It has never been possible, as this article shows. The market may be pricing in low or falling inflation—probably is, to some extent—but that doesn’t mean the market thinks it’s problematic. That’s a human’s interpretation.

Fallout From Swiss Move Hits Banks, Brokers
Anjani Trivedi, Tommy Stubbington, David Enrich and Katie Martin, The Wall Street Journal

Some currency brokers are in hot water as a result of the Swiss Central Bank eliminating its franc floor against the euro. Now, we will readily admit we don’t much advise trading in currencies generally—not our stock and trade, if you will. But here is one thing we definitively know for a fact: Never, ever make a leveraged bet on central bankers keeping their word. This may be a dramatic chapter in that book, but folks, the moral of the story is the darn same. Do not, under any circumstances, take a central banker’s words to the bank. (And really, don’t make a 100-to-1 leveraged bet on anything—that’s how margined up some of these currency traders were. Egads!)

Here’s another strategy lesson: Don’t assume stop losses actually stop loss. Many traders had the currency market equivalent of stop losses on their positions, theoretically to “protect” them from big losses like that. However, as this shows, the franc blew right past them, and brokers couldn’t find enough liquidity to execute the trades. While this is an extreme example, there is always zero guarantee the market will have any liquidity at your stop price. Prices can also move lightning fast. Stop losses are not a cushion or safety blanket.

Casualties From Swiss Shock Spread From New York to New Zealand
David Evans and Kevin Buckland, Bloomberg

Now, what you’re really waiting for after that last story: How many brokers face insolvency after Thursday, and how big is the damage? From a macro view, the amounts in question are dinky in the grand scheme of the financial system. The biggest, global currency broker FXCM, Inc., shut down because clients couldn’t cover $225 million worth of margin calls. Million. With an “M.” Other firms went bust on losses in the tens of millions. FXCM already seems to have lined up a savior, investment bank Jefferies. Also, these are brokerage firms. Not banks. Customer accounts are walled off. The firms simply didn’t have enough equity to cover their rears when their customers’ leveraged bets went bad. When the final damage is tallied, it might amount to a couple billion dollars at most in bankruptcies. The world economy is over $74 trillion. As a percentage of world GDP, this problem rounds to zero. (0.0027%, technically, assuming a $2 billion fallout, which is high.)

Swiss Turmoil Hints at Future Lehman Moments
Mark Gilbert, Bloomberg

So the thesis is that the Swiss National Bank’s elimination of its currency floor highlights the risk of sudden shocks that could derail the economy and send the financial system into a tailspin, like Lehman. It then goes on to argue Greece’s upcoming election and the Fed hiking rates are also potential shocks. Here is the thing: Lehman’s failure didn’t cause the crisis. It was a victim of the crisis caused by FAS 157 and the government’s haphazard moves to stanch the panic. But also, there is a world of difference between the SNB accepting that currency floors cannot be maintained indefinitely, causing a one-day wiggle and issues in the hundreds of millions for currency trading firms and FAS 157, which quietly (and unnecessarily) destroyed trillions worth of regulatory capital in its 18 months of life. As to the other factors, Greece is neither big nor surprising, and there is no history of an initial Fed hike hitting stocks materially. (On a related note, while this article says, “By the third quarter, the Federal Reserve's 0.25 percent interest rate is expected to at least double,” the Fed usually hikes in 0.25 percentage point increments. We are talking about one hike to double today’s low-low rates.)

Economic Lessons From Switzerland’s One-Day, 18-Percent Currency Rise
Neil Irwin, The New York Times

Of course it isn’t every day that “the currency of an advanced, economically important country rises by double-digit percentages against the currencies of other such countries within mere hours.” Advanced, economically important countries just tend not to peg their currencies. This was a currency peg that broke, as all currency pegs in countries with free capital flows are inherently prone to do. That’s really the main lesson this saga teaches. Don’t base any investing decisions on the assumption currency pegs will last indefinitely. And, again, don’t take central bankers at their word, as we’ve said many times before.

 

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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