ON THURSDAY January 15th Switzerland’s central bank, the Swiss National Bank (SNB), removed the cap on its currency, which it had imposed over three years ago and reaffirmed only three days before its repeal. The doffing of the cap surprised and upset the foreign-exchange markets, hobbling several currency brokers, including Alpari (which happens to sponsor the London football team I support). Many commentators nonetheless welcomed the cap’s removal, arguing that the policy was either unsustainable, protectionist or risky, exposing the SNB to grievous losses. I find these criticisms of the cap unconvincing—and not just because I am a West Ham United fan. Let me address each of them in turn.
Misconception 1: The cap on the Swiss franc was unsustainable
Exchange-rate pegs often fail. To prop up its currency, a central bank might have to buy large amounts of its own money in exchange for dollars or euros. Eventually, it will exhaust its hard-currency reserves forcing it to abandon its peg.
The first thing to understand about the Swiss drama is that it is the exact opposite of this more familiar case. The Swiss central bank was trying to keep its currency down not prop it up. To achieve this goal, the SNB had promised to sell as many Swiss francs as necessary (in exchange for “unlimited quantities” of foreign currency). The promise was credible, because a central bank can print its own currency without limit. It cannot run out of its own money to sell. The cap was, therefore, sustainable if the SNB had wished to sustain it.
If a central bank overworks the printing press, its money will eventually lose value, of course. Inflation and depreciation set a limit on the power of central banks. But the Swiss had imposed the cap precisely because they wanted to raise domestic inflation from dangerously low levels (consumer prices fell by 0.3% in the year to December 2014, according to the Federal Statistics Office). Persisting with the currency cap might have pushed up prices. But that is no objection to the policy; on the contrary, it was the objective of it.
Misconception 2: The Swiss central bank needed to worry about big losses on its euro holdings
The second misconception is less basic. Every economist knows that a central bank cannot run out of its own currency. But many believe the Swiss cap was unsustainable for a different reason.
If the SNB had stuck with its cap, buying as many euros as people were willing to sell at its set price of 1.20 Swiss francs, its holdings of the single currency would have swollen in size. By the end of September 2014, it already held over €174 billion, according to its balance sheet. With the single currency weakening in anticipation of further monetary easing by the European Central Bank, this hoard was likely to grow to epic proportions.
Perhaps because I live in Hong Kong, where the monetary authority’s foreign assets amount to over 120% of the economy’s annual output, big central-bank balance sheets don’t scare me. But others worry. They point out that if the franc were ever permitted to rise against the single currency, the Swiss central bank would suffer an enormous loss on its euro assets. Euro holdings worth, say, 240 billion francs at the capped exchange rate would be worth 40 billion less in the Swiss currency if it rose by 20%.
If the loss were big enough, the central bank’s assets (which include its euro holdings) might end up being worth less than its liabilities (which are overwhelmingly in its home currency). The central bank, known until last week for its quiet conservatism, would be technically insolvent.
That would be a little awkward. It would not be easy to explain the central bank’s predicament to its shareholders, who include the Swiss cantons, or to unsympathetic political parties, such as the Swiss People’s Party—which has already sponsored an unsuccessful referendum to force the SNB to hold at least a fifth of its assets in gold.
But although insolvency is humbling for a central bank, it is far from crippling. “Central banks may operate perfectly well without capital as conventionally defined,” pointed out Peter Stella in a working paper published by the International Monetary Fund back in 1997. Central banks cannot go bust in the way that a commercial bank can. They can always pay their bills, because they print the money they owe.
Their debts are also peculiar. The SNB’s liabilities are chiefly Swiss francs. For the most part, as its balance sheet shows, they take the form of simple banknotes or the deposits that commercial banks hold at the central bank.
The franc, like all fiat money, is not backed by anything tangible. People accept it as payment because they are confident other people (including the tax authorities) will accept it. Try to redeem a banknote at the central bank and all you will get is a newer banknote. That is all that a central bank’s liabilities promise: I owe you an IOU.
These debts are also uniquely easy to service. Banknotes pay zero interest. Deposits at the SNB now yield even less than that: depositors pay the central bank, not the other way around.
Central banks do not, then, have to worry much about satisfying their creditors. Nor are they judged by the returns they earn for shareholders. They are judged by their ability to keep inflation in check and the financial system stable. Their balance sheet—the size and mix of their assets and liabilities—is important insofar as it serves that mission. It is a macroeconomic tool, not a statement of financial success or failure.
The SNB itself understands this. After it reported big losses on its foreign-exchange holdings in 2010 and early 2011, it faced doubts about its financial strength. Some people speculated that it might eventually suffer from negative net worth (also known as “negative equity”). In a 2011 speech, Thomas Jordan, who now heads the institution, answered these concerns directly.
“Might the SNB lose its capacity to act as a result of a negative equity level? And, if its equity were negative, would the SNB have to be recapitalised, or might it even have to go into administration?...[T]he short answer to all these questions is ‘No’.”
If the SNB ever became insolvent, it would not be the first central bank to suffer such an indignity. The Czech central bank and the Bank of Chile, among others, functioned perfectly well for years with liabilities that exceeded their assets.
Some economists argue that negative net worth is damaging for other reasons. It undermines a central bank’s “institutional credibility”, even if it doesn’t impair its day-to-day viability. These economists worry that a broke central bank might compromise its independence by going cap in hand to the government, asking to be recapitalised. Or it might print currency willy nilly to cover its losses and earn its way out of its financial hole. Either response would damage its standing as the guardian of the nation’s money.
But these worries hardly apply to the SNB. It has suffered losses (now and in the past) because its currency has strengthened, a reflection of the confidence foreigners place in it. If anything, “institutional credibility” is a cause of its balance-sheet problem not a potential casualty of it. Right now, the Swiss National Bank’s ability to prevent inflation is not in doubt. What is in doubt is its ability to create it.
Besides, a central bank’s financial strength is not ultimately the source of its operational independence. If a society is not, on balance, committed to price stability, the central bank will struggle to achieve it, no matter how strong its balance sheet. By the same token, if inflation is sufficiently unpopular, the state will give its central bank the leeway it needs to prevent it. That remains the case even if the central bank needs recapitalising once in a while.
Misconception 3: The cap was protectionist
When the SNB imposed the cap back in September 2011, the Swiss franc was strengthening fast, bid up by “refugee-capital” seeking a safe haven from the eurozone’s troubles. The strong franc made Switzerland’s upscale goods even pricier abroad, damaging its exporters’ competitiveness.
The cap put a stop to that. It thus drew criticism from economists worried about the impact on Switzerland’s trading partners. Ted Truman of the Peterson Institute for International Economics has described the cap as “openly protectionist”. According to other commentators, the cap contributed to the “currency wars”, in which countries try to seize market share from each other by weakening their exchange rates. By removing the cap, Switzerland was acting like a “good world citizen”, according to Dean Baker of the Center for Economic Policy Research, giving an “economic boost” to other countries that will enjoy healthier trade balances as a result.
When the SNB introduced the cap, it was indeed concerned about the “massive overvaluation” of the Swiss franc. Safe-haven flows were driving up the currency, displacing its manufacturers, just as oil or gas earnings can hollow out a country’s industrial base. The Swiss cap was helpful in preventing Dutch disease.
But the central bank’s main motivation for imposing the cap was not protectionism. It was trying instead to avert the risk of deflation. In keeping the currency down, it was trying to drive prices up. This ambition to raise prices is at odds with the notion that it was seeking to protect Swiss exporters. Because in raising inflation, the SNB would have reduced Switzerland’s competitiveness (all else equal) not sharpened it. If an exporter’s local prices and wages go up, it becomes less competitive abroad, even if the exchange rate remains the same.
Currencies, it is fair to point out, move much faster than goods prices or wages. So although inflation would have eroded the competitiveness of Swiss exporters eventually, it would have taken time. Currency appreciation, on the other hand, worked with brutal speed.
In seeking gradual inflation rather than abrupt currency appreciation, the SNB was therefore helping the country’s exporters. But in doing so, it was not defying fundamental market forces. It was instead choosing to expose exporters to one set of market forces rather than another: the sluggish forces of the goods market, rather than the bone-shaking forces of the foreign-exchange market. Neither market is perfect. The goods market is bogged down by inertia, transaction costs and long-term contracts that inhibit price flexibility. The currency markets, on the other hand, are swayed by bouts of speculation and skittishness. Neither does an unimpeachable job of setting an economy’s terms of exchange with the rest of the world.
In practice, there is an easy way to tell the difference between the SNB’s policy and that of the “currency warriors”, mercantilist central banks that suppress their exchange rates for competitive gain. Like the SNB, the currency warriors buy dollars or euros to keep their currencies cheap. In so doing, they create additional local money, just as the SNB did. But unlike the SNB, they “sterilise” their interventions, withdrawing this extra money from circulation (either by selling other assets or raising reserve requirements on banks). This prevents prices from rising, thus preserving the competitive advantage their cheap currency provides.
The SNB was not waging this kind of warfare. In printing francs it was keeping its currency down but not its prices. If its policy had hurt its trading partners, they were free to retaliate by printing more money themselves. This tit-for-tat monetary easing would not have resulted in a zero-sum scramble for a fixed amount of global demand. It would instead have helped to increase world demand, in a process of mutually-assured reflation.
The Swiss policy was not, then, protectionist in intent, nor was it unsustainble. It exposed the Swiss National Bank to a loss of face, but not to a financial loss of any great economic consequence. I believe currency pegs remain a legitimate monetary choice—as long as central banks allow prices to adjust accordingly—if not always a wise one. I also think the removal of the Swiss cap was unnecessarily disruptive. The SNB must now find a new way to fend off deflation. And West Ham must find a new sponsor for its kit.
Disclaimer: This article does not represent investment advice or any kind of professional counsel, nor does it represent an offer to buy or sell securities or investment services. The opinions, which are subject to change, are those of the author not BNY Mellon Investment Management.
Source: http://www.economist.com/blogs/freeexchange/2015/01/switzerlands-monetary-policy
Showing posts with label franc. Show all posts
Showing posts with label franc. Show all posts
Wednesday, January 21, 2015
Saturday, October 6, 2012
Currencies: The weak shall inherit the earth
OVER most of history, most countries have wanted a strong currency—or at least a stable one. In the days of the gold standard and the Bretton Woods system, governments made great efforts to maintain exchange-rate pegs, even if the interest rates needed to do so prompted economic downturns. Only in exceptional economic circumstances, such as those of the 1930s and the 1970s, were those efforts deemed too painful and the pegs abandoned.
In the wake of the global financial crisis, though, strong and stable are out of fashion. Many countries seem content for their currencies to depreciate. It helps their exporters gain market share and loosens monetary conditions. Rather than taking pleasure from a rise in their currency as a sign of market confidence in their economic policies, countries now react with alarm. A strong currency can not only drive exporters bankrupt—a bourn from which the subsequent lowering of rates can offer no return—it can also, by forcing down import prices, create deflation at home. Falling incomes are bad news in a debt crisis.
Thus when traders piled into the Swiss franc in the early years of the financial crisis, seeing it as a sound alternative to the euro’s travails and America’s money-printing, the Swiss got worried. In the late 1970s a similar episode prompted the Swiss to adopt negative interest rates, charging a fee to those who wanted to open a bank account. This time, the Swiss National Bank has gone even further. It has pledged to cap the value of the currency at SFr1.20 to the euro by creating new francs as and when necessary. Shackling a currency this way is a different sort of endeavour from supporting one. Propping a currency up requires a central bank to use up finite foreign exchange reserves; keeping one down just requires the willingness to issue more of it.
When one country cuts off the scope for currency appreciation, traders inevitably look for a new target. Thus policies in one country create ripples that in turn affect other countries and their policies.
The Bank of Japan’s latest programme of quantitative easing (QE) has, like most of the unconventional monetary policy being tried around the world, a number of different objectives. But one is to counteract an unwelcome new appetite for the yen among traders responding to policies which have made other currencies less appealing. Other things being equal, the increase in money supply that a bout of quantitative easing brings should make that currency worth less to other people, and thus lower the exchange rate.
Ripple gets a raspberry
Other things, though, are not always or even often equal, as the history of currencies and unconventional monetary policy over the past few years makes clear. In Japan’s case, a drop in the value of the yen in response to the new round of QE would be against the run of play. Japan has conducted QE programmes at various times since 2001 and the yen is much stronger now than when it started.
Nor has QE’s effect on other currencies been what traders might at first have expected. The first American round was in late 2008; at the time the dollar was rising sharply (see chart). The dollar is regarded as the “safe haven” currency; investors flock to it when they are worried about the outlook for the global economy. Fears were at their greatest in late 2008 and early 2009 after the collapse of Lehman Brothers, an investment bank, in September 2008. The dollar then fell again once the worst of the crisis had passed.
The second round of QE had more straightforward effects. It was launched in November 2010 and the dollar had fallen by the time the programme finished in June 2011. But this fall might have been down to investor confidence that the central bank’s actions would revive the economy and that it was safe to buy riskier assets; over the same period, the Dow Jones Industrial Average rose while Treasury bond prices fell.
After all this, though, the dollar remains higher against both the euro and the pound than it was when Lehman collapsed. This does not mean that the QE was pointless; it achieved the goal of loosening monetary conditions at a time when rate cuts were no longer possible. The fact that it didn’t also lower exchange rates simply shows that no policies act in a vacuum. Any exchange rate is a relative valuation of two currencies. Traders had their doubts about the dollar, but the euro was affected by the fiscal crisis and by doubts over the currency’s very survival. Meanwhile, Britain had also been pursuing QE and was slipping back into recession. David Bloom, a currency strategist at HSBC, a bank, draws a clear lesson from all this. “The implications of QE on currency are not uniform and are based on market perceptions rather than some mechanistic link.”
In part because of the advent of all this unconventional monetary policy, foreign-exchange markets have been changing the way they think and operate. In economic textbooks currency movements counter the differences in nominal interest rates between countries so that investors get the same returns on similarly safe assets whatever the currency. But experience over the past 30 years has shown that this is not reliably the case. Instead short-term nominal interest-rate differentials have persistently reinforced currency movements; traders would borrow money in a currency with low interest rates, and invest the proceeds in a currency with high rates, earning a spread (the carry) in the process. Between 1979 and 2009 this “carry trade” delivered a positive return in every year bar three.
Now that nominal interest rates in most developed markets are close to zero, there is less scope for the carry trade. Even the Australian dollar, one of the more reliable sources of higher income, is losing its appeal. The Reserve Bank of Australia cut rates to 3.25% on October 2nd, in response to weaker growth, and the Aussie dollar’s strength is now subsiding.
So instead of looking at short-term interest rates that are almost identical, investors are paying more attention to yield differentials in the bond markets. David Woo, a currency strategist at Bank of America Merrill Lynch, says that markets are now moving on real (after inflation) interest rate differentials rather than the nominal gaps they used to heed. While real rates in America and Britain are negative, deflation in Japan and Switzerland means their real rates are positive—hence the recurring enthusiasm for their currencies.
The existence of the euro has also made a difference to the way markets operate. Europe was dogged by currency instability from the introduction of floating rates in the early 1970s to the creation of the euro in 1999. Various attempts to fix one European currency against each other, such as the Exchange Rate Mechanism, crumbled in the face of divergent economic performances in the countries concerned.
European leaders thought they had outsmarted the markets by creating the single currency. But the divergent economic performances continued, and were eventually made manifest in the bond markets. At the moment, if you want to predict future movements in the euro/dollar rate, the level of Spanish and Italian bond yields is a pretty good indicator; rising yields tend to lead to a falling euro.
The reverse is also true. Unconventional interventions by the European Central Bank (ECB) over the past few years might have been expected to weaken the currency, because the bank was seen as departing from its customary hardline stance. They haven’t because they have normally occurred when the markets were most worried about a break-up of the currency, and thus when the euro was already at its weakest. The launch of the Securities Market Programme in May 2010 (when the ECB started to buy Spanish and Italian bonds), and Mario Draghi’s pledge to “do whatever it takes”, including unlimited bond purchases, in July 2012 were followed by periods of euro strength because they reduced fears that the currency was about to collapse.
Currency war, what is it good for?
Currency trading is, by its nature, a zero-sum game. For some to fall, others must rise. The various unorthodox policies of developed nations have not caused their currencies to fall relative to one another in the way people might have expected. This could be because all rich-country governments have adopted such policies, at least to some extent. But it would not be surprising if rich-world currencies were to fall against those of developing countries.
In September 2010 Guido Mantega, the Brazilian finance minister, claimed that this was not just happening, but that it was deliberate and unwelcome: a currency war had begun between the North and the South. The implication was that the use of QE was a form of protectionism, aimed at stealing market share from the developing world. The Brazilians followed up his statement with taxes on currency inflows (see Free Exchange).
But the evidence for Mr Mantega’s case is pretty shaky. The Brazilian real is lower than it was when he made his remarks (see chart). The Chinese yuan has been gaining value against the dollar since 2010 while the Korean won rallied once risk appetites recovered in early 2009. But on a trade-weighted basis (which includes many developing currencies in the calculation), the dollar is almost exactly where it was when Lehman Brothers collapsed.
Many developing countries have export-based economic policies. So that their currencies do not rise too quickly against the dollar, thus pricing their exports out of the market, these countries manage their dollar exchange rates, formally or informally. The result is that loose monetary policy in America ends up being transmitted to the developing world, often in the form of lower interest rates. By boosting demand, the effect shows up in higher commodity prices. Gold has more than doubled in price since Lehman collapsed and has recently reached a record high against the euro. Some investors fear that QE is part of a general tendency towards the debasement of rich-world currencies that will eventually stoke inflation.
The odd thing, however, is that the old rule that high inflation leads to weak exchange rates is much less reliable than it used to be. It holds true in extreme cases, such as Zimbabwe during its hyperinflationary period. But a general assumption that countries with high inflation need a lower exchange rate to keep their exports competitive is not well supported by the evidence—indeed the reverse appears to be the case. Elsa Lignos of RBC Capital Markets has found that, over the past 20 years, investing in high-inflation currencies and shorting low-inflation currencies has been a consistently profitable strategy.
The main reason seems to be a version of the carry trade. Countries with higher-than-average inflation rates tend to have higher-than-average nominal interest rates. Another factor is that trade imbalances do not seem to be the influence that once they were. America’s persistent deficit does not seem to have had much of an impact on exchange rates in recent years: nor does Japan’s steadily shrinking surplus, or the euro zone’s generally positive aggregate trade position.
In short, foreign-exchange markets no longer punish things that used to be regarded as bad economic behaviour, like high inflation and poor trade performance. That may help explain why governments are now focusing on other priorities than pleasing the currency markets, such as stabilising their financial sectors and reducing unemployment. Currencies only matter if they get in the way of those goals.
Friday, December 30, 2011
Forex traders hunt for fresh havens
Investors looking for havens from the eurozone crisis have had a frustrating year.
Central banks in countries that have attracted people trying to seek shelter in their currency have sent a firm message: only a limited number of investors are welcome here.
That has left investors hunting for havens outside the US dollar, which has attracted huge inflows this year from those looking for somewhere liquid to park their cash.
But analysts say that there are fresh haven opportunities in 2012. They point to the Norwegian krone and the Canadian dollar as among those currencies that could do well in times of market stress.
New currency havens next year would be welcomed by investors who have this year found themselves thwarted by unexpected foreign exchange interventions.
For the first half of the year, the yen and the Swiss franc were seen as ideal. Haven currencies – also referred to as “hard” currencies – are usually those that are backed by stable governments and economies. Strong exports and current account surpluses, which Japan and Switzerland possess, are key factors as they are likely to shore up demand for a currency.
But following the market turmoil over the summer, the demand for the yen and the franc grew so high that the Swiss National Bank and the Bank of Japan took steps to weaken their respective currencies.
Alarmed by the rate at which foreign money was flooding in from investors concerned about the escalating eurozone crisis, the Bank of Japan embarked on its biggest monthly foreign exchange intervention in eight years in August. That sent the yen, which had risen more than 5 per cent against the dollar since January, tumbling nearly 5 per cent in one day.
The move was welcomed by the country’s exporters, who had been complaining that a strong yen was harming trade. But foreign investors were undeterred. The central bank sold more yen on October 31 after the currency hit its strongest ever level against the US dollar.
Then, on September 6, the Swiss National Bank said it was prepared to buy euros in unlimited quantities to weaken the Swiss franc, effectively pegging its currency to the euro. Markets opted not to test its resolve.
Investors instead began looking for the next best haven. Some have pointed to Norway, a big oil exporter with a current account surplus.
Indeed, HSBC’s currency analysts argue that the krone is “in a league of its own” against other G10 currencies due to Norway’s strong economic fundamentals.
But others have raised concerns over liquidity. Investors this year have prioritised liquidity above most other factors, fearing that any “lock down” in markets will leave them unable to get their cash out quickly and return it to shareholders or other investors. That explains why the US dollar has been the ultimate haven this year.
Trade in the Japanese yen accounts for 19 per cent of the $4tn a day foreign exchange market. Trade in the Swiss franc is more than 6 per cent. In the krone it is just 1.3 per cent, according to the latest data available from the Bank for International Settlements.
“The main problem is finding something that has all the constituents of a safe haven,” says Simon Derrick, currency analyst at BNY Mellon. “The thing that everyone forgets is liquidity.”
The pound is another contentious haven. Sterling has tended to strengthen this year when the euro weakens, as the UK economy has looked in better shape than that of the eurozone. But if the outlook for Europe deteriorates significantly, the UK is very exposed through its trade links. That has led some to label the pound a “bogus” haven.
Others believe the Canadian dollar could come to the fore. The so-called “loonie” is backed by a politically stable country, with large reserves racked up by the central bank. On the downside, it is traditionally referred to as a commodity currency because of its oil exports, making its performance closely tied to that of the global economy. Its strong trade links with the US also make it susceptible to any weakening in the US economy.
However, Simon Derrick, currency analyst at BNY Mellon, argues that those who believe the US dollar will be a decent haven next year should consider diversifying into the Canadian dollar, as that should rise against other major currencies if the US dollar does well.
Investors hopeful of less government intervention to weaken currencies next year could be disappointed. The SNB believes the franc is still significantly overvalued. Many analysts believe the central bank will still adjust the ceiling at which it will buy euros to weaken the franc again next year.
The Bank of Japan is also widely expected to take further action, though in the past intervention has not managed to weaken the yen for more than a few days due to the vast size of the market. As a result, many analysts still believe the yen will be a key haven next year.
But most agree the US dollar will remain the least contentious haven for 2012. “The anticipated relative outperformance of the US economy, especially if continued to be supported by fiscal and monetary policy, is expected to provide continued support for the dollar in the coming year. We maintain our view that the dollar and the yen will be the top performers among the G10 in 2012,” says Morgan Stanley.
Source: http://www.ft.com/intl/cms/s/0/3fc72532-2d78-11e1-b985-00144feabdc0.html?ftcamp=rss#axzz1i2eOMioF
Friday, November 25, 2011
Hungary First To Offer Real Solution To Debt Crisis; Sets Stage for Gold's Re-Monetization
Hungary is considering allowing its citizens with mortgages denominated in a foreign currency -- typically the Swiss Franc -- to pay back their mortgages at an exchange rate that is lower than the current Forint/Franc exchange rate. Hungarian banks would be responsible for picking up the difference between the fixed exchange rate mandated by the government on these mortgages and the Forint/Franc market rate.
This plan has some problems -- in that Hungarian banks may not be able to afford picking up the tab on the exchange rate difference, and that the Swiss National Bank (SNB) may find an influx of capital, even in the form of loan repayments, to strengthen their currency (something the SNB has vowed to prevent) -- but I think it has some key features that may help us understand how the global sovereign debt crisis will be resolved, and what this means for the global economy. Specifically:
By letting those with mortgages pay back their debts denominated in foreign currencies at a lower exchange rate, Hungary is basically making banks pay for part of the loan -- not just the debtor with the mortgage. This type of debt cancellation is exactly what is needed and is the first step to a real solution. Until global debt levels are significantly reduced, there will not be sufficient capital available for investment or consumption. It's that simple.
By proposing a lower exchange rate for foreign-denominated loans, Hungary is pursuing an indirect form of currency appreciation; at least for Hungarians with mortgages denominated in foreign currencies, the Forint will be able to buy them a greater piece of their debt repayment. I still think the Forint has many problems and is not worth owning as a store of value, but a central bank pursuing a stronger currency in some way, while also helping advance the cause of debt cancellation, may be a policy we may see more of as this is at the heart of the solution to the global sovereign debt crisis.
As other central banks realize the need to strengthen their currency, they will naturally turn to where history has always turned to find strength in the midst of public debt crises: gold. This puts us on the trajectory toward some type of re-monetization of gold, which is what sends gold and gold mining shares both much, much higher.
Hungary's proposal here is also unlocking a new era in monetary policy, suggesting a reversal to fixed exchange rates and the end of the floating exchange rate system born when US President Richard Nixon terminated the link between US dollars and gold in 1971. We've already seen the SNB announce that they are basically pegging the Franc to the Euro, and now we are seeing talks of the Forint being pegged in certain situations at a rate different than what the market is pricing the Forint at. I don't think monetary authorities around the world have the trust of their constituents to pull this off, and think various forms of revolution and political re-organization are likely.
So, at the very least, developments in this story will be worth watching. If the right type of debt cancellation deal can be worked out, we may be on our way out of the global debt crisis and ready for the next secular bull market in equities.
Source: http://seekingalpha.com/article/293104-hungary-first-to-offer-real-solution-to-debt-crisis-sets-stage-for-gold-s-re-monetization
This plan has some problems -- in that Hungarian banks may not be able to afford picking up the tab on the exchange rate difference, and that the Swiss National Bank (SNB) may find an influx of capital, even in the form of loan repayments, to strengthen their currency (something the SNB has vowed to prevent) -- but I think it has some key features that may help us understand how the global sovereign debt crisis will be resolved, and what this means for the global economy. Specifically:
By letting those with mortgages pay back their debts denominated in foreign currencies at a lower exchange rate, Hungary is basically making banks pay for part of the loan -- not just the debtor with the mortgage. This type of debt cancellation is exactly what is needed and is the first step to a real solution. Until global debt levels are significantly reduced, there will not be sufficient capital available for investment or consumption. It's that simple.
By proposing a lower exchange rate for foreign-denominated loans, Hungary is pursuing an indirect form of currency appreciation; at least for Hungarians with mortgages denominated in foreign currencies, the Forint will be able to buy them a greater piece of their debt repayment. I still think the Forint has many problems and is not worth owning as a store of value, but a central bank pursuing a stronger currency in some way, while also helping advance the cause of debt cancellation, may be a policy we may see more of as this is at the heart of the solution to the global sovereign debt crisis.
As other central banks realize the need to strengthen their currency, they will naturally turn to where history has always turned to find strength in the midst of public debt crises: gold. This puts us on the trajectory toward some type of re-monetization of gold, which is what sends gold and gold mining shares both much, much higher.
Hungary's proposal here is also unlocking a new era in monetary policy, suggesting a reversal to fixed exchange rates and the end of the floating exchange rate system born when US President Richard Nixon terminated the link between US dollars and gold in 1971. We've already seen the SNB announce that they are basically pegging the Franc to the Euro, and now we are seeing talks of the Forint being pegged in certain situations at a rate different than what the market is pricing the Forint at. I don't think monetary authorities around the world have the trust of their constituents to pull this off, and think various forms of revolution and political re-organization are likely.
So, at the very least, developments in this story will be worth watching. If the right type of debt cancellation deal can be worked out, we may be on our way out of the global debt crisis and ready for the next secular bull market in equities.
Source: http://seekingalpha.com/article/293104-hungary-first-to-offer-real-solution-to-debt-crisis-sets-stage-for-gold-s-re-monetization
Wednesday, November 2, 2011
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