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Screenshot of a breaking news alert e-mail from Q2 2017
On Sunday this week, LeapRate took a look at the possible reasoning behind the Swiss National Bank’s sudden decision to remove the 1.20 floor on EURCHF pair in an editorial which opined that the central bank may have been taking evasive action to mitigate any exposure to the country’s vault-like economy should the Eurozone suffer even further economic woes, or be forced to write down Greek debt should it exit the European Union.
This view has been somewhat reinforced by Forex education company Tradimo, whose co-Founder and Managing Director Dean Peters-Wright has been among the few industry participants to put an opinion forward on Switzerland’s move since Thursday, a day in which the entire FX industry experienced monumental volatility in the EURCHF pairs, which at best exposed them to negative balances, and at worst saw off previously long established and well-capitalized companies.
Mr. Peters-Wright has gone into comprehensive detail, affirming that there is clearly no smoke without fire in his assessment as to why the SNB pulled the plug.
The Swiss National Bank shock has undoubtedly been the centrepiece over the last few days, with even the biggest names in the forex industry being affected. FXCM and Alpari being the clear losing leaders, with others close behind.
While the focus has been mainly on the smoke, it’s worth paying attention to what caused the fire.
First of all, an examination of the events that led to last week’s announcement that plunged the euro is a prudent starting point.
The devil in the economic details
A top European Union lawyer stated that the ECB bond-purchasing program is legal, removing any of the last obstacles in front of the ECB to engage in quantative easing (QE). It is now expected that the ECB will announce this program next week and, as expected, the euro will fall in value. This left the Swiss National bank in a predicament: do they continue to spend money propping up the euro against the Swiss franc at great cost (because in order to prop up the euro against the CHF, they have to purchase more euro to do so) or stop the program and risk hurting the Swiss economy by letting the value of the Swiss franc appreciate to a more true market value.
It seems that the bank chose the lesser of two evils – probably helped by the fact that the cost of propping up the CHF will escalate even further as the euro falls in value once QE takes hold. This scenario may have simply been too costly for the SNB. In the face of the open market, not even a central bank can hold out indefinitely against a falling currency value if the fundamentals point to a different price than the one the central bank desires. This was self-evident when the British pound collapsed after the Bank of England could no longer prop up the pound against the Deutsche mark in the 1990s.
Even if the SNB had decided to continue propping up the Swiss franc, the cost may have been too great, risking a default in the bank itself which would have been too much of an impact in on the Swiss economy itself. Left with seemingly no choice, the SNB pulled the plug.
Furthermore, the cost of keeping the euro would have been compounded after the value of the euros, that the Swiss National Bank had already purchased over the last three years, would have plummeted in the face of QE.
The calm before the even bigger storm
However, after the shock value of what happened, it is a drop in the ocean compared to what could happen in the euro-zone, because with the distraction of the SNB actions, the reason as to why the ECB needs to engage in QE in the first place has been overlooked.
The euro-zone is facing deflation throughout the 19 members – this isn’t a slow down in rising prices, this is an actual fall. While on the face of it, it seems that deflation is a knight in shining armour (you would think that with lower prices everywhere, people go into a spending frenzy which helps the economy); but it is actually the last thing that the euro-zone needs right now.
This is because when deflation takes hold, people actually stop buying and spending money. Consumers will hold off purchases if they believe they can get it at a cheaper price later on. Investors won’t hand out cash if they think that the assets they purchase are going to be worth less in a few months. If spending grinds to a halt, so does the economic machine of every member nation of the euro-zone, which is is far from an outright recovery. This is why central banks target a slow growth in prices – 2-3% – because it keeps people spending and investing without impacting on their own personal finances too much.
The Greek factor
There is also the small inconvenience of the Greek general elections coming up and the anti-austerity Syrizia party is leading the opinion polls. This puts a Greek exit from the euro firmly on the table. Faced with the overwhelming austerity measures holding the nation back, the Greek people are likely to rebel in the face of oppressed public spending.
Greece is also on its knees begging for a currency that reflects the state of its economy and a Greek exit will almost certainly mean a devalued Greek sovereign currency, enabling them to pick themselves off of the floor.
Euro not out of the woods yet
When the euro concept was born, there were no provisions for an exit. It was thought that once in the euro-zone, forever would that be the case. This means that an exit of any one of its members spells the complete treaty overhaul for the euro.
This scares many nations within the euro, but especially Germany, because they have the most to lose; because of the implications it will have on the euro single currency altogether. When the euro concept was born, there were no provisions for an exit. It was thought that once in the euro-zone, forever would that be the case. This means that an exit of any one of its members spells the complete treaty overhaul for the euro. Also the knowing fact that if a sovereign state falls outside the spending practices that the treaty dictates, gets into trouble and then when they can’t pay back debts they can always leave, it makes it hard, if not impossible, to police euro-members and keep them within the confinements of the single currency rules across fiscally independent nations.
This, if anything, would be the ultimate result of a failed system leading to the end of the euro. Of course this doomsday is not inevitable, far from it, but the notion of it could see investors withdrawing cash from the euro to place into more stable havens leading to a further demise of the euro value.
This is a guest editorial which was written by Dean Peters-Wright, Managing Director, Tradimo