The decision by the Swiss National Bank (SNB) to unpeg the Swiss franc from the euro in January 2015 has elicited various reactions from financial experts worldwide. According to the SNB, the decision was influenced by the need to strengthen the Swiss franc following the depreciation in the value of the euro in recent years. This paper examines the issues surrounding the unpegging of the franc from the euro. It highlights the historical exchange rate system of the Swiss franc and examines literature focusing on the same. Also, this paper gives insight into why the Swiss unpegged the franc, its market effects, and some of the lessons learned from the Swiss case study.
Swiss Franc Unpegged 2015: A Case Study
Historical Exchange Rate System of the Swiss Franc
One of the aims in the world of central banking is to have slow and predictable decisions although this was not the case when the Swiss National Bank (SNB) made an announcement in January 2015 that it would not hold the Swiss Franc at a fixed exchange rate with the Euro anymore. The rapid decision caused panic among global financial institutions and investors with the Swiss franc soaring greatly at the time. Before the decision to unpeg the Swiss franc, one euro was worth 1.2 Swiss francs with the value of the euro falling to 0.85 francs after the decision (Davies, 2015). The Swiss Franc has historically been considered a safe-haven currency because of the country’s legal requirement that a minimum of 40 percent of the currency should be backed by gold reserves and virtually zero inflation rate (Reynard, 2009). The valuing of the Swiss franc began with the formation of the Latin Monetary Union on 1865 by countries such as France, Italy, Belgium, and Switzerland. At the time, the franc was valued to a standard of 4.5 grams of silver which was equivalent to 0.290322 of gold. Although the Latin Monetary Union faded away and ended in 1927, the Swiss franc was on standard until 1936 after which it suffered significant devaluation because of the Great Depression. The depression saw the devaluation of key currencies such as the US dollar, French franc, and the British pound, which in turn saw the Swiss franc devalued by 30 percent. In 1945, with Switzerland joining the Bretton Woods System, the franc was pegged to the US dollar at a rate of $1= 4.30521 francs. There was a significant increase in the value of the US dollar in 1949, and as a result, $1 was equivalent to 4.375 francs. The period between 2011 and 2014 saw a massive overvaluation of the Swiss franc. In March 2011, 1 USD was equivalent to 0.91 francs with the US dollar exchanging at 0.833 francs in June 2011. In September 2011, in an attempt to counter the franc’s massive overvaluation, the Swiss National Bank (SNB) set a minimum exchange rate of 1.20 francs to the euro. The decline of the value saw the SNB unpeg the Swiss Franc from the Euro in December 2014. Currently, 1USD is equivalent to 1.0281 francs, which means that the SNB’s efforts to devalue the franc against major currencies such as the US dollar are bearing fruits.
According to Ružičić (2015), the need to strengthen the Swiss franc was one of the reasons why it was unpegged from the Euro. Since its introduction as the means of payment in all of the Swiss cantons 160 years ago, the Swiss franc has never been withdrawn from usage. In fact, it is considered one of the most stable currencies in the international monetary relations and has maintained the ratio of 1Euro= 1.5 francs over the years. Ružičić (2015) argues that the financial turmoil witnessed in the Eurozone, especially during and after the Greek Financial crisis, resulted in the devaluation of the euro that saw an increase in the GBP/CHF ratio from 1:2.25 to the current 1:1.58. In 2009, Switzerland held a referendum that directed the SNB to tie the Swiss francs to the euro, a move that resulted in a dramatic decrease in the value of the Swiss franc that was formerly considered one of the most stable currencies in regard to the euro and the US dollar. At the time, the SNB allowed the strengthening of its currency against the euro above the 1:1.20 ratios with the aim of stabilizing the currency at the approximate 1:1.03 ratio. However, a significant decrease in the value of the Euro in 2014 caused a decrease in the value of the franc as it was pegged to the euro. This forced the SNB to unpeg the franc from the euro, and in the past couple of months, there has been an increased demand for the Swiss franc from investors; hence the increase in its value against the euro and the US dollar.
Lleo & Ziemba (2015) highlight the intrigues and issues surrounding the pegging of the Swiss franc to the euro and its elimination years later. This article mentions that the SNB’s decision to peg the Swiss franc to the euro at 1.20 in 2011 was aimed at tracking the euro in its moves against all other currencies. Further, it states that the adoption of the peg was in the midst of the European debt crisis, during which the Swiss francs was experiencing massive safe haven inflows. The flow of funds was regarded as a significant threat to the competitiveness of the Swiss economy and the creation of significant asset bubbles in Switzerland. The pegging of the Swiss francs to the euro was seen as a pledge to buy francs at the set rate even in the face of a growing desire to sell euros. In the real sense, the pegging meant that the SNB made a pledge to print Swiss francs on demand, and this resulted in the SNB holding large balances of other currencies. The pegging of the franc to the euro saw the SNB lose about 78 billion franc, which was about 12 percent of the Swiss GDP at the time. Lleo & Ziemba (2015) argue that the initial aim of the pegging was to stem a further appreciation of the CHF, which would be detrimental to the Swiss economy and that of neighboring economies. However, the questions and concerns raised by the Swiss about the peg saw political costs of maintaining the same too high to bear resulting in its abandonment years later.
Why did the Swiss unpeg the franc?
The peg was installed in September 2011 following the decision made by the SNB but was later eliminated in January 2015 (Davies, 2015). Several factors have been attributed to the unpegging of the franc from the euro. First, the pegging of the franc to the euro resulted in the SNB building up large foreign-exchange reserves, especially with the pledge that more francs would be printed. Research indicates that the increased printing of funds would be accompanied by hyperinflation, which is considered a significant threat to economies. As such, the SNB was under pressure to do away with the possibility of building up large foreign-exchange reserves, and this could only be achieved by unpegging the Swiss franc from the euro. Second, the European Central Bank’s decision to introduce quantitative easing played a role in the abandonment of the peg. The ECB’s quantitative easing would result in the creation of money to buy the government debt of countries within the euro-zone. It was anticipated that this decision would see a significant decrease in the value of the euro, meaning that the SNB would have been forced to print more francs prompting a decrease in the value of the franc as well. For instance, in 2014, the euro underwent depreciation against other major currencies such as the US dollar, and this saw the franc (pegged to the euro) lose about 12 percent of its value against the dollar and 10 percent of its value against the rupee. The bottom line is that the decrease in value of the euro saw a decrease in the value of the franc, which prompted the SNB to abandon the peg (Groux & Jesswein, 2011).
Market Effects of the unpeg of the franc
The decision by the SNB to remove the peg resulted in adverse market effects, especially from the viewpoint of exports, the hotel industry, banks, hedge funds, brokerage firms, as well as individual traders within and outside Switzerland (Lleo & Ziemba, 2014). From the export viewpoint, Switzerland is a renowned producer of watches, chocolate, pharmaceuticals, and several tourist activities such as hiking, skiing, and visiting the beautiful landscape. It is understood that half of Swiss GDP comes from exports, and thus the decision to unpeg the franc from the euro had a significant impact on Swiss exports. With Canada being the main market of Swiss chocolates, the CAD went from 0.85 to 0.74 Swiss francs with the unpegging, and this means that the franc is some 13.75 percent more expensive. In the real sense, the unpegging has seen an increase in the value of the Swiss franc, meaning that exports to countries such as Canada are more expensive than before, and this has prompted a decrease in the revenues pumped into the Swiss economy from exports.
The other impact of the unpegging is that ski resorts in Switzerland have been hit hard by the high prices, which are as a result of the increase in the value of the Swiss franc (Danielsson, 2015). Research indicates that the ski resort prices in Switzerland are about double those in neighboring countries such as France and Austria. This has prompted Swiss ski resorts to lower their prices, especially for foreign tourists, a move that has resulted in significant losses.
The adverse market effects of the unpegging are also evident in the fact that Swiss research institutes have lowered growth forecasts by 75 percent in recent years, Swiss companies are giving lower pay to employees with more hours of work, and local retailers have cut prices of products and services and have the added problem of cross-border shopping into neighboring countries such as Italy, Germany, and France (Groux & Jesswein, 2011).
Lessons learned from the Swiss case study
Several lessons can be learned from the decision by the SNB to unpeg the franc from the euro. One of the lessons is that the unpegging had a minor impact on the growth of the Swiss economy. Economists argue that the GDP growth forecasts for 2015 stood at about one percent with the strength of the currency pushing the economy to focus on high-value goods with low price elasticity. Another lesson that other countries can learn from the Swiss case study is that unpegging a currency from a stronger one can result in deflation caused by currency appreciation. However, deflation is a significant threat to economic growth as it results in the decrease or fall of a country’s account surplus.
Danielsson, J. (2015). What the Swiss FX shock says about risk models. VoxEU. org.
Davies, G. (2015). The Swiss currency bombshell cause and effect. Financial Times Blog. Available at: http:// blogs. ft. com/ gavyndavies, 1, 18.
Groux, S., & Jesswein, K. (2011). The Continuing Role of Switzerland and the Swiss Franc in International Finance. Journal of Economics and Economic Education Research, 12(3), 65.
Lleo, S., & Ziemba, W. T. (2014). How to lose money in derivatives: Examples from hedge funds and bank trading departments. Available at SSRN 2433506.
Lleo, S., & Ziemba, W. T. (2015). The Swiss Black Swan Bad Scenario: Is Switzerland Another Casualty of the Eurozone Crisis?. International Journal of Financial Studies, 3(3), 351-380.
Reynard, S. (2009). What drives the Swiss franc?. Aussenwirtschaft, 64(4), 335.
Ružičić, B. (2015). Strengthening of the Swiss Franc through an Example of Housing Loans. Proceedings of FIKUSZ 2015, 153.