The Washington PostDemocracy Dies in Darkness

Why Switzerland’s currency is going historically crazy

Old Swiss people in Zurich can't believe what's happening to their currency (AP Photo/Keystone,Walter Bieri)

This is how a currency peg ends. This is how a currency peg ends. Yes, with a bang, actually.

The Swiss National Bank (SNB) shocked markets on Thursday by announcing that it would no longer hold the value of the Swiss franc down at 1.2 per euro, although it would lower interest rates from -0.25 to -0.75 percent. Mayhem ensued. The Swiss franc immediately shot up as much as 39 percent against the euro, before settling at "only" up 17 percent on the day. This is basically the biggest single-day move for a rich country's currency, as economist David Zervos points out, in the last 40 years. And it's sent Switzerland's stock market down 10 percent, as its suddenly more expensive currency will cripple its exporters by making their goods more expensive abroad.

Now let's back up a minute. Why was Switzerland pushing its currency down, and why has it stopped now? Well, in four words, it's the euro crisis. Back in 2011, you see, what looked like the imminent end of the euro made people want to move their money to the safety of Swiss banks. It wasn't about the secrecy, though. It was the fact that Swiss banks use Swiss francs, and those wouldn't get devalued like, say, Italian euros would if the common currency broke apart. The problem, though, was that this flood of incoming money pushed Switzerland's currency up too much, over 40 percent in just a year. The Swiss franc got so expensive that Swiss exporters, who sell 56 percent of their goods to the EU, were becoming uncompetitive, and Swiss prices were starting to fall.

And then the SNB remembered that a central bank can always push its currency down just by printing more of it. So that's what it did. Even better, it told everybody that this was what it was doing. It said it would buy as many euros with newly-printed Swiss francs as it took to keep the Swiss franc from being worth more than 1.2 per euro. That meant that, for awhile, the SNB didn't actually have to do anything, since nobody wants to bet against somebody with infinite money.

But then, in 2012, when it looked like the imminent end of the euro was once again here, so much money poured into Switzerland that its currency cap was briefly breached twice. It wasn't ready, in other words, to print money fast enough to keep its currency from momentarily going higher than it said it would let it. The result was that it had to print a whole lot more Swiss francs, and use them to buy a whole lot more euro-denominated assets to keep the exchange rate at 1.2 Swiss francs per euro. Indeed, the SNB ended up buying assets worth 80 percent of Switzerland's GDP to do so. (As point of comparison, the Fed's balance sheet is around 25 percent of GDP).

That, apparently, was as far as the SNB was willing to go. Russia's ruble crisis, you see, has already made more money start to come into Switzerland. And that figures to only become more of an issue if the ECB begins buying bonds with newly-printed euros as everyone expects it to at the end of the month. The SNB would have to print just as many Swiss francs as the ECB prints euros to maintain its peg, and that would push its balance sheet that much closer to the stratosphere. So it pulled the plug instead. You can see below what that did to the Swiss-franc-to-euro exchange rate today.

But was this a good idea? Well, probably not. Switzerland is still stuck in deflation, with prices falling 0.3 percent, and a stronger currency is only going to make that worse. Now, they tried to offset this by charging people even more to hold their money in Switzerland—aka negative interest rates—but that wasn't nearly enough to stop the Swiss franc from going vertical. The SNB, in other words, chose a slower economy today, because it was afraid of a bigger balance sheet tomorrow, maybe a much bigger one if the ECB buys more bonds than expected. Their thinking seems to be that the Swiss franc was inevitably going to get stronger, which will inevitably mean taking paper losses on their euro assets, so why rack up even bigger losses for what might only be a minimal gain?

If they're wrong, though, Switzerland's currency might not be the only thing that goes bang. Its economy might too—and not in a good way.