Going off the peg – the Swiss case

So, the Swiss National Bank dropped its peg of the CHF against the EUR of 1.20, to the complete surprise of … well, anbydody, I suppose. As a result, the EUR dropped to lows of 0.975, according to yahoo, and remaining at 0.99 at pixel time.


The Swiss case is different from the normal case of a central bank stopping to defend a peg, because usually it has to defend against a depreciation of its currency, usually by selling its foreign reserves. Of course, such a defense is not sustainable in the long run, as foreign reserves are finite, if the fundamentals favor a depreciation.

Theoretically, these mechanisms have been well understood since the papers from Krugman on currency crises and later by Obstfeld on multiple equilibria, which explain speculative effects in a grey zone of so-so fundamentals, which could, for example, be effected by contagion. The practical results were very visible in the Asian crisis of 1997, and but for the political costs of leaving the EUR, we would have witnessed it in Europe in the last couple of years.

This is a matter close to my heart, as I wrote my diploma thesis on this subject, in an attempt to develop an early warning indicator. But even if that indicator would be still updated, and worked reasonably well, it would have missed the Swiss case – it was looking for depreciations against the central currency. But the SNB defended against appreciation, and theoretically, it should have been able to do so indefinitely, as it could just have kept on selling CHF against EUR.

Another indicator apparently also proved desastrous for a number of retail FX brokers – Value at Risk based on historical volatility. At least one broker declared insolvency, another is talking with regulators and investors about raising fresh capital, a number halted trading CHF. Here is an overview.

With a peg, of course the volatility would decline continously, lowering VaR. This allowed these brokers to decrease the required margin for their retail traders, or increase their leverage, with many brokers requiring only 2% margin. Those trades of course are completely underwater, and unless the traders answer the margin calls, the brokers have serious liquidity shortfall.

So, why did the SNB act like it acted? I can only speculate, of course, but here are some points whih I think are at least noteworthy:

  • While having a positive current account overall, it’s current account with the EU is negative, therefore appreciation would help closing this gap.
  • In a similar way, pegging to the EUR lead to depreciation against the USD and other major currencies, which might have lead to the impression that the pressure to appreciate the CHF against the trade wheighted basket has vanished to a manageable degree.
  • Expectations of European quantitative easing would weaken the EUR further, accelerating the growth of the SNB’s balance sheet, which might have been seen as a political liability.  This I don’t find very convincing, as the SNB is independent from direct government intervention, and a referendum to prescribe a minimum holding of gold as reserves just lost a popular vote, strengthening its independence further.

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