Switzerland abandons floating exchange rate in dramatic 'currency war' twist

The Swiss national bank (SNB) said it would “no longer tolerate” a euro rate below 1.20 francs. “The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities. The massive overvaluation of the franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development,” it said.

The franc plummeted against all major currencies, falling 9pc against the euro as markets opened on Tuesday. The Swiss action will be studied closely in Norway, Singapore and above all Japan, where the yen has also rocketed to levels that threaten to blight exporters and tip the country into deep deflation.

“The market must fear this will lead to a sharp escalation in currency wars,” said David Bloom from HSBC. “Gold is the only safe haven asset that will not do QE, put in capital controls or complain.”

Mr Bloom said the Swiss move will exacerbate Europe’s debt crisis by widening the spreads betweeen core EMU and the periphery. “This is a risky policy for the Swiss,” he said.

Simon Derrick from BNY Mellon said the Swiss are restricting EMU debt purchases to German and French bonds, unlike earlier rounds of intervention. “The SNB is just as keen to have a safe-haven for its money as any other investors. It is recycling money leaving southern Europe into northern Europe. This is the darker message,” he said.

Japan has warned that it may intervene at any moment, especially if the US weakens the dollar by printing more money (QE). Michael Saunders from Citigroup said Britain may beat them to it. “We suspect the UK will be the next central bank to reach into the unconventional tool box, with a decision to restart QE on Thursday,” he said.

The Swiss economy is at risk of crippling damage appreciating from CHF 1.7 against the euro in 2008 to near parity in August. Currency hedges have protected Swiss firms until now but these contracts are expiring, leaving exporters nakedly exposed.

The SNB was forced to act once global recovery stalled and Europe’s debt crisis metastasized. The minimim floor is a copy of the bank’s desperate strategy - after all else failed - in October 1978. It did stabilize the franc at that time but at a very high cost.

The flood of liquidity from “unsterilized” interventions stored up all kinds of problems. “Inflation skyrocketed, reaching over 7pc in 1981,” said Paul Mackel from HSBC.

The SNB said in July that it had already lost 9.9bn francs from intervention this year. This is a political hot potato. There are already calls from the Swiss parliament for heads to roll.

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Of aphrodisiac currency: ten facts chocolate

-World Cocoa Foundation, there is between five and six million cocoa farmers worldwide, with between 40 and 50 million people with cocoa for their livelihood.

-70pc of world cocoa comes from West Africa with only production of 40pc of global supply to Côte d'Ivoire. Outside Africa, the main producers of cacao include Indonesia, Malaysia and the Brazil.

-Chocolate is made from the seeds of cocoa tree tropical, officially known as Theobroma Cacao, who, in Greek, literally means "food of the gods".

-A cocoa tree takes five years to produce its first beans.

-The Olmec are the first people known to use cocoa, three to four thousand years, which grew wild in Central America, followed by the Mayas and Aztecs of the 10th century to the 1520s...

-Maya created a ritual drink cocoa mixed with water, black pepper, vanilla and spices, shared marriage ceremonies. This was one of the first links between chocolate and romance.

-Cocoa beans has also used silver in South America of civilization and were consumed only that they wore. A horse, antique show, can be bought for ten beans, with rabbits, costs four beans or 100 for a slave.

-The word "chocolate" was registered in English usage in 1604, but there is no record of drunken chocolate here in 1647.

-January 1, 1900, Queen Victoria has sent a donation of 100,000 boxes of chocolates from troops in the Boer War.

-Chocolate is estimated to contain up to 300 different chemicals. One of them, phenylethylamine (PEA), is a natural substance that in 1982, New York researchers found stimulated by the same reaction in the body like the feeling of falling in love. However, a controlled study in 1995 suggested that the moods of the chocolate addicts have quite improved eating chocolate.

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QE2 risks currency wars and the end of dollar hegemony

The Fed's "QE2" risks accelerating the demise of the dollar-based currency system, perhaps leading to an unstable tripod with the euro and yuan, or a hybrid gold standard, or a multi-metal "bancor" along lines proposed by John Maynard Keynes in the 1940s.

China's commerce ministry fired an irate broadside against Washington on Monday. "The continued and drastic US dollar depreciation recently has led countries including Japan, South Korea, and Thailand to intervene in the currency market, intensifying a 'currency war'. In the mid-term, the US dollar will continue to weaken and gaming between major currencies will escalate," it said.

David Bloom, currency chief at HSBC, said the root problem is lack of underlying demand in the global economy, leaving Western economies trapped near stalling speed. "There are no policy levers left. Countries are having to tighten fiscal policy, and interest rates are already near zero. The last resort is a weaker currency, so everybody is trying to do it," he said.

Pious words from G20 summit of finance ministers last month calling for the world to "refrain" from pursuing trade advantage through devaluation seem most honoured in the breach.

Taiwan intervened on Monday to cap the rise of its currency, while Korea's central bank chief said his country is eyeing capital controls as part of its "toolkit" to stem the flood of Fed-created money leaking out of the US and sloshing into Asia. Brazil has just imposed a 2pc tax on inflows into both bonds and equities – understandably, since the real has risen by 35pc against the dollar this year and the country has a current account deficit.

"It is becoming harder to mop up the liquidity flowing into these countries," said Neil Mellor, of the Bank of New York Mellon. "We fully expect more central banks to impose capital controls over the next couple of months. That is the world we live in," he said. Globalisation is unravelling before our eyes.

Each case is different. For the 40-odd countries pegged to the dollar or closely linked by a "dirty float", the Fed's lax policy is causing havoc. They are importing a monetary policy that is far too loose for the needs of fast-growing economies. What was intended to be an anchor of stability has become a danger.

Hong Kong's dollar peg, dating back to the 1960s, makes it almost impossible to check a wild credit boom. House prices have risen 50pc since January 2009, despite draconian curbs on mortgages. Barclays Capital said Hong Kong may switch to a yuan peg within two years.

Mr Bloom said these countries are under mounting pressure to break free from the dollar. "They are all asking themselves whether these pegs are a relic of the past," he said.

China faces a variant of the problem with its mixed currency basket, a sort of "crawling peg". Commerce minister Chen Deming said last week that US dollar issuance is "out of control". It is causing a surge of imported inflation in China.

Critics in the US Congress say China could solve that particular problem very quickly by letting the yuan rise enough to bring the country's $180bn trade surplus into balance.

They say the strategy of holding down the yuan to underpin China's export-led model is the real source of galloping wage and price inflation on China's eastern seaboard. The central bank has accumulated $2.5 trillion of foreign bonds but lacks the sophisticated instruments to "sterilise" these purchases and stem inflationary "blow-back".

But whatever the rights and wrongs of the argument, the reality is that a chorus of Chinese officials and advisers is demanding that China switch reserves into gold or forms of oil. As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony – to use the term of Charles de Gaulle.

The innocent bystanders caught in the crossfire of Fed policy are poor countries such as India, where primary goods make up 60pc of the price index and food inflation is now running at 14pc. It is hard to gauge the impact of a falling dollar on commodities, but the pattern in mid-2008 was that it led to oil, metal, and grain price rises with multiple leverage. The core victims were the poorest food-importing countries in Africa and South Asia. Tell them that QE2 brings good news.

So the question that Ben Bernanke and his colleagues should ask themselves is whether they have thought through the global ramifications of their actions, and how the strategic consequences might rebound against America itself.

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Currency wars are necessary if all else fails

They are taking active steps to prevent America extricating itself from the worst unemployment since the Great Depression, now 17.1pc on the latest U6 index and rising again.

Each country is doing so for understandable reasons: Japan to avoid a deflationary crisis, China to hold together a political order that is more fragile than it looks. In both these cases they are trapped because they clung too long to a mercantilist export strategy, failing to wean themselves off American demand when the going was good.

Yet this is an intolerable situation for the US. It should be no surprise that Washington has begun to retaliate in earnest, and not just by passing the Reform for Fair Trade Act in the House (not yet the Senate), clearing the way for punitive tariffs against currency manipulators.

The atomic bomb, of course, is quantitative easing by the Federal Reserve. America has in effect issued an ultimatum to China and G20: either you stop this predatory behaviour and agree to some formula for global rebalancing, or we will deploy QE2 `a l’outrance’ to flood your economies with excess liquidity. We will cause you to overheat and drive up your wage costs. We will impose a de facto currency revaluation by more brutal and disruptive means, and there is little you can do to stop it. Pick your poison.

This is what QE2 means, though Fed officials prefer to talk of their “mandate” of supporting employment. It is nothing like QE1, which was emergency action to halt the economic free-fall of late 2008 and early 2009. This time the Fed is using QE as a long-term tool to manage America’s chronic ailments.

Uber-dovish Fed comments over recent days have been enough to send the dollar crashing to a 15-year low of 82 against the Japanese yen, to below parity against Swiss franc, and back to the EMU pain barrier of $1.40 against the euro.

There was much tut-tutting about currency warfare at the IMF meeting over the weekend. "If one lets this slide into protectionism, we run the risk of the mistakes of the 1930," said World Bank chief Robert Zoellick.

You have to say this kind of thing if you run a Bretton Woods institution, but in real life wars occur because somebody finds the status quo unacceptable, perhaps justifiably so. As Nobel economist Paul Krugman puts it: “people are looking for innocuous ways to deal with this problem, and there aren’t any”.

Devaluation was not the mistake of the 1930s: it was the cure, albeit a bad one. The Gold Standard broke down during the inter-war years because the US and France had structurally undervalued exchange rates (like China/Asia today) and ceased recycling their trade surpluses (like China/Asia today). This caused a deflationary downward spiral for everybody.

Escaping from such a deformed system was a path to recovery. The parallel with modern globalization – though not exact – is obvious. So is the 1930s lesson that currency and trade clashes are asymmetric: they are calamitous for surplus countries, but not always for deficit countries. Britain enjoyed a five-year mini-boom after retreating into an Empire trade bloc in 1932.

Fed chair Ben Bernanke knows his history. In a speech as a junior Fed governor he described Roosevelt’s 40pc devaluation against gold as “an effective weapon” against deflation and slump, adding “1934 was one of the best years of the century for the stock market”.

I suspect that the Bernanke Fed is working with the Treasury to steer the dollar lower, and above all to stop it rising again, since the global dollar index looks poised for a powerful rebound.

There is certainly something odd about the latest Fed rhetoric. New York chief William Dudley said inflation had fallen to “unacceptable” levels. Has it really? The Dallas Fed’s `trimmed-mean’ CPE inflation index has been creeping up over the last three months.

His Chicago colleague Charles Evans has called for “much more accommodation". Why now? Bank credit has stopped contracting. The M2 money supply growth has accelerated sharply to a 7.4pc rate over the last month of published data. The St Louis Fed’s monetary multiplier has edged up at last. By the Fed’s own account, the double-dip scare of the early summer has abated.

I happen to think that the Fed will need to launch QE2 on a big scale as US fiscal tightening bites, the inventory spike fades, and the housing foreclosure crisis gathers pace. But we are not there yet. Fresh QE cannot be justified at this juncture under any normal understanding of central bank policy.

Is the Fed in reality trying to shore up consumption by juicing asset prices, and trying to ensure that the effect boosts jobs at home rather than in China, Germany, or Japan by holding down the dollar?

This is a dangerous moment for the world, and may backfire against the US itself. We are already starting to see the same sort of rush into oil and resources that played such havoc in mid-2008, and may have been a key trigger for the Great Recession. There is a risk that this commodity shock will hit before QE stimulus filters through.

And while the French deny that they are in talks with China over the creation of a new currency regime, I heard French finance minister Christine Lagarde say in person at a meeting in Italy that France would use its G20 presidency to push for an alternative to the dollar. She specifically cited the “Bancor”, the idea floated by Keynes in the 1940s for a commodity currency priced off a basket of metals. The US risks gambling away the “exorbitant privilege” it has enjoyed for two thirds of a century as currency hegemon.

Yet the surplus states have most to lose if this brinkmanship tips into commercial war. They must know this, but what we are witnessing may run deeper than a calculus of advantage. Was it naïve to think that Confucian Asia and the old democracies of the Atlantic seaboard can share an open global trading system?

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Gold is the final refuge against universal currency debasement

The US and Britain are debasing coinage to alleviate the pain of debt-busts, and to revive their export industries: China is debasing to off-load its manufacturing overcapacity on to the rest of the world, though it has a trade surplus with the US of $20bn (£12.6bn) a month.

Premier Wen Jiabao confesses that China’s ability to maintain social order depends on a suppressed currency. A 20pc revaluation would be unbearable. “I can’t imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs,” he said.

Plead he might, but tempers in Washington are rising. Congress will vote next week on the Currency Reform for Fair Trade Act, intended to make it much harder for the Commerce Department to avoid imposing “remedial tariffs” on Chinese goods deemed to be receiving “benefit” from an unduly weak currency.

Japan has intervened to stop the strong yen tipping the country into a deflation death spiral, though it too has a trade surplus. There is suspicion in Tokyo that Beijing’s record purchase of Japanese debt in June, July, and August was not entirely friendly, intended to secure yuan-yen advantage and perhaps to damage Japan’s industry at a time of escalating strategic tensions in the Pacific region.

Brazil dived into the markets on Friday to weaken the real. The Swiss have been doing it for months, accumulating reserves equal to 40pc of GDP in a forlorn attempt to stem capital flight from Euroland. Like the Chinese and Japanese, they too are battling to stop the rest of the world taking away their structural surplus.

The exception is Germany, which protects its surplus ($179bn, or 5.2pc of GDP) by means of an undervalued exchange rate within EMU. The global game of pass the unemployment parcel has to end somewhere. It ends in Greece, Portugal, Spain, Ireland, parts of Eastern Europe, and will end in France and Italy too, at least until their democracies object.

It is no mystery why so many states around the world are trying to steal a march on others by debasement, or to stop debasers stealing a march on them. The three pillars of global demand at the height of the credit bubble in 2007 were – by deficits – the US ($793bn), Spain ($126bn), UK ($87bn). These have shrunk to $431bn, $75bn, and $33bn respectively as we sinners tighten our belts in the aftermath of debt bubbles.. The Brazils and Indias of the world are replacing some of this half trillion lost juice, but not all.

East Asia’s surplus states seem structurally incapable of compensating for austerity in the West, whether because of the Confucian saving ethic, or the habits of mercantilist practice, or in China’s case by the lack of a welfare net. Their export models rely on the willingness of Anglo-PIGS to bankrupt themselves.

So we have an early 1930s world where surplus states are hoarding money, instead of recycling it. A solution of sorts in the Great Depression was for each deficit country to devalue, breaking out of the trap (then enforced by the Gold Standard). This turned the deflation tables on the surplus powers – France and the US from 1929-1931 – forcing them to reflate as well (the US in 1933) or collapse (France in 1936). Contrary to myth, beggar-thy-neighbour policy was the global cure.

A variant of this may now occur. If China continues to hold down its currency, the country will import excess US liquidity, overheat, and lose wage competitiveness. This is the default cure if all else fails, and I believe it is well under way.

The latest Fed minutes are remarkable. They add a new doctrine, that a fresh monetary blitz – or QE2 – will be used to stop inflation falling much below 1.5pc. Surely the Fed has not become so reckless that it really aims to use emergency measures to create inflation, rather preventing deflation? This must be a cover-story. Ben Bernanke’s real purpose – as he aired in his November 2002 speech on deflation – is to weaken the dollar.

If so, he has succeeded. The Swiss franc smashed through parity last week as investors digested the message. But the swissie is an over-rated refuge. The franc cannot go much further without destabilizing Switzerland itself.

Gold has no such limits. It hit $1300 an ounce last week, still well shy of the $2,200-2,400 range reached in the late Medieval era of the 14th and 15th Centuries.

This is not to say that gold has any particular "intrinsic value"’. It is subject to supply and demand like everything else. It crashed after the gold discoveries of Spain’s Conquistadores in the New World, and slid further after finds in Australia and South Africa. It ultimately lost 90pc of its value – hitting rock-bottom a decade ago when central banks succumbed to fiat hubris and began to sell their bullion. Gold hit a millennium-low on the day that Gordon Brown auctioned the first tranche of Britain’s gold. It has risen five-fold since then.

We have a new world order where China and India are buying gold on every dip, where the West faces an ageing crisis, and where the sovereign states of the US, Japan, and most of Western Europe have public debt trajectories near or beyond the point of no return.

The managers of all four reserve currencies are playing fast and loose: the Fed is clipping the dollar; the Bank of England is clipping sterling; the European Central Bank is buying the bonds of EMU debtors to stave off insolvency, something it vowed never to do just months ago; and the Bank of Japan has just carried out two trillion yen of “unsterilized” intervention.

Of course, gold can go higher.

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Capital controls eyed as global currency wars escalate

Guido Mantega, the Brazilian Finance Minister, said an international currency war threatened the country's competitiveness.

Brazil, Mexico, Peru, Colombia, Korea, Taiwan, South Africa, Russia and even Poland are either intervening directly in the exchange markets to prevent their currencies rising too far, or examining what options they have to stem disruptive inflows.

Peter Attard Montalto from Nomura said quantitative easing by the US Federal Reserve and other central banks is incubating serious conflict. "It is forcing money into emerging market bond funds, and to a lesser extent equity funds. There has truly been a wall of money entering many countries," he said.

"I worry that we are on the cusp of a competitive race to the bottom as country after country feels they need to keep up."

Brazil's finance minister Guido Mantega has complained repeatedly over the past month that his country is facing a "currency war" as funds flood the local bond market to take advantage of yields of 11pc, vastly higher than anything on offer in the West.

"We're in the midst of an international currency war. This threatens us because it takes away our competitiveness. Advanced countries are seeking to devalue their currencies," he said, pointing the finger at America, Europe and Japan. He is mulling moves to tax short-term debt investments.

Goldman Sachs said net inflows have been running at annual rate of $520bn (£329bn) in Asia over the last 15 months, and $74bn in Latin America. Intervention to stop it creates all kinds of problems so the next step may be "direct capital controls", the bank warned.

Brazil's real has been one of the world's strongest currencies over the past two years, aggravating a current account deficit nearing 2.5pc of GDP. The overvalued exchange rate endangers Brazil's industry, especially companies that compete with Chinese imports. The real has appreciated to 1.7 to the dollar from 2.6 in late 2008, and by almost the same amount against China's yuan.

"Everybody is worried that global growth is fading and they are trying to use exchange rates to protect exports. Brazil has watched as the Asians intervened and feels it can't stand by," said Ian Stannard, a currency expert at BNP Paribas.

Brazil has used taxes to slow the capital inflows but the allure of super-yields and the country's status as a grain, iron ore, and commodity powerhouse have proved irresistible. It is a textbook case of the "resources curse" that can afflict commodity producers.

A $67bn share issue by Petrobras has been a fresh magnet for funds, forcing the central bank to buy an estimated $1bn of foreign bonds each day over the past two weeks. Such action is hard to "sterilise" and can it fuel inflation.

Japan has begun intervening to stop the yen appreciating to heartburn levels for Toyota, Sharp, Sony and other exporters. A strong yen risks tipping the country deeper into deflation.

Switzerland spent 80bn francs in one month to stem capital flight from the euro, only to be defeated by the force of the exchange markets, leaving its central bank nursing huge losses.

Stephen Lewis from Monument Securities said the Fed is playing a risky game toying with more QE. There are already signs of investor flight into commodities. The danger is a repeat of the spike in 2008, which was a contributory cause of the Great Recession. "Further QE at this point may prove self-defeating," he said.

Meanwhile, Dominique Strauss-Kahn, managing director of the International Monetary Fund, tried to play down the fears of a currency war, saying he did not think there was “a big risk” despite “what has been written”.

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