Currency Wars?

The Financial Times reports today that the Swiss Central Bank has started to intervene in the currency markets to lower the value of the Swiss Franc because they fear that a rapidly appreciating currency will worsen their economic slowdown.

In a free floating exchange rate system the value of a currency is left to market forces i.e. the weight of supply of and demand for a currency. Britain has operated with a floating system since we suspended membership of the ERM in September 1992. Although the Bank of England has considered intervention, it has not done so, although it knows that changes in policy interest rates will have an impact on exchange rates through changes in the flow of hot money.

Managing the currency

But the Swiss Central Bank has opted to intervene directly in the currency exchanges. According to a report in the Financial Times, “this is the first time a leading central bank has intervened in the foreign exchange markets since Japan sought to weaken the yen in 2004.” Reuters reports that this is the first official intervention in the markets by the SNB since 1995 although they have tried ‘verbal intervention’ in the past in an attempt to ‘talk the currency down’.

At times of global economic uncertainty investors look for assets and currencies that hold their value and offer a safe haven - gold and the Swiss Franc fit neatly into this category and the result has been strong demand for Francs driving it higher against the Euro. For the Swiss National Bank an appreciating currency represents an “inappropriate tightening of monetary conditions” during an economic slowdown and they have decided to enter the market and use Swiss Francs to buy other foreign currencies. This will lead to an outward shift in the market supply of Swiss Francs and an outward shift in the demand for Euros.

The Swiss franc had risen some 6 percent against the euro since December and some 10 percent against a range of currencies in trade-weighted terms since the credit crisis broke in 2007. Official policy interest rates are already at zero and the Swiss economy (which is heavily export dependent) is facing the worst recession for 30 years and a serious risk of price deflation.

Are we moving into an age when more countries opt to use currency intervention as a tool of monetary policy? Britain has this option because we are outside of the Euro and therefore retain a degree of independence or autonomy with respect to our monetary policy. But if nations engage in currency wars - intervening to manipulate currencies to create a competitive advantage in international markets, the chances of a co-ordinated policy approach to the economic and financial crisis will deteriorate.