The lessons of Switzerland

Earlier this week, the central bank of Switzerland (the Swiss National Bank) announced that it will enact a policy of buying euros in order to ensure that the Swiss franc does not continue to strengthen against the foundering euro. They set a target of requiring that the euro retain a value equal to at least F1.20 per euro.

Without this intervention, fewer and fewer Swiss francs would be required to obtain one euro (or, seen from the other direction, more and more euros would be required to obtain a set number of Swiss francs from one day to the next, as demand for Swiss francs drove the price of a franc higher and higher versus the declining currency of the economically troubled European Union).

This is a momentous occasion and a sad but probably necessary move from Switzerland, which abstained from joining the EU and which has been a true model of stable currency over the years.

As the European debt crisis intensifies, Switzerland has found itself in a difficult position, surrounded by eurozone countries filled with investors who have been trying to get their capital out of euros and into something more solid. Switzerland has been a rock in the midst of the recent stormy European sea (see diagram below), and as demand for their francs soared, their economy was put at risk by the rapid and increasing relative overvaluation that resulted.

Here is a link to an editorial in today's Wall Street Journal opinion page which explains that this move by the Swiss National Bank should not necessarily be seen as a sop to Swiss exporters whose goods were becoming too expensive for the rest of the world (or Swiss tourism, which would suffer as eurozone visitors found that their euros were not buying them much traction when turned into Swiss francs), nor as a nod to inflating their currency, but rather as a move to keep their foreign exchange rates more stable (having your currency appreciating rapidly can be as destabilizing as can having it depreciate rapidly).

The Wall Street Journal editors explain that the Swiss concern for stability is all too rare in recent decades, saying:
It's not fashionable these days for central bankers to worry too much about the external value of their currencies. Since the collapse of the Bretton Woods exchange-rate system in the 1970s, policy makers have grown fond of saying that markets should set exchange rates. But markets can't set the value of a commodity whose sole supplier is the central bank, and this pseudo-laissez-faire is an abdication of central banks' duty to control the supply of their currency, both internally and externally. Full marks to the Swiss for breaking with this mistaken central-bank orthodoxy.
This echoes arguments we have put forward in previous posts regarding the US dollar, saying that we are not among the camp that argues for a weaker dollar, but neither are we among the camp that argues for a constantly strengthening dollar. We are among the tiny camp of those who argue for a stable dollar.

On a related note, we also believe it is worth pointing out that the current turbulence in Europe is revealing once again that in a crisis, investors from around the world do not just flee to Swiss francs, but also to US dollars. There has been a lot of doomsday talk in the US in recent months that the US dollar cannot last much longer as the world's reserve currency.

We believe that such fearmongering is irresponsible: the US may be making egregious monetary and fiscal mistakes, but the fact remains that the US is by far the largest economy in the world and the only one with a system large enough to handle the job of acting as the reserve currency. We take our hats off to the bankers and policymakers in Australia and Canada (and Switzerland) who have done a far better job than those here in the US in managing their fiscal and monetary affairs than has the US, but the fact remains that those economies are nowhere near as diversified as the American economy in terms of goods and services produced, nor are they anywhere near as large. This should be well understood by investors who are being bombarded on all sides by politically-motivated messages threatening the end of the US dollar's reserve currency status.

The real thing that investors should take out of all this currency turbulence of late is the core lesson that we have tried to make central to everything we say here on this blog: that investors should be focusing on the businesses to which they commit capital, and avoid being sucked in to the siren song of chasing currency-based speculations (or any other primarily market-driven trading activity, all of which are the opposite of making business-based investments).

The real question for investors at any time and in any economic situation is, "What kind of businesses do you own (or to what kind of businesses do you lend investment capital)?" This is the question investors should ask themselves, rather than the seductive but dangerous questions of "How are you playing the (weakening/strengthening) US dollar?" or "What kinds of international plays are best to take advantage of the current situation in (insert latest headline-grabbing country or region of the world)?"

These are some of the important lessons investors should take out of the current situation in Switzerland and Europe.