Ramifications of the Swiss Franc Move

The Swiss National Bank, which had previously worked tirelessly to suppress the value of its currency, the Swiss franc, decided to end the effort. The franc immediately soared 30% vs. the euro, and the Swiss stock market crashed 10%.
This has many ramifications – I’m sure I’ll miss several – so let’s go through them and what the domino effect could be. I will try to fit them in three different categories: 1) Stability perception by the world, 2) the cost of doing business and 3) possible domino effect.

Stability Perception by the World
Financially, Switzerland is considered very conservative and very safe. People and business all over Europe borrow Swiss francs because rates are low, and it’s considered a safe haven. In fact it’s reported by Bloomberg that 40% of mortgages in Poland are denominated in Swiss francs.
All this can be throw out the window. A very trusted and stable financial center is no longer stable and can no longer be trusted.
According to Yahoo Finance, Switzerland has less people than Virginia and a smaller economy than Turkey, so it’s not exactly a major financial player. Still, this event – albeit relatively minor – can be a tipping point? It could be the equivalent of Bear Sterns or Lehman going belly up. I’m not predicting this, but trust is important, and if an extremely trusted financial center can so easily renege on cited intentions, who can be trusted?
The Cost of Doing Business
The price of goods and doing business for those that deal in a currency other than francs will go up.
Yesterday I could go to Switzerland and for every dollar I gave them, they’d give me approximately 1.02 francs. Today that same dollar will only get me 0.88 francs. So assuming the price of good remains the same, prices just jumped for tourists – and for the sake of this write-up, let’s call all businesses tourists too because they arrive in the country with dollars or euros and have to convert.
The opposite is also true. Anyone who gets paid in francs but then has to convert to dollars will be happen to get more dollars, so this is a big boon for Switzerland locals.
I saw the opposite take place in Costa Rica. When I arrived, the conversion was 1 dollar = 500 colones. But about a year later, the conversion jumped to 1 dollar = 550 colones. For me, I was in heaven – well, if you could consider saving a little money to be heaven – because when I converted my dollars to the local currency, they gave me more. I was hedged. If the price of things went up 10%, it didn’t matter because I got 10% more money when I converted. The people who got screwed were locals who were paid in colones but then had to convert to dollars to pay rent or other things.
The opposite is happening in Switzerland. Those inside the country who get paid in francs benefit when they exchange to another currency, but those outside the country take a hit. This could certainly hit tourism in the near term and could discourage business from entering the country in the long term.
But tourism is minor compared to those who took out loans in francs.
Let’s take a Polish homeowner who borrowed francs to buy a house. He’s not screwed, but it’s going to be much harder to make the monthly payments. Instead of 1 Polish zloty converting to 0.28 francs, now it only converts to 0.23 francs. That homeowner is going to have to come up with a lot more money to make the payment. Yikes.
Possible Domino Effect
I don’t know how contained the Polish housing market, but spreading losses among millions of individual people is much more manageable than having big hedge funds and banks possibly throw into the mix.
If the Swiss government was going to limit the franc’s upside, that sounds like a good short.
Short the franc and take the money and play the game somewhere else. Sounds like a good trade to me. Heck the government invitations to do this were as strong as the Saudi Oil Minister repeatedly saying oil production would not be cut…and that he didn’t care if oil dropped to $20.
So what just happened to those who shorted the franc? They immediately have a huge loss.
And what if they did it with leverage? Even bigger loss.
And this comes in many forms. It’s not just those who shorted the franc. What about those who just borrowed in francs – because the currency was stable, boring and rates were very low – and now find themselves on the wrong side of a currency conversion. And what if they used leverage?
I don’t know how this will play out. No doubt some funds will go belly up if they were short the franc with leverage. But what if they have to liquidate holdings…which causes the market to drop…which triggers margin calls elsewhere and causes other funds to have to liquidate, etc, etc.
And it’s not just funds. What if big banks or entire countries sold francs, converted to another currency, and then did business elsewhere. It many be hard or impossible to service the loans.
It doesn’t take much to tip the market over, and considering the computers at work – if they sniff trouble, they will get very aggressive – I wonder if things could unravel like they did in 2007 and 2008. I’m not predicting it. I’m just throwing in out there.
The first step of an unraveling would be the drop in highly liquid assets (to cover losses elsewhere), but if the losses are too big, jump to counter party insurance risk and all that other stuff (and who knows what’s going on behind the scenes) (remember AIG imploding)…
Bear Sterns wasn’t a massive company, and the infested part of the company was very tiny – I think it was just two funds that were way over-leveraged. Yet it still was enough to get the ball rolling. I’m not predicting this, but this is the type of sudden and unexpected event that could begin the process of unraveling the world financial system.