Short Cuts

John Lanchester

You know that thing where you draw a line in the sand, stand behind it and declare: ‘They shall not pass!’ That’s what the Swiss National Bank, the SNB, did in September 2011, when it surprised the currency markets by suddenly announcing that it wouldn’t allow the Swiss franc to appreciate in value below CHF 1.20 to one euro. The SNB’s problem was that the Swissie, as it is known in currency trading circles, is a safe-haven currency, one to which money and bank deposits flee in times of trouble, especially trouble in Europe. (London property plays a similar role in relation to more general global instability.) Worries about the future of the EU were causing a spike in the Swissie which in turn was making life difficult for Switzerland’s exporters (watches, chocolates) and tourist industry. The SNB’s response was hardcore:

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development. The Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

‘Unlimited quantities’: when a central bank says that, it is in effect a declaration of currency war. Normal war involves projecting strength; currency war involves projecting weakness. In this instance, the SNB was announcing an open-ended willingness to print its own cash and use it to buy foreigners’ money.

And then there’s the other thing, where, having drawn a line in the sand, you realise it was a mistake, and you can’t defend the line any more, or you can no longer be bothered, or you just change your mind, or something, so you wave your arms and say ‘Fuck it’ and walk away. That’s what the SNB did on 15 January, when it abandoned the currency peg. The action was taken with no advance warning, not even to other central banks or the IMF. The immediate effects were spectacular. The Swiss franc appreciated against the euro by 39 per cent within ten minutes. Moves of that sort simply never happen between developed economy currencies. Result: market pandemonium.

It’s traditional to announce that events of this type create both winners and losers. This one, though, is all about the losers. The first group is the Swiss manufacturers and hoteliers and everyone whose economic well-being is linked to theirs. The second is the surprisingly numerous group of foreign nationals, mainly in Eastern Europe, who have mortgages denominated in the Swissie rather than in their own currencies. Fun fact: 37 per cent of all Polish household debt is held in Swiss francs. If zloty interest rates are highish and volatile, and Swiss interest rates are crazy-low and famously stable, and the SNB has promised to keep them that way, why not take out a Swiss mortgage? Actually, the answer to that is obvious: because it’s an incredibly reckless idea. At some times and in some places, though, the apparent logic seems irresistible. When I was researching the credit crunch, I met people in Iceland who had bought their houses with mortgages denominated in yen. When I asked them why, they replied with variations on the same theme: ‘Because everyone was doing it.’

The third group of losers is, in at least one sense, closer to home. About four million people globally are small retail ‘investors’ who bet on currency prices. I put ‘investors’ in inverted commas because what this really is, is a very pure form of gambling. The classic technique is to pick a pair of currencies and bet on how they will move relative to each other. In 2010, the US Commodity Futures Trading Commission cracked down on companies that were offering these services to retail investors. Some of the firms were operating what amounted to a scam based on customer ignorance. Clients were given the opportunity to ‘leverage’ – i.e. magnify – their bets, by as much as two hundred times. A $5000 deposit would give you the opportunity to speculate with $1,000,000. Because currency markets are volatile and prices jerk about unpredictably, the client is all but guaranteed to lose. With money leveraged two hundred times, all it takes is a move of 0.5 per cent the wrong way, and the client has lost all his capital. Then the company closes the account and goes in search of some new suckers. The beauty is that on the very infrequent occasions when the client wins his bets and cashes out, he’ll then tell everyone he knows, who will tell everyone they know, and it works as a thrillingly effective form of marketing.

The CFTC wanted to limit leverage to ten times: your $5000 would allow you to gamble only as much as $50,000. The industry’s response was to storm off in a huff and move to somewhere it could operate without any regulation. Guess where it moved to find an unregulated environment: go on, guess. On three now, one, two, three: London! Here in the UK, foreign exchange firms allow the customers as much as five hundred times’ leverage, so your £5000 will let you risk £2,500,000. As Paul Murphy points out in a brilliant piece in the FT: ‘Trading on such terms blows the client up very quickly, which is why all these forex operators employ lavish sums on marketing targeting motor racing and Premier League football in particular. If the clients are always losing money, you need to replenish them.’ Makes you proud to be British.

At a time when banks and other parts of the financial sector are wrestling with proliferating amounts of regulation, this sector is a free-for-all. The reason seems to be that the regulators regard this not as a form of investment but as an especially risky type of gambling, and therefore not really as their business. You can’t ban stupidity and you can’t make it illegal for people to punch themselves in the face, and so similarly you can’t crack down on retail forex: that seems to be the logic.

It’s been estimated that an enormous number of retail forex investors were betting against the Swissie versus the euro. Since the SNB had promised this was a safe bet, why not? Well, now we know why not. Very many of these investors have been wiped out. The market move happened so quickly that they lost all their capital and then some. When that happens, the losses are passed on to the relevant forex companies, a number of which have in turn lost all their capital and gone insolvent, and then passed on their losses to the banks that underwrote them. Barclays has lost $50 million, Citigroup $150 million, and there are rumours that big hedge-fund players have lost a lot more.

Those of us who aren’t Swiss hoteliers, don’t have franc-denominated mortgages, and don’t gamble on forex, may not feel too bothered about all this. The trouble with the Olympian perspective concerns the underlying reason for the SNB’s sudden move. It seems that the central bank abandoned its currency peg because it didn’t feel it could defend it any more in the face of the quantitative easing expected from the European Central Bank. This long-overdue QE programme was finally announced on 22 January. Eurozone QE will push down the value of the euro, which would have started to exert serious strain on the SNB, given that notorious promise to buy ‘unlimited quantities’ of foreign currency. In effect, the SNB would be standing in front of a firehose and promising to drink everything that came out. If the SNB was a normal central bank, able to print its own currency until the cows come home with their prettily tinkling bells, that might have been okay. But the SNB is in fact an odd hybrid institution, which is 45 per cent privately owned, with the remainder owned by the Swiss cantons. It looks as if the owners got nervous about the prospectively open-ended expansion of the SNB balance sheet. Hence the sudden and unforeseen abandonment of the peg with the euro – a move which by universal consent made the SNB look flaky. Swiss banks are not supposed to be flaky, central banks even less so, and as for a flaky Swiss central bank, there is no world in which that’s an imaginable thing. Except the one we’re living in.

The problem is that we – that’s ‘we’ in the sense of everybody in the world – need Eurozone quantitative easing to work. The Eurozone economy is smaller than it was in 2008, and is in a state of stagnation and decline. If the stagdecline continues, I don’t think we can be sanguine about either the continued existence of the Eurozone, or the prevalence of consensus democratic politics inside it. To make the prospect gloomier, the form of QE that the ECB are adopting is one that severely restricts the sharing of risk between countries, and instead leaves each country’s central bank with most (80 per cent) of the responsibility for that country’s QE. It is a solidarity-light version of quantitative easing. As such, it is much more likely to fail. The head of the ECB, Mario Draghi, quietened market turmoil in 2012 by saying he would do ‘whatever it takes’ to save the euro. That unequivocal commitment is a long way from this partial, arms-tied-behind-the-back version of QE. It makes the ECB look weak.

The announcement of QE was supposed to be the moment when the ECB demonstrated its determination to survive. Unfortunately, this version of QE is constructed along national lines, which makes the failure and the break-up of the Eurozone easier. The language is resolute; the body language is checking the exits. It’s this which makes the panicked and abrupt nature of the Swiss move unfortunate for the rest of us. Banking is a confidence game, central banking especially so. I write before the outcome of the Greek election is known: if Syriza turn their poll lead into a win, there is likely to be a head-on confrontation between the new Greek government and the economic powers of the Eurozone. If it doesn’t happen right now, in Greece, it will happen somewhere else, in the undistant future. This is a bad moment for central bankers to be looking flaky and weak.

23 January