Emerging Markets at the Japan 2020 Olympics (4)


Extract from our "Why is the CHF so Strong? A Balance Sheet Explanation" research paper, published 18th February 2021

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Money printing is no good for fiat currencies in the long run; money printing to finance sustained large fiscal deficits is, in theory, terrible for the currency in the long run. Among the world’s major reserve currencies – the USD, EUR, CNY, GBP, JPY, and CHF – only the People’s Bank of China (PBOC) has refrained from money printing in the past decade. A glaring counterexample in this discussion is the CHF: the Swiss National Bank (SNB) has been ‘printing money’ more aggressively than anyone else. Yet the CHF remains well-supported. In this short note, we propose explanations – some conventional and one novel – for the CHF’s strength.

1. Switzerland has had superior economic fundamentals over the years.

2. Much of the SNB’s balance sheet consists of foreign assets (foreign bonds and equities) and not domestic government bonds. When such foreign reserves reach levels that are considered very large, in excess of what the country might need for current account purposes (e.g., paying for imports or paying down foreign debt), downside risks to the currency are significantly reduced, and such a perception of a skewed probability distribution of future exchange rate movements in turn supports the currency today.

3. The SNB’s foreign reserves are not your usual foreign debt holdings but contain a substantial portion of foreign equities that generate ample dividend returns. Essentially, the SNB is both a central bank and a SWF (sovereign wealth fund). The CHF – a fiat currency – is indirectly backed by these foreign assets, and not a purely ‘fiat’ currency that derives its value solely from the credibility of the central bank in question.

4. Switzerland, like Japan, is a landlord to the world that has a positive net foreign asset position as well as positive investment returns. As central banks conduct more financial operations, traditional currency valuation methods that are based on real economic fundamentals may be insufficient in capturing the equilibrium value of currencies. In the case of the CHF, not only are the traditional determinants of currency valuation (e.g., CA surplus, productivity growth, fiscal balances, and long-term real interest rates) supportive of the CHF, the quality of the balance sheet of the SNB is arguably superior to those of most other central banks. Further, any depreciation in the CHF would mean an enhancement in the value in CHF of the foreign asset holdings. This negative correlation helps maintain low volatility in the CHF.

Bottom Line

Since 2008, the CHF has not only been strong, exhibiting the classic traits of a safe haven currency in times of distress in Europe and the rest of the world, it has struggled to sell off when risk recovered. The superior relative economic fundamentals of Switzerland have driven the fair value of the CHF steadily stronger over the years. In addition, we believe its form of money printing (through currency interventions rather than purchases of domestic sovereign bonds) has led to a superior balance sheet that is diversified across assets and hedged against the CHF itself. The value of this particular fiat currency, thus, is supported by not only the credibility of the SNB but actual dividend-yielding foreign assets. We don’t see a lot of downside to the CHF but expect it to rally again in the next regional or global sell-off in risk.

Extract from "Why is the CHF so Strong? A Balance Sheet Explanation", published 18th February 2021

Sections included within this report are:

  • CHF is a good currency; a bit of recent history
  • The SNB’s balance sheet
  • Fiat monies and financial assets
  • Currency valuation and money printing
  • Automatic stabilisers for the SNB’s balance sheet
  • Outlook for the CHF

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