A Primer in Currency Manipulation

You may have heard that various currencies have been “pegged” to another currency. You may have wondered what that means. The Chinese Yuan is pegged to the US Dollar. Hong Kong, Belize, the Bahamas, Barbados and a number of other countries also peg their currencies to the US dollar. This does not mean that they have a 1:1 ratio (i.e. one US dollar is not equal to one Hong Kong dollar). It simply means that there is a fixed exchange rate between the two currencies; it does not fluctuate freely.
 
Switzerland pegged the Swiss franc to the euro in September of 2011. I remember when it happened because I was trying to buy some Swiss francs at the time. It was such a strong currency. If your country’s currency is losing value, a way to preserve your purchasing power is to buy a currency that is getting stronger relative to your currency. As your currency falls in value, the other currency remains strong. When you want that money back to buy something or invest in something in your own country, you convert the strong currency back into your currency and now it buys more of your currency than it used to. Pretty cool, huh? Of course, if you’re wrong about the other currency being stronger than yours, you lose purchasing power, which is not so good.
 
The Swiss economy was doing very well in 2011. There was a concern, though, that it would not continue because the nations of the European Union could not afford to buy things in Switzerland and Switzerland sells most of its goods to the rest of Europe. Unfortunately, most of the rest of Europe is hurting, so they’re not buying from Switzerland or anywhere else. This will eventually be very damaging to the Swiss economy. The Swiss National Bank (SNB) acted to head-off what they saw coming in an attempt to stimulate exports.
 
Investors were also driving the Swiss franc up. Anyone who wanted to use currencies to preserve their purchasing power was buying the Swiss franc. As with anything, when there are more buyers than sellers, the price goes up. When a currency goes up in value relative to other currencies, it hurts exports. The prices of the goods manufactured in the country with the strong currency go up relative to the purchasing power of buyers outside that country. This phenomenon was discussed in my previous article entitled “China is the U.S.’s Biggest Creditor – How We Got Here.”
 
When the SNB pegged the Swiss franc to the euro, it caused a huge instant devaluation of the Swiss franc. The peg fluctuates very closely around 1.20 Swiss francs to 1 euro. The SNB actually said they wanted to create a “substantial and sustained weakening of the Swiss franc.” In April of 2011, it took 1.32 Swiss francs to buy 1 euro. Going from 1.32 to 1.20 was an increase of 10% in the value of the Swiss franc relative to the euro in about 4 months. Other Europeans couldn’t afford to vacation there or to buy goods from Switerland. To make matters worse, Swiss who lived near the border were crossing over into Germany to do their shopping!
 
By pegging the Swiss franc to the euro, it means that these two currencies will not fluctuate relative to each other. As long as they are pegged, no matter what happens to the euro, the same thing will happen to the Swiss franc. If the euro loses value, the Swiss franc will lose value. This means the Swiss are losing purchasing power.
 
This situation is unfortunate for the Swiss people. They used to be able to buy more and more from other countries when their currency was free floating. Now, they’re in the same boat as the rest of us who live in countries that devalue their currencies to make their exports affordable for people in other countries.
 
When the euro loses value because of massive money-printing, the SNB must print more Swiss francs to keep its value even with the euro. Let’s look at a super-simple example, just to get a feel for how it works. I’m just pulling numbers out of the air that are easy to work with. If there are 1,000,000 euros in existence and the franc is pegged at 1.2 francs per euro, then there must be 1,200,000 francs in existence. If the European Central Bank (ECB) prints 500,000 more euros so that there are 1,500,000 in existence, then the SNB must print 600,000 more francs so that there are 1,800,000 francs in existence.
 
It’s a lot of work to maintain the peg. The SNB is buying euros with Swiss francs to maintain the peg. Selling their currency helps to drive it’s price down and buying the euro helps to drive its price up. If the rest of the world still wants to buy francs, the SNB must sell more francs than the rest of the world wants to buy to keep its price down. Switzerland is a relatively small country and experts don’t think they can keep this up much longer. 
 
Because Switzerland is buying so many euros, their foreign reserves are growing rapidly. As of July 2011, the amount of euros on the SNB’s balance sheet was equivalent to 65% of the Swiss Gross Domestic Product! Because the euro is not a healthy currency, the SNB was selling the euros it bought for other currencies in order to lessen their risk of the euro being ditched as a currency. It sounds like they are having trouble finding buyers for all those euros lately.
 
Devaluing their currency helps Swiss exporters and the tourism industry. However, it hurts the residents of Switzerland due to loss in purchasing power. Yet, keeping the Swiss economy healthy helps everyone in the long run. So you can see that it’s tricky business to manipulate currencies.
 
I hope that gives you a bit of an understanding of what is involved in manipulating a currency. It is a lot of work and the outcome may or may not be beneficial. The Federal Reserve is in the business of manipulating the US currency. They’ve been in business for 99 years and they still appear to be having problems figuring it out.


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