One of the themes of this blog has been that politicians often engage in hyperbole and nearly as often in outright misrepresentation. Indeed I often quote from the apocryphal civil servant Sir Humphrey Appleby from the series Yes Minister who observed.
Never believe anything until it has been officially denied.
I am reminded again of Sir Humphrey’s words this morning and let me explain why. Back at the end of March you could see this on the website of the central bank of Belarus (a Russian republic which includes the city of Minsk).
The National Bank completely rules out the possibility of a significant one-time adjustment in the exchange rate of the Belarussian ruble.
You are probably now wondering how much rather than if aren’t you? The Belarus rubles official exchange rate has been devalued by 56% from 3155 to the US dollar to 4930! Even better the statement I have shown above is still on their website so they are denying the possibility of a significant devaluation even after they have done it!
A Consequence of this
As there are issues here which could be passed onto places like Greece or Ireland where a return to previous currencies such as the drachma and punt is being debated more and more let me give some illustrations. Firstly for foreign purchases the official rate leaves them 36% poorer. However those who had invested abroad may well have been protected for example at the end of last week the official price of gold was 152,432 rubles per gram and it is now 239,102. In ordinary trading there have been heavy falls in the price of silver recently as it has reversed course from near to US $50 per ounce to US $35, but measured in Belarus rubles it has now hit a new high of 5516 per gram as the currency fall has outweighed the price drop!
So there is some food for thought for you. I shall be returning to the impact of currencies on commodity and oil prices going forwards as it seems possible that price falls could be accompanied by a rise in the US dollar. But for now here is a conundrum for those in Greece,Ireland and Portugal which is that the more the likelihood of a devaluation rises the more it is in their interest to move funds abroad which of course makes a devaluation more likely although they do have the advantage of being able to move funds in the same currency as they could move to overseas bank accounts in Euros.
The rise and rise of the Swiss Franc
Yesterday the Swiss France hit (yet another) new high against the Euro. This subject had gone quiet for a while but as ever it has returned to haunt not only Switzerland and her central bank but all those who borrowed in Swiss Francs in the “carry trade” period. I wrote on this subject back on the tenth of June last year and let us first look at the situation for Switzerland herself.
In the recent melee which has surrounded the Euro and its recent falls against other currencies there has been a nation indirectly affected quite badly and it is Switzerland. It is a side-effect of the euro zone crisis but is also becoming something of an economics test case. As money flees the euro zone and the Euro it looks for somewhere to go and Switzerland has a reputation not only for economic stability but stability all round and so money has gone into the Swiss Franc. The problem with this is that Switzerland is only a small country and there is a limit to this implied in her size.
Economics textbooks often have as an example a small open economy and this applies to Switzerland here. If we move on from last year to now we can see that the rise in the price of precious metals particularly gold is one of the reasons why the Swiss Franc has been driven higher. As we stand now it is a lot higher as again from the article.
However the flood of money that entered Switzerland in the earlier part of 2010 caused the exchange rate between the Euro and the Swiss Franc to drop from 1.51 in mid-December to 1.4325 at the end of April.
As you can see the Swiss Franc exchange rate is much stronger against the Euro now that it was then. The new high is at 1.2322 versus the Euro. This may be bad enough in its implications for the Swiss economy but there is something worse as the Swiss National Bank did this in response.
In April she intervened on a scale estimated at 1 billion Euros a day and in May she intervened on an enormous scale as her foreign exchange reserves rose from 151 billion Swiss Francs to 232 billion which is an increase of just over 50% in one month according to the provisional figures she has released.
So not only has the Swiss economy been punished – a report at that time suggested and exchange rate of 1.25 to the Euro would create deflation, so if this rate is sustained there are serious dangers- but her central bank has amassed very large losses in a failed attempt to halt the surge of the Swiss Franc. Whilst I had sympathy for its problems I did not have much respect for the SNB’s intelligence.
I have often thought that currency intervention against long or even medium term pressure on a currency is likely to be pointless and it is the Swiss National Bank’s misfortune to have pretty much established a test case proving my point.
The SNB has lost around 26 billion Swiss Francs or just over 20 billion Euros from this and not even the rally in gold prices which made it 6 billion Swiss Francs on its holdings was able to put much of a dent in this. I will leave you with the implication of this and possible deflation for Switzerland and move onto another consequence.
Eastern Europe borrowed heavily in the Swiss Franc
Again back on the tenth of June last year I observed this.
Moving outside of Switzerland a lot of property and construction borrowing in Eastern Europe was denominated in Swiss Francs. It is not a good situation for these borrowers to see the flip side of the Swiss Franc appreciation ie. their debt has risen in their own currency. Quite what the regulators were doing in these countries to allow mortgages etc. to be denominated in this way escapes me… However it is not a surprise to me that we have seen signs of economic distress recently in Bulgaria and Hungary for this reason.
Just to give you a flavour of some of the numbers involved here and concentrating on Hungary where this was and is a particularly big factor some 1.7 million mortgages were taken out in Swiss Francs and the total sum borrowed is estimated at around half of her Gross Domestic Product or GDP. This issue is such a big one for the Hungarian economy that since 2010 there has been a moratorium on repossession and evictions as the Hungarian government decided that its economy could not take the scale of what might happen if it did not do this. This has led to the inevitable moral hazard result that many who can pay have chosen not to so the underlying effect is to stop the housing market operating in any sort of an efficient manner. It looks as though for its next move the Hungarian government will cover exchange rate losses until 2015 when it will hand them back to the homeowners in an almost textbook definition of “kicking the can down the road”.
I have some sympathy with Hungarians who find themselves in such a position as the misselling scandals that have taken place in the UK have shown how salesmen and women operate with a juicy commission cheque in their eyes but much less for the country and its regulators which let this happen on their watch. However the problem is geographically wider as others borrowed in Eastern Europe.
If we move to look at the other countries affected we see this. In Lithuania, Croatia, and Romania, loans denominated in foreign currencies account for between three fifths and three quarters of the total, with the figure for Bulgaria also being close to 60%. Poland has a lower overall percentage in terms of loans but Unicredit has estimated that some two-thirds of all mortgage borrowing was in Euros and Swiss Francs and there is another problem too.
Who loaned the money?
If we think of the other side of the balance sheet we think of the banks who made these loans. We can see quite quickly that their chance of full repayment is in line with the joke “slim to none and slims out of town”. So not only have the economies of Eastern Europe been adversely affected but so have the banks which lent the money.
My understanding is that they were mainly based in Germany,Austria ,Italy and the Nordic countries. As an example of the problems created for banks in the Euro zone the European Central Bank had to open a lending facility in Swiss Francs for a while when the credit crunch hit. We also got a clue as to who was most affected as Austrian banks were responsible for 28% of the borrowings made which is quite a lot for a small country! Of course Austrian banks were also lending to mortgage borrowers in Swiss Francs on a substantial scale so Austria will be being hit on both sides of the balance sheet. Makes you think about Austria’s future stability does it not?
Still we have learnt something for the future surely?
Back in February Bloomberg news reported this.
Carry trades funded in the yen and Swiss franc are becoming profitable as borrowing costs rise in Europe and Canada, according to UBS AG.
As central banks resume boosting interest rates, investors should start thinking about borrowing in the Japanese and Swiss currencies to buy the Swedish krona, the Norwegian krone, the euro and the Canadian dollar.
Now this is not the same as an outright recommendation to take out foreign currency mortgages again but it is only a short step. It is a particularly short step for a banking industry that has not been reformed at all as what I have described above about Hungary has been yet another banking bailout dressed up as help for distressed homeowners. They will be helped until the banks have recovered!
The Carry Trade Explained
I have written on this subject quite a few times before with articles on the 31st of August last year and the 28th of February this for those looking for more information. For those looking for why this happened but do not want the full explanation the short version is that the borrowing was cheaper usually much cheaper. So banks could offer cheaper mortgages to borrowers whilst awarding fat commissions to themselves which no doubt led to the awarding of even fatter bonuses….
To receive our free weekly email sign up here.