University of Melbourne Making Sense of The Swiss Shock Article Questions Readthe two attached articles. Then answer the following questions (two pages max

University of Melbourne Making Sense of The Swiss Shock Article Questions Readthe two attached articles. Then answer the following questions (two pages max).

My Requirement: Use your own word, or type-in reference what you used from these article or other resource. (Similarity should meet the turnitin) The maximum is 800 words. You could use probably 600 or more.

1. Briey explain what do the authors mean by Swiss shock? Briey describe the

reasons behind that event?

2. In what fundamental way does the Swiss shockdi⁄er from typical historical

examples of a failed attempt to unilaterally defend a xed exchange rate such as

thesuccessfulspeculativeattacksontheBritishpoundin1992oronthecurrencies

of Thailand, Indonesia and South Korea in 1997?

3. In your view, what main lesson do these historical events (e.g. South East Asian

Financial Crisis of 1997) and the Swiss shockteach us regarding the viability of

unilaterally xed exchange rates?

4. Finally, assess the SNBs decision to abandon the peg. In your view, could the

SNB have done things di⁄erently? Were there any better alternatives? 2
The Swiss Shock
Read the two attached articles. Then answer the following questions (two pages max).
1. Brie‡y explain what do the authors mean by ‘Swiss shock’? Brie‡y describe the
reasons behind that event?
2. In what fundamental way does the ‘Swiss shock’ di¤er from typical historical
examples of a failed attempt to unilaterally defend a …xed exchange rate such as
the successful speculative attacks on the British pound in 1992 or on the currencies
of Thailand, Indonesia and South Korea in 1997?
3. In your view, what main lesson do these historical events (e.g. South East Asian
Financial Crisis of 1997) and the ‘Swiss shock’teach us regarding the viability of
unilaterally …xed exchange rates?
4. Finally, assess the SNB’s decision to abandon the peg. In your view, could the
SNB have done things di¤erently? Were there any better alternatives?
2
Making Sense of the Swiss Shock by Markus Brunnermeier and Harold…
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http://www.project-syndicate.org/print/swiss-central-bank-stops-swiss-…
ECONOMICS
MARKUS BRUNNERMEIER
Markus Brunnermeier is Professor of Economics and Director of the Bendheim Center for
Finance at Princeton University.
HAROLD JAMES
Harold James is Professor of History and International Affairs at Princeton University,
Professor of History at the European University Institute, Florence, and a senior fellow at
the Center for International Governance Innovation. A specialist on German economic
history and on globalization, he is the author of The Creation and Destruction of
Value: The Globalization Cycle, Krupp: A History of the Legendary German Firm,
and Making the European Monetary Union.
JAN 17, 2015
PRINCETON – Since the European sovereign‐debt crisis erupted in 2009, everyone has
wondered what would happen if a country left the eurozone. At irst, the debate focused on
crisis countries – Greece, or maybe Portugal, Spain, or Italy. Then there was a rather
hypothetical discussion of what would happen if strong surplus countries – say, Finland or
Germany – left.
Through it all, a consensus emerged that an exit by one country could – like the collapse of
Lehman Brothers in 2008 – trigger a wider meltdown. Now, in Switzerland, we have a
demonstration of just some of the risks that might emerge were a surplus country to leave
the eurozone.
In September 2011, Switzerland pegged its currency to the euro to set a ceiling to the Swiss
franc’s rapid appreciation in the wake of the global inancial crisis that erupted in 2008. The
country thus became a temporary adjunct member of the European monetary union. But,
on January 15, the Swiss National Bank (SNB) suddenly and surprisingly abandoned the
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Making Sense of the Swiss Shock by Markus Brunnermeier and Harold…
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http://www.project-syndicate.org/print/swiss-central-bank-stops-swiss-…
peg.
Obviously, exiting a real currency union is far more complex and legally fraught than ending
a temporary exchange‐rate arrangement; the effects of such a move would be greatly
magni ied. Nonetheless, the Swiss move reveals at least some of the uncertainties that a
full‐ ledged exit could create.
The SNB was not forced to act by a speculative run. No inancial crisis forced its hand, and,
in theory, the SNB’s directorate could have held the exchange rate and bought foreign assets
inde initely. But domestic criticism of the SNB’s large buildup of exchange‐rate reserves
(euro assets) was mounting.
In particular, Swiss conservatives disliked the risk to which the SNB was exposed. Fearing
that eurozone government bonds were unsafe, they agitated to require the SNB to acquire
gold reserves instead, even forcing a referendum on the matter. Though the initiative to
require a ixed share of gold reserves failed, the prospect of large‐scale quantitative easing
by the European Central Bank, together with the euro’s recent slide against the dollar,
intensi ied the political pressure to abandon the peg.
Whereas economists have modeled inancial attacks well, there has been little study of just
when political pressure becomes unbearable and a central bank gives in. The SNB, for
example, had proclaimed loyalty to the peg just days before ending it. As a result, markets
will now hesitate to believe central banks’ statements about future policy, and forward
guidance (a major post‐crisis instrument) will be much more dif icult.
There is historical precedent for the victory of political pressure, and for the recent Swiss
action. In the late 1960s, the Bundesbank had to buy dollar assets in order to stop the
Deutsche mark from rising, and to preserve the integrity of its ixed exchange rate. The
discussion in Germany focused on the risks to the Bundesbank’s balance sheet, as well as
on the in lationary pressures that came from the currency peg. Some German conservatives
at the time would have liked to buy gold, but the Bundesbank had promised the Fed that it
would not put the dollar under downward pressure by selling its reserves for gold.
In 1969, Germany unilaterally revalued the Deutsche mark. But that was not enough to stop
in lows of foreign currency, and the Bundesbank was obliged to continue to intervene. It
continued to reduce its interest rate, but the in lows persisted. In May 1971, the German
government – against the wishes of the Bundesbank – abandoned the dollar peg altogether
and loated the currency.
Politics had prevailed over central‐bank commitments. Within three months, the fallout
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http://www.project-syndicate.org/print/swiss-central-bank-stops-swiss-…
destroyed the entire international monetary system, and US President Richard Nixon took
the dollar off the gold standard. The credibility of the entire system of central bank
commitments had collapsed, and international monetary policy became extremely
unstable. The Deutsche mark appreciated, and life became very hard for German exporters.
Today, the global rami ications of a major central bank’s actions are much more
pronounced than in 1971. When the Bundesbank acted unilaterally, German banks were
not very international. But now inance is global, implying large balance‐sheet exposures to
currency swings.
Big Swiss banks fund themselves in Swiss francs, because so many people everywhere want
the security of franc assets. They then acquire assets worldwide, in other currencies. When
the exchange rate changes abruptly, the banks face large losses – a large‐scale version of
naive Hungarian homeowners’ strategy of borrowing in Swiss francs to inance their
mortgages.
Though the SNB had given many warnings that the euro peg was not permanent, and
though it had imposed a higher capital ratio on banks, the uncoupling from the euro came
as a huge shock. Swiss bank shares fell faster than the general Swiss index.
The risks created by the SNB’s decision – as transmitted through the inancial system – have
a fat tail. The negative effects for the Swiss economy – through the decreased
competiveness of its export industries (including tourism and medicine) – may already be
showing that abandoning the euro peg was not a good idea.
But the consequences will not be limited to Switzerland. After years of wondering whether
the exit of a small, iscally weak country like Greece could undermine the euro,
policymakers will have to deal with an even bigger shock stemming from the exit of a small,
iscally strong country that is not even a member of the European Union.
https://www.project‐syndicate.org/commentary/swiss‐central‐bank‐stops‐swiss‐franc‐
euro‐peg‐by‐markus‐brunnermeier‐and‐harold‐james‐2015‐01
© 1995‐2015 Project Syndicate
29/01/2015 2:07 PM
MacroMania
Believe those who are seeking the truth. Doubt those who find it. Andre Gide
Saturday, January 17, 2015
On the Instability of Unilateral Fixed Exchange Rate Regimes
Was there an easy way to bet on a CHF/EUR appreciation? Because if there was, we must all
be kicking ourselves for not exploiting that trade!
The difference between winning and losing in the FX market is usually just a matter of luck.
To a first approximation, floating exchange rates seem to follow a random walk (see here).
But the trade I’m describing here is one I think we should have expected to pay off for
reasons beyond pure luck. That is, there is a pretty sensible theory of currency crises that
might have guided our investment strategy in the present context. In particular, I’m thinking
of Paul Krugman’s (1979) model, which he describes here.
The basic idea is as follows. Suppose that a central bank wants to peg its currency relative to
some other currency. Suppose that it does so unilaterally. The success of the peg will depend
critically on its perceived credibility. This credibility may depend on, among other things, the
amount of foreign reserves held by our intrepid central bank. To defend the peg, the central
bank must stand ready to buy its own currency on the FX market, which it does so by selling
off its stock of foreign reserves.
A unilateral peg of this sort is just ripe for speculation. The two most likely outcome in this
case are (1) the peg holds or (2) the peg fails (the domestic currency depreciates). The trade
in this case is to go short on the pegging bank’s currency and long in the foreign currency. A
speculator either breaks even if (1) or wins if (2). It’s a can’t lose proposition (but please don’t
try this at home kids). Rational speculators, recognizing the opportunity, start shorting the
pegged currency. If they do so en masse, our little central bank will soon run out of reserves
and be forced to abandon the peg–a self-fulfilling prophecy.
I didn’t spot this in the case of the SNB because, well, Switzerland is not a banana republic–
the Swiss Franc is considered a safe-haven security. And the SNB was pegging because it
was worried about currency appreciation–not the usual concerns about excess volatility or
depreciation. Of course, there was never any danger of the SNB running out of reserves–they
can print all the Francs they want! So what was the danger?
Central bankers are by nature a highly conservative bunch. They become uncomfortable with
things that are unfamiliar. Like balance sheets the size of the moon, for example. With an
ECB QE policy on the horizon, there was the prospect of EUR for CHF conversions
proceeding at an even more rapid rate–leading to a very, very large SNB balance sheet. My
claim is this: we should have guessed that the SNB would have at some point in this process
lost its nerve and abandoned the peg, allowing their currency to appreciate (And if it didn’t
lose its nerve, the peg would have been maintained, so we would not have lost on the other
likely outcome of my proposed bet). Rational speculators anticipating this should have … oh
well, forget it. (Let’s try it next time and see what happens?).
As for the SNB abandoning its peg, especially the way it did, well, it just seems crazy to me.
It would have made sense if one thought that EUR inflation was likely to take off. But all the
worry at present is directed toward the prospect of EUR deflation. Yes, that’s right, the SNB
is stocking up on a currency whose purchasing power is projected to increase. And as for
being concerned about EUR inflation because of QE, it seems unlikely to me that the ECB
wouldn’t be willing and able to defend its low inflation target.
In short, I think the SNB could have let it’s balance sheet grow much larger without any
significant economic repercussions. Instead, by removing the peg as they did, they suffered a
huge and needless capital loss on their EUR assets. Strange move. But how can we argue
against the past success of Swiss bankers?

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