The Swiss Canary in the European Coal Mine

By Peter Pham - June 1, 2012 | Tickers: FXY, FXF, TLT | 0 Comments

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Since instituting a peg to the Euro of €1.20 to 1 in August of 2011, The CurrencyShares Swiss Franc ETF (NYSEMKT: FXF) has lost 37%.  The Swiss Franc has also lost 31% versus the Japanese Yen.  The Swiss were the first to blink in the game of chicken in who will print first to stave off the debt deflation emanating from the periphery of the Eurozone.  But, the Swiss do not care about that as their trade is mostly predicated on that with the rest of the Eurozone.  As things deteriorate in Spain now the news comes that the Swiss are considering capital controls as the inflows of Euros into Switzerland are accelerating from Italy, Germany, France and Austria. 

The relative safety of the Swiss banking system is what prompted them to peg the Franc to the Euro last year in a futile attempt to divert the capital flight out of the Euro.  To maintain this peg the SNB has printed a staggering amount of money, attempting to keep pace with the ECB who has added more than $1 trillion to its balance sheet since QE2 ended last June. 

One has to think of this in terms of a game.  This one is called The Printing Game.  So far the Fed, the ECB and the SNB have all had their turns bailing out banks over the PIIGS sovereign debt.  It is now the IMF and Bundesbank’s turn to accept some of the responsibility for the matter.   Bernanke and the Fed, along with the IMF are playing hard ball with Germany to pay for that which they ultimately wanted in the first place, control over all of Europe.   The uncertainty has driven U.S. bond prices soaring.  The iShares Barclays 20+ Yr Treasury Bond ETF (NYSEMKT: TLT) has risen to the same levels as October 2011, when the rally in U.S. Equities began. 

The peg however, once this situation sorts itself out, and I’m becoming ever more convinced that it will, will wind up being a boon for the Swiss.  The Swiss have been buyers of Euros at depressed prices for months now as the ECB has printed via the LTRO and EFSF.  They’ve reached their limit of absorbing capital and are barking about capital controls. 

The pressure on German Chancellor Angela Merkel to accept Eurobonds is enormous.  Eurobonds are, after all, the surest path to keeping the Euro together; aggregating all of the debt under one rubric, backed by the whole capital base and the Eurozone’s gold reserves with one credit rating.  Bailing out Spain’s Bankia is going to cost a minimum of €20 Billion.  This is, of course, just the beginning.  The only way out of this is to print to cover the debts.

I’m not focused on the Greek election on June 17^th.  The odds-on bet is the Greece will stay in the Euro and will get a better deal from the ECB and the IMF than they currently are.  This is a very big moment in The Printing Game and Greece holds the winning hand, make no mistake.  It may cost them their sovereignty to play that hand, but there it is.  Once Germany accepts the inflation the Euro will stabilize and then it will be the U.S.’s turn to make a move.   

The Swiss call for capital controls along with a gold franc coin containing 0.1g of gold being considered by the Swiss Parliament should be a signal to everyone that the current phase is coming to an end.  When things get this crazy that’s usually the best contrarian indicator.  It was during times like this last year that the Swiss came out and put the peg on in the first place.    Whichever country is the first one to refuse to print and formally back their currency with gold is the one that will win the currency wars.   This would require a central banker to give up their mercantilism and accept that their currency will be the strongest one for the foreseeable future, the new reserve currency.  So far, no one has indicated a willingness to do this. 

So, during the next few moves in The Printing Game capital will continue to leak away to the Far East towards Japan, China, Hong Kong and Singapore, where growth will continue, however muted.  The Japanese Yen is being positioned to replace the U.S. Dollar in regional trade, as China has opened up direct exchange of the Yuan and the Yen beginning on June 1^st.  This will increase demand for Yen and the CurrencyShares Japanese Yen ETF (NYSEMKT: FXY) should rally further, giving Japanese companies further incentive to deploy their capital around the region.

This will reverse the Yuan’s appreciation versus the yen as more Yuan will be available on the open market, making it easier for China to manage their peg versus the U.S. dollar; holding down domestic inflation while they attempt to stimulate their economy via monetary policy.  The Fed will be caught in the ugly position of needing to bail out U.S. banks over European debt issues, fund the U.S. budget deficit and absorb dollars being dumped from the Far East. 

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