Daily forex market watchers like myself can’t help but notice the futile efforts of central banks to manage their currencies. Today’s lesson in futility is given by none other than our friends at the Swiss National Bank (SNB), who had the temerity to intervene in forex markets today only to have their entire investment swallowed whole by the market in a matter of hours. Whoops. Last time they tried this Swiss citizens called for the head of their SNB chief for foolish waste of funds. Too bad (for them) they didn’t get what they asked for as he’s just gone an wasted more of their money. The Swiss franc exchange rate has been going up for decades as a result of their relative fiscal stability amid everyone elses foolishness.
Why Central Banks Intervene
Central banks feel compelled to intervene in markets because of domestic business interests. The idea behind intervention is by reducing the value of the currency in global markets domestic goods remain competitive (at least locally if not globally). The problem with doing so is that the forex market is so deep (trading $3 trillion daily – a.k.a. roughly 1/4 the entire US annual GDP output) that any sweeping purchase (today’s effort by SNB amounted to CHF billion) is trivial relative to the normal activity on any given day. In other words, the traders (investment banks, institutional traders, and large financiers) control the value of money, NOT the Central Banks themselves. You can see the effects of intervention post-mortem via live European Central Bank exchange rates.
Does This Mean That Central Bank Policy Is Meaningless?
Does the futility of Central Bank intervention mean that CNB policy is meaningless? Not entirely. Central Banks do have the power to set interest rates in their own currencies, and as a result that has an impact on the growth rate of the economy, but the problem lies that you can only go as low as zero. Once rates hit zero, the investment banks control your currency and nothing you do to further stimulate borrowing (reducing rates further) will have any impact whatsoever. We have now watched in succession multiple Central Banks attempt to stop the ascention of their currency via printing money and distributing it into foreign currency markets (see Yen intervention, Chinese Yuan, Swiss franc, Euro…) – but in the end all their bills get swallowed up and disappear and the rates continue higher.
I don’t know why this just occurred to me, but I wonder what would happen to all these investment banks if the Federal Reserve decided to raise rates by a full percent overnight tonight? I wonder just how many investment banks would go belly up immediately thereafter. After all, if you can’t push a string (and everyone is SURE you’re going to try to push the string…) why not give a giant YANK on the string instead?