How the Swiss National Bank just made big trouble for Poland

1. The Swiss franc soared almost 40 percent relative to the euro in early trading today, before settling at appreciation of "only" 14 percent.
2. It's up relative to the US dollar by a similar amount.
3. This came in the wake of a surprise announcement by the Swiss National Bank that it was abandoning a years-long peg that fixed the price of Swiss francs relative to euros.
4. In the same announcement, the SNB said it would cut its key policy interest rate to negative 0.75 percent, pushing the country's negative rates experiment into some uncharted waters.
5. Switzerland's stock market promptly fell almost 10 percent on the news.

Why is Switzerland doing this?

Back in the fall of 2011 with the value of the euro sagging and foreign investors pouring money into Swiss francs, the SNB was concerned about a weakening job market. The inflation rate had fallen to zero percent, so the bank was comfortable with the idea of aggressive monetary stimulus. So they did something much bolder than anything the US Federal Reserve or the European Central Bank has done. They formally set a target for a cheaper franc, and said they would print as many francs as it took — selling the francs for euros — to hit and maintain a fixed exchange rate between Switzerland and the Eurozone.

Initially, a few investors tried to test the bank's will. But the SNB swiftly established its credibility and found it didn't need to do much of anything to maintain the peg.

Recently, two things have changed.

One is that the euro has fallen a lot relative to the dollar for reasons related to the upcoming election in Greece, meaning that the pegged franc is getting cheaper in dollar terms. The bank didn't necessarily want this outcome.

The other is that foreigners started buying Swiss francs again, meaning it was gut-check time for the SNB. Either commit to a new round of money-printing, or else decide that the peg is obsolete and go back to a floating exchange rate. They chose option #2.

CHF Power. What. A. Move. pic.twitter.com/6LFFm9TqhF

— Jonathan Ferro (@FerroTV) January 15, 2015

Hence the plunge. The SNB believes that the Swiss economy can weather this storm, and that the use of interest rate tools — including negative rates — will be enough to stabilize things without a currency peg.

A disaster for Poland

Swiss exporters — especially watch-makers concerned about new competition from Apple — are not happy about the change, which will make their products more expensive in foreign markets.

But there is a whole other class of people who are going to lose out in the deal. Over the years, many people who are not Swiss have chosen to take advantage of Switzerland's low interest rates to take out home mortgages that are denominated in terms of Swiss francs. In the United States people (sensibly) almost never borrow money to buy a home in a foreign currency, so Americans are largely unfamiliar with this issue. But wealthy English people do it, as do Russian billionaires seeking London property.

In Central Europe it's even more common. Fully 46 percent of Polish home loans are denominated in Swiss francs.

The problem here is twofold. Polish people earn incomes that are denominated in zlotys, and Polish real estate is priced in zlotys. So if you're a Polish person with a Swiss mortgage and the value of the franc soars, you simultaneously end up owing more on your house than the house is worth and owing more relative to your income than you are able to pay. This is why, in general, it is not wise to take out foreign mortgages. What you may gain in cheaper interest rates you lose in terms of exposing yourself to a wide new range of risks — risks that are managed by a foreign central bank that has no interest in your welfare.

The winners

The flipside is that if you're a Swiss person who neither works in nor owns a watch factory (or a hotel or other company that's strongly oriented toward foreign customers) a more expensive franc means more purchasing power. Swiss teachers, nurses, waiters, pensioners, and plumbers will all find iPhones and Spanish vacations and German cars more affordable in the new paradigm.

They will, that is, unless tight money goes too far and pushes the unemployment rate up sharply. Exchange rate appreciation boosts living standards if it's compatible with continued labor market strength. If it's not, then pretty much everyone ends up losing out.

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