In our third series in the currency catch up we’re going to look at what I call true fiat currencies. Switzerland holds this title out of the major currencies, Japan used to hold it (some people still think it does), but they’ve lost this right. Of the minor and exotic currencies, the Singaporean Dollar would also qualify.
Unlike the resource currencies, there is no primary industry tied to the value of these currencies, nor are they significant sources of global debt. These currencies actually benefit the most from contractions in demand for debt. It’s fairly easy to understand how these currencies move, but it’s a bit complicated to explain why we’ll get into that in section 1.
Table of Contents
Risk on vs. Risk off
The Yen, an old man
The Swiss Franc, still in its prime
Japanese News
Next Bank of Japan Head
Swiss News
Conclusion
Internal References
1. Risk on vs. Risk off
You’ve probably seen these terms a million times before, and you might have a rough idea of what they mean but I’m going to be using them quite a bit in this section. Definitions can be found on the definitions page if you need a short refresher.
In general, Risk-off assets are those that the markets prefer investing in when they want safety and security. While Risk-on assets are those that the market pursues when it wants to speculate on growth.
One might also discuss market conditions by stating that the markets are risk-on or risk-off at any given moment as a means of describing the general appetite for risk. When people are borrowing money, taking on leverage, and loading up long on indexes, stocks, etc., appetites for risk are high. When appetites for risk are low you’ll see people rotating into bonds, treasuries, gold, and certain currencies that the markets view as “safe havens.”
In the past, The Swiss Franc, and Japanese Yen were considered to be the major safe haven currencies, with the US dollar playing a smaller role as a safe haven currency.
Why did these two currencies in particular have this reputation among traders? It’s actually quite simple. Central banks in the US, Eurozone, Australia, New Zealand, and Canada engaged in QE buying up primarily their own treasuries and putting them on to their balance sheets.
The Bank of Japan and the Bank of Switzerland were two major central banks that took on risks themselves. In layman's terms, these two banks bought significant holdings of foreign stocks.
So what happens when we enter a bear market? What happens when global risk appetites go down? Well as these assets go down, these central banks typically have to take some risk off of the table and sell these stocks and then convert the currency back into their local currency. In fact, these two central banks are usually at the front of the move-out of assets when these rotations occur.
In a down market, these central banks have been the ones who are mechanically forced to buy their own currency, which causes their currencies to appreciate in times of global risk.
Switzerland still very much holds this position, but Japan has lost its position as a safe haven currency over the last 1-2 years, but not everyone in the market has come to understand that this has happened to Japan just yet.
These currencies are considered safe havens simply because people believe and expect the central bank to have to act in this manner when markets rotate out of risk. It’s purely based on faith.
The Yen, an old man
In life, it is often hard to contextualize who you are in the moment. But it is much easier to contextualize an entire life once it is over by looking across its breadth and scope of it. Charles Bukowski is an author I enjoy. He’s dead now, and his life makes sense and can be appreciated from our perspective as consumers of literature. One of his most famous pieces is a novel called Post Office. It’s the first book he wrote and published and it essentially was an autobiography of his time working as a mail sorter and delivery man for the USPS.
When he was working at the post office he was a 32-year-old nobody. The book is even dedicated specifically to “nobody.” If you had asked him to contextualize his life at 32, or even at 52 when he finally published the book he would probably tell you he was nobody in particular or had not achieved anything worth talking about. Yet we know him for the critical acclaim he began to receive near the end of his life and after his death.
We can easily contextualize his life and the meaning of it in a way that couldn’t quite be done while he was alive. The same can be said about you, me, and the people you know. Some of us combat this by adopting well-defined roles and portraying those roles to others. Some of us let nihilism and meaninglessness push us into apathy. And others skip through life blissfully unaware that they can’t quite tell you what their purpose is. All are perfectly reasonable things to do with your time here.
On this substack, I often refer to the Yen as an old man or a samurai halfway through a ritual suicide. The imagery fits. I’m often reminded of the movie Inception when I think of Japan. In the movie, the character Saito gets killed in a dream, and as such he ended up descending into an unstructured dream space far below the levels of the consciousness the characters were operating in. In real life, Japan has succumbed to levels of QE far in excess of the US and Europe. It’s killing them slowly, as we’ve covered many times over the past year.
Cobb is coming back for Saito this April, but we’ll see if Japan is brave enough to come back to sanity so we can be young together again. Or if Japan is determined to die an old man, filled with regret. The current head of the Bank of Japan’s term ends in April of this year. He will never budge off his current path, and anyone expecting him to change at this point in his life is fooling themselves. He will die on his sword, and he’s doing that right now.
The story of Japan may be coming to some type of ending soon, and in that end, we may be able to contextualize what happened and is happening now in a way that makes sense retrospectively. We see Japan as it exists today. But in the future people may be able to see Japan across the breadth of its existence and this point in time will make far more sense when viewed in that way.
As QE has continued, the Bank of Japan’s exposure to foreign assets and stocks compared to its exposure to its own internal assets has continued to fall. And as it falls while they buy up Japanese stocks, and Japanese government bonds, the safe haven correlation of the currency continues to degrade and fall.
When trying to find articles about the Yen as a safe haven currency, most of the accurate and well-researched articles are from a decade ago or longer. The yen is very much an old man in this way. It’s past its time, but traders are stubborn, and still even today many cling to this belief of the Yen as a safe haven. Most of them got blown out last year despite the Bank of Japan telling traders exactly what it was going to do before it did. I suspect that this year, far fewer of them will try the same trade again.
The Swiss Franc, still in its prime
So what makes the Swiss Franc different from the Japanese Yen? It’s the same thing that separates every stable currency from every basket case running into hyperinflation.
Switzerland isn’t running massive deficits and has a small and manageable amount of national debt. The central bank isn’t significantly monetizing debt, and due to the low annual issuance of Swiss Government bonds, they didn’t struggle to hold rates low when their policy was about keeping in line with the Euro.
As we discussed in the past, for most of the 2010s, and up until last year, the Swiss had enacted a soft peg between the swiss franc and the Euro. This peg was solely designed to keep the Swiss franc from ever being worth more than 1 Euro. The purpose of this was to ensure that the export of Swiss goods to the Eurozone didn’t ever get too expensive for neighboring Europeans and to normalize.
But unfortunately, the Europeans had to begin significant QE throughout the 2010s to buy up toxic sovereign debt from Italy, Greece, Portugal, Spain, and other insolvent European governments. This QE pushed European interest rates negative while simultaneously running up a €10T balance sheet within the ECB. Switzerland pushed rates down low similarly and engaged in several large purchases of Euro’s (and European stocks) with Swiss Francs at times in order to keep the value of the Swiss Franc below the value of the Euro.
You may remember when Trump left office that he called Switzerland and several other nations currency manipulators.
Countries must at least have a $20 billion-plus bilateral trade surplus with the United States, foreign currency intervention exceeding 2% of gross domestic product and a global current account surplus exceeding 2% of GDP to be labeled a manipulator.
Vietnam and Switzerland far exceeded these criteria, with foreign exchange interventions of 5% and 14% of GDP respectively.
The report said that at least part of Vietnam’s intervention was aimed at pushing down the dong for a trade advantage, while at least part of Switzerland’s action was aimed at pushing down the Swiss franc to prevent effective balance of payments adjustments.
Ironically, the countries named in this report can similarly be understood to have strong economies and sound fiscal policies. Think about it. These countries’ currencies were growing too strong for other brokies to be able to afford to buy their goods. So these countries took their extra money to buy money from other countries simply to help them out. In much the same way that you might give a $5 bill to the beggar at your corner.
But they’re not going to bother holding on to significant amounts of foreign currency by itself. Why? The money isn’t making money on its own. So the Swiss National Bank is forced to invest in much the same way as any large institution would be had they been given a couple hundred million, or billion of currency. They buy stocks and bonds.
The Swiss, in their attempt to fit in with their broke friends, have been buying all of their friends’ stocks and bonds because there is nothing else worthwhile to do with their broke friends’ money. So now you see the cycle. We’ve previously discussed the cycle of how the Swiss National Bank turns a profit on their investments and has to distribute this profit to local governments. That was last year based on their 2021 holdings. This year, their 2022 holdings didn’t perform too well, but the Swiss were forced to rebalance anyways. This rebalancing along with last year’s profit redistribution pushed the Swiss Franc higher. On top of this, everyone knows the Swiss are doing this, so traders go long on the Swiss Franc with an expectation that the Swiss will do this. All of this just pushes the Swiss Franc higher.
At some point, probably far in the future, the Swiss will have to give up on this campaign to stop the Franc from appreciating, just like you eventually have to find new friends if your old friends are broke and do broke things like cooking food. At that point, they will probably take a massive loss on such activities. Realistically, I’d expect that the Swiss will be the first major central bank to intentionally take on exposure to crypto (not CBDC’s, but actual crypto), and the most sensible way for them to do that is a rotation out of some of their holdings of foreign assets.
Being rich is a problem. No matter how I frame the above, it’s still a huge problem to have your own currency appreciate too significantly, especially while you have such large exposure to assets denominated in other currencies. You’ll note in the article linked above, one of the biggest sources of loss for the Swiss was the fact that their own currency appreciated against their assets. The best way to avoid that problem is to rotate into assets that aren’t the Swiss Franc. From European stocks into Gold. From US stocks into crypto, etc. You can’t rotate back into your own currency all at once.
I don’t know when it will happen, but I expect that we may be hearing announcements from the Swiss in the future about rebalancing their FX and asset exposure. This is how central bankers tell their friends “You’re Broke! You’re fucking poor!”
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