4
$\begingroup$

I have read articles about the Swiss Franc breaking its peg with the dollar and I would like to understand what indicators people look at to determine whether a currency break/depegging is imminent. More which of these useful economic aggregates are most important in determining a currency peg break?

$\endgroup$
  • 1
    $\begingroup$ Hi. Welcome to Economics.SE. This question will likely generate opinion based answers and so I think it will (and in my opinion probably should) get closed. A fix might be to ask a slightly more general question about how certain aggregates relate to exchange rates (although this could be a difficult question to answer as well). $\endgroup$ – cc7768 Aug 24 '15 at 22:52
  • 1
    $\begingroup$ Thanks for reworking it. I think it is better now than it was before. $\endgroup$ – cc7768 Aug 25 '15 at 16:56
1
$\begingroup$

If they expected the peg to break then it is clear that the franc would gain in value. Since the currency has been held artifically cheap by the central bank, i.e. would have gained value if the central bank had not intervened, then the moment the central bank stops intervening (abandons the peg) the currency will appreciate.

Why would it have gone up otherwise, i.e. what are the factors driving exchange rates? We call these "fundamentals". Basically exchange rates are determined by supply and demand for a currency, just like for anything else. So basically anything influencing supply and demand for currencies would be cause for a change in exchange rates. Further expectations of changes in fundamentals cause them as well. These include the trade balance (typically governs the long run behavior of exchange rates in reality) and the difference between domestic and foreign interest rates (typically govern the short run behavior in reality).

Now one might ask, why did they expect the peg to be abandoned? That depends on the specifics about Switzerland. I'm not an expert there, so I'm sorry if I cannot give a very concrete answer. However pegs are typically unstable and usually abandoned eventually. This is because the longer the central bank keeps a currency at the "wrong" price, the more pressure from the market there is to correct it which means the central bank must fight harder and harder to keep it and eventually gives up or decides its not worth it anymore.

| improve this answer | |
$\endgroup$
1
$\begingroup$

There's a bunch of things you could look at. Here's a couple:

  1. Foreign currency reserves. Does Switzerland have a lot of dollars on hand? If so, there's nothing to worry about, the peg will hold. Switzerland can just buy CHF using dollars, increasing the demand and therefore the price, until the price is back to normal. (CHF is the abbreviation for the Swiss Franc, from "Confederatio Helvetica Franc.")
  2. Where is the currency currently trading? Usually, a currency peg can't be perfectly maintained, and there's a slight difference between the nominal peg and the actual spot price. The nominal peg might be \$1 to 1 CHF, but the spot price might be \$1.001 to 1 CHF depending on the central bank's tolerance for error. If the ratio is much higher than usual that can indicate strain on the peg.
  3. What does trading look like? If a lot of people are selling the CHF, which the government has had to buy up to maintain the peg, this indicates that investors think the peg will break, and that the Swiss government would have to put a lot of money into maintaining the peg.
  4. How has the central bank moved interest rates? This one's a bit tricky because the interest rate has two different components. When Swiss interest rates are hiked, this encourages people to buy CHF, so that they can deposit it in Swiss banks and get the higher interest rate. The extra demand for the CHF strengthens the CHF. However, if the government has to hike the interest rate, that might indicate that they're worried about the peg breaking so they need to raise interest rates. So interest rates can indicate the peg will hold, or that it's in danger of breaking.
  5. Policy announcements. How dedicated does the government sound when it says they want to maintain the peg? Do they seem willing to do "Whatever it takes," or are they hinting they're willing to modify the peg?
  6. Balance of trade. Does Switzerland have a lot of exports or a big trade deficit? Big trade deficits can spell trouble for maintaining a peg, since this indicates that the peg has been set too high -- the CHF is too valuable, so people are trading their CHF for dollars to buy goods from the US. This puts pressure on the CHF because of the increased supply.

All of these are things to take into account when trying to predict whether a peg is stable.

| improve this answer | |
$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.