February 7th, 2015
in Op Ed
by Robert P. Murphy, Free Advice
Recently the Swiss National Bank (SNB) dropped the peg it had established in September 2011, holding the Swiss franc at 1.2 to the euro. Unlike the pegs of weaker, less trustworthy monetary authorities, the aim of the Swiss policy was to keep its currency cheap-in other words, they were propping up the euro at the 1.2 francs level.
Famous "market monetarist" Scott Sumner was critical of the SNB's move, arguing not only that it was wrong, but that the stated reasons made no sense. In this post I want to show people just how untenable Sumner's position is.
First let's establish Sumner's view. When discussing how great the Swiss peg was working back on December 21 (i.e. before the surprise drop which would not happen until a few weeks later), Sumner wrote:
I found some monetary base data that is quite interesting. From January to September 2011 the Swiss monetary base soared from 79b SF to 253b SF. That's Zimbabwean money printing, and it shows why Krugman is so contemptuous of the inflationistas. Switzerland got essentially zero inflation. But then something interesting happened; after the currency was depreciated and pegged at 1.2 SF/euro, the base actually fell to 215b by May 2012. Once investors stopped thinking the SF was going to move ever higher, they no longer had a strong incentive to speculate in that asset. It became easier to defend the currency.
Alas, there was one more attack in mid-2012, as eurozone investors worried about a collapse in the euro. Naturally, in that environment the SF would be attractive at even a zero expected rate of return. The base rose again to 349b SF in September 2012, at which point growth slowed sharply (it's 376b today.) More importantly, the 1.2 SF/euro peg held. Krugman was wrong, currency depreciation is not difficult if it is followed up with a level targeting regime.
In the above quotation we see a running theme of Sumner and some of his disciples: They argue that the huge expansions in central bank balance sheets are due to the stop-and-go policies. If the central banks would just be adults about it and announce a specific target, come hell or highwater, then actually their battle would be much easier and the inflation hawks would have less of a leg to stand on. In case you doubt my interpretation, note that Sumner specifically repeated this argument after the SNB dropped the peg; he even made this idea the title of his blog post.
But let's think about what Sumner is actually saying here. It will help if we're looking at the actual graph of the Swiss monetary base:
With the above visual aid, reconsider Sumner's argument: He's saying that it was no big deal for the SNB to establish and hold the peg to the euro. After all, from September 2011 through May 2012, the Swiss monetary base actually fell! This shows the power of market monetarism; faith really can move mountains.
Now it's true, Sumner goes on to concede, that speculators attacked in 2012, forcing the monetary base to swell. But the speculators failed. The peg held. (Sumner doesn't seem to tell his readers anything about the jump in 2013.)
So to sum up: That first huge spike in 2011 shows the "Zimbabwean" money printing that a central bank needs to do, if it doesn't follow Sumner's advice. The second spike you see (in 2012) shows how easy a currency peg is to maintain.
More generally, so long as speculators don't attack you, you should be fine.
To get a sense of why the Swiss authorities threw in the towel, look at the size of their central bank's balance sheet as a percentage of GDP. I found the following chart which includes some other major countries for comparison:
In case the color key is hard to read, let me clarify: The SNB's balance sheet blows the other ones out of the water; it was pushing 80% when they dropped the peg. And the reason they did this, of course, was to get out before the ECB made its huge quantitative easing announcement.
The thing that is the most shocking in Sumner's handling of this situation is not that he liked the peg; people can obviously disagree on the merits of a policy. What is shocking is that he couldn't even understand why Tyler Cowen (and I) argued that the peg was not credible. Again, if Sumner thought it was credible but could see why we disagreed-fair enough. But no, in his response to me, he was acting like I was being absurd for thinking the Swiss authorities eventually would have to give up.
In case people wonder why I pick on Scott Sumner so much, it's because he is to Market Monetarism what Paul Krugman is to Keynesianism. Sumner is super-sharp and very prolific. And now he holds a new chair on monetary policy at the Mercatus Center. Since I disagree so strongly with his views, you'll be reading a lot more of my critiques in the future.
Robert P. Murphy is the author of The Politically Incorrect Guide to Capitalism, and has written for Mises.org, LewRockwell.com, and EconLib. He has taught at Hillsdale College and is currently a Senior Economist for the Institute for Energy Research. He lives in Nashville.