Have the Swiss proved Larry Summers right?

January 15, 2015, 5:30 PM UTC

Why would Switzerland let its currency jump by 13% in a single day against its largest trading partners?

The move will hammer exporters, bring more woe to the beleaguered wealth management industry, risk importing deflation through the current account and, always important for a central bank, wreck its reputation as a reliable and credible force in international markets.

It will also–and stifle those sobs please–make it even more expensive for the Great and Good to attend the World Economic Forum in Davos this year (and they’d already put their prices up 20% in the fall).

Truly, the board must have had some pretty good reasons.

It’s the shock element of the move that is the most, well, shocking. In the last 10 days alone, after all, both Governor Thomas Jordan and his deputy Jean-Pierre Danthine had given interviews stressing how important it was to keep in place a mechanism which had seen it pay any price to keep the franc from rising against the euro since 2011.


The Euro vs the Swiss franc. Nobody saw that one coming.


As Steven Lewis, chief economist of ADM ISI in London, points out, it’s not that anything has happened in Switzerland since then to change their mind. The reason has to come from outside. You don’t have to look too far to see where.

The European Central Bank has been signalling very clearly this week that it’s about to start buying government bonds, with the announcement coming as early as next week’s council meeting. On past experience, such programs increase the supply of a currency, putting downward pressure on it down against other currencies on the foreign exchange market.

In such circumstances, the SNB would have had to print yet more francs with which to buy yet more euros to keep its most important exchange rate stable. Since it started that trick in 2011, the SNB’s holdings of euro reserves have risen by over CHF200 billion–around 33% of GDP. Small wonder it didn’t want to double down on that bet.

But that figure itself highlights an often overlooked aspect of the way Europe has dealt with its financial problems in the last four years. The ECB has often been chastised for not doing “quantitative easing”, or QE, the way the Federal Reserve, Bank of Japan and Bank of England have done. What the critics have often missed is that the SNB has effectively been doing QE on the ECB’s behalf, creating liquidity for the purpose of buying euros, and then investing the money in Eurozone government bonds. That’s been a big factor in driving, for example, the French 10-year government bond yield down to a record low of 0.66% this year, lowering funding costs for the whole of French industry.

In that sense, Thursday’s action restores things to normal. The ECB can take full responsibility for interest rates in the Eurozone and the SNB can stop worrying about all the FX risk building up on its balance sheet.

But in another sense, the new equilibrium is anything but normal. An official interest rate of -0.75% is a clear sign that something is still badly wrong. How, for example, is a bank in Switzerland supposed to survive if it starts charging everyday Joes to keep money in their checking and deposit accounts?

Bill Clinton’s old finance chief, Larry Summers, argued last year that the ravages of the Great Financial Crisis and the recession that followed may have left the equilibrium interest rate–the one needed to produce long-term growth without inflation–below zero. That’s a claim with profoundly awkward consequences for the future of capitalism and the world’s pointy-heads are understandably slow to sign up to the thesis. But the SNB’s move on Thursday–and the relentless downward march of government bond yields from Japan to the U.S. and Germany–may be the clearest indication yet that he’s right.

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