Asset bubble ‘threatens SNB euro stockpiles’

Nouriel Roubini speaking at the the Swiss Economic Forum in Interlaken Keystone

The threat of a collapse in the price of assets, such as government bonds, cannot be ruled out, star economist Nouriel Roubini tells swissinfo.ch. If that happens, the Swiss National Bank (SNB) could be faced with a multi-billion franc bill.

Since introducing a CHF1.20 exchange rate with the euro in 2011, the central bank has rapidly built up a huge stockpile of foreign exchange reserves that have nearly doubled in the past two years to over CHF440 billion ($470 billion) in May 2013.

A large portion of these reserves has been pumped into eurozone government bonds as the SNB successfully held down the value of the franc. So far, the policy has paid off with interest payments on bonds helping to wipe out direct foreign exchange losses last year, leaving the central bank with a CHF6.9 billion profit in 2012.

But a sudden rise in the currently rock bottom interest rates could lead to a sharp reduction in the value of bonds, leaving Switzerland’s central bank with massive losses if it cannot divest its investments fast enough.

Asset prices have been rising at an unsustainably faster rate than real global economic growth in recent months, United States economist Roubini told the Swiss Economic Forum in Interlaken on Thursday.

Unless general economic conditions improve, global markets could start to experience a bubble as soon as next year, he warned. Such a bubble could then burst, leading to further global economic shocks.

“I worry more about asset bubble risks than the traditional risk of goods inflation,” Roubini told swissinfo.ch. “At the moment, we are witnessing a frothiness in asset prices that could lead to a bubble – not this year, but possibly next – and eventually end up in a crash.”

Saving the franc

Investors flocked to the safe haven franc following the 2008 financial crisis and subsequent global recession and eurozone crisis.
 
Faced with an uncontrollably appreciating franc that threatened deflation and harmed exporters and the domestic tourism industry, the central bank decided in 2009 to buy up large quantities of euros.
 
Foreign currency holdings rose from CHF47.5 billion in 2008 to CHF204 billion in 2010. But the foreign exchange intervention came at a steep CHF26.5 billion loss, resulting in an overall loss of CHF19.2 billion for the central bank at the end of 2010.
 
With the franc threatening to hit parity with the euro in August 2011 (reaching CHF1.04 on August 11), the SNB was forced to announce on September 6 that it would react against the “massive overvaluation” of the franc by enforcing an exchange rate floor of CHF1.20.
 
The central bank has since stood by its stated intention to defend its policy by buying foreign currency in “unlimited quantities”. The policy has not resulted in any more annual losses for the central banks but its foreign exchange reserves stood at CHF441.4 billion in May 2013, the latest available figures.

Structural weaknesses

Roubini, who was one of the few economists to accurately predict the 2008 financial crash, told forum delegates that the global economy was currently faring better than a year ago but was still dogged by underlying structural weaknesses that could flare up at any moment.

These included a possible break-up of the eurozone, collapse in the US economic recovery, a sharp fall in Asian economies and the threat of military conflict in Asia and the Middle East.

Roubini forecast the eurozone to “at best” experience a continuing recession for a decade to come, a situation that would harm Swiss exporters and pile more pressure on the SNB to continue its euro spending spree.

“The eurozone is no longer in the emergency room, but it is still in a chronically critical condition,” Roubini said.

“Sound institutions”

But he tipped Switzerland to survive even a worst-case scenario thanks to its traditionally solid economic and financial decision making.

“Switzerland is linked to the eurozone; no country is an island. But any country with such sound institutions and economic framework will be able to withstand shocks,” he said.

Roubini also believes Switzerland’s beleaguered financial system – under sustained global attack to give up its role as a secretive haven for international assets – can prosper even if the country caves into demands for reform.

“The Swiss financial system will continue to flourish because it provides a far more diverse range of financial and asset management services than other jurisdictions,” he said. “There are some jurisdictions that rely purely on tax evasion to survive.”