Markus Brunnermeier and Harold James write:\u00a0 Since the European sovereign-debt crisis erupted in 2009, everyone has wondered what would happen if a country left the eurozone. At first, the debate focused on crisis countries \u2013 Greece, or maybe Portugal, Spain, or Italy. Then there was a rather hypothetical discussion of what would happen if strong surplus countries \u2013 say, Finland or Germany \u2013 left.
\nThrough it all, a consensus emerged that an exit by one country could \u2013 like the collapse of Lehman Brothers in 2008 \u2013 trigger a wider meltdown. Now, in Switzerland, we have a demonstration of just some of the risks that might emerge were a surplus country to leave the eurozone.<\/p>\n
In September 2011, Switzerland pegged its currency to the euro to set a ceiling to the Swiss franc\u2019s rapid appreciation in the wake of the global financial crisis that erupted in 2008. The country thus became a temporary adjunct member of the European monetary union. But, on January 15, the Swiss National Bank (SNB) suddenly and surprisingly abandoned the peg.
\nObviously, exiting a real currency union is far more complex and legally fraught than ending a temporary exchange-rate arrangement; the effects of such a move would be greatly magnified. Nonetheless, the Swiss move reveals at least some of the uncertainties that a full-fledged exit could create.
\nThe SNB was not forced to act by a speculative run. No financial crisis forced its hand, and, in theory, the SNB\u2019s directorate could have held the exchange rate and bought foreign assets indefinitely. But domestic criticism of the SNB\u2019s large buildup of exchange-rate reserves (euro assets) was mounting.
\nIn particular, Swiss conservatives disliked the risk to which the SNB was exposed. Fearing that eurozone government bonds were unsafe, they agitated to require the SNB to acquire gold reserves instead, even forcing a referendum on the matter. Though the initiative to require a fixed share of gold reserves failed, the prospect of large-scale quantitative easing by the European Central Bank, together with the euro\u2019s recent slide against the dollar, intensified the political pressure to abandon the peg.
\nWhereas economists have modeled financial attacks well, there has been little study of just when political pressure becomes unbearable and a central bank gives in. The SNB, for example, had proclaimed loyalty to the peg just days before ending it. As a result, markets will now hesitate to believe central banks\u2019 statements about future policy, and forward guidance (a major post-crisis instrument) will be much more difficult.<\/p>\n
Today, the global ramifications of a major central bank\u2019s actions are much more pronounced than in 1971. When the Bundesbank acted unilaterally, German banks were not very international. But now finance is global, implying large balance-sheet exposures to currency swings.
\nBig Swiss banks fund themselves in Swiss francs, because so many people everywhere want the security of franc assets. They then acquire assets worldwide, in other currencies. When the exchange rate changes abruptly, the banks face large losses \u2013 a large-scale version of naive Hungarian homeowners\u2019 strategy of borrowing in Swiss francs to finance their mortgages.
\nThough the SNB had given many warnings that the euro peg was not permanent, and though it had imposed a higher capital ratio on banks, the uncoupling from the euro came as a huge shock. Swiss bank shares fell faster than the general Swiss index.
\nThe risks created by the SNB\u2019s decision \u2013 as transmitted through the financial system \u2013 have a fat tail. The negative effects for the Swiss economy \u2013 through the decreased competiveness of its export industries (including tourism and medicine) \u2013 may already be showing that abandoning the euro peg was not a good idea.
\nBut the consequences will not be limited to Switzerland. After years of wondering whether the exit of a small, fiscally weak country like Greece could undermine the euro, policymakers will have to deal with an even bigger shock stemming from the exit of a small, fiscally strong country that is not even a member of the European Union.<\/p>\n
Markus Brunnermeier and Harold James write:\u00a0 Since the European sovereign-debt crisis erupted in 2009, everyone has wondered what would happen if a country left the eurozone. At first, the debate focused on crisis countries \u2013 Greece, or maybe Portugal, Spain, … Continue reading ![\"Swiss](\"http:\/\/www.w-t-w.org\/en\/wp-content\/uploads\/2015\/01\/Swiss-Franc-300x190.jpg\")
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