Beggar thy neighbor (part 2); this time its Switzerland?!?

Back in December, I wrote an article about the risks of rising protectionism in which I forecast the potential rise in beggar-thy-neighbor policies as a result of the ongoing economic crisis.  I called that article “part one” in anticipation that further articles may need to be written (hoping that they would not).  But unfortunately, there has been a string of recent news articles that have shocked me into writing a part 2 for this series  (lets hope there wont be a part 3!).   The culprit this time comes from the most unlikely of all places…Switzerland (yes, the home of the “WTO“, the global protector of free trade).

Why worry about Switzerland?  Well, because of a recent quote from Swiss National Bank Vice President Philipp Hildebrand….where he  pledged to sell “unlimited amounts of the currency (Swiss Franc) to curb its  appreciation.”  In other words, the Swiss National Bank would do everything in its power to devalue their currency (compared to market supply /demand).  This means selling their own currency to buy another currency (likely target = the Euro).

On the surface it appears harmless for Switzerland to assume this protectionist stance…what can it hurt if a tiny country decides to defend its currency?  ( With a GDP of around $490 billion, Switzerland is about the size of Belgium or Sweden, two middle-ranking economies in the 27- nation EU.)…And, doesn’t Switzerland need the help? (because their banking-dependent economy has been harmed by the global crisis, with the resulting unemployment and potential deflation which are threatening the Swiss economy)…

The reasons actually make some sense…

  1. Switzerland is facing the risk of deflation….which is terrible….and so, in order to avoid this terrible economic situation of deflation, Switzerland might need to have a weaker currency so that prices of imports will be higher, hopefully leading to some inflation (some rise in prices, which would counter this deflationary pressure)…
  2. Also, Switzerland needs jobs, and since the economy is heavily dependent on exports (to Europe mostly), the currency should be weaker to help drive up exports and keep the Swiss economy moving.  (Swiss exports, make up more than half of Swiss gross domestic product, and account for a  large percentage of Swiss jobs).

Ok, that sounds reasonable…but Switzerland is not just a “tiny European country”…they are a modern, advanced economy at the heart of the global financial system (and hence, smack in the middle of this global crisis).

The trouble with protectionism in Switzerland is that the same excuses (to turn protectionist) could equally apply to both Japan and to the US…who are both fighting slow economic growth, rising unemployment, falling exports and the threat of deflation (which Japan fought for over a decade).

Why focus on the relationship among Switzerland, Japan and the US?

Because all three of these currencies have appreciated during the global crisis.   These are the three major “safe havens” for global capital as it flees risk in other areas.  All three were major carry-trade partners (in the past) in which their local currency was borrowed at low interest rates, and invested abroad at higher interest rates.  But, as the world lost its appetite for risk, and as volatility increased, global investors were forced to unwind (reverse) those investments, and to bring massive amounts of capital home (to all three countries).  This explains why US, Japan and Swiss have seen their currencies appreciate during this crisis.

The trouble is that none of these countries manufacturing base benefits from having currency appreciate.  All three see their exports less competitive internationally as a result of strengthening currencies.  All three are facing job losses and deflation and near-zero percent interest rates.  All three are facing political pressures to create jobs and fight their local recessions.

And up until now, all three have respected the principles of free trade, and have allowed their currencies to float on international markets.  But, this changed when Switzerland broke-ranks with the others, and announced their intention to try and stop this appreciation to help their local economy.

This is extremely dangerous because it sets precedent for the other major trading partners.

What would happen if Japan were to announce their intention to also try to devalue their currency?  It clearly is in Japans interests to do so as it would help their important export sector…but, would that set off competitive devaluations across SE Asia?  Would China follow?  If both the Swiss and the Japanese (the only two other appreciating currencies along with the US dollar) were to actively devalue their currencies, would the US be far behind?  Can all currencies devalue?  Clearly not…but if all try to …its the basis of a competitive trade war.

Note:  the Japanese Yen has appreciated much more strongly during this global crisis than the Swiss Franc, but they have been surprisingly quiet and restrained in their non-defense of the currency.  In the chart below…you can see that the Swiss franc was steadily strengthening vs the Yen for about 4 years…but then the crisis hit, and the Yen has strengthened much more in comparison to the Swiss franc (inverted scale…so a downward sloping line = Yen strengthening, Swiss franc weakening).


In summary…it is important to remember that not ALL countries can follow this strategy of devaluing their currency, because one currency must appreciate if another depreciates…the trouble is that if all countries try to follow this strategy, we would have a trade war!

. A closer look at the Swiss Franc – a 5-year perspective… What is Switzerland really worried about?

Has their currency really appreciated that much?   As we saw in the previous chart, the Swiss Franc has actually depreciated a lot compared to the Japanese Yen (or, not appreciated as much vs other currencies as has the Japanese yen).

How about comparing the Swiss Franc vs the Euro (which is the major trading partner of Switzerland)?  Well, in this case, you do see that the Swiss Franc has appreciated during this crisis.  Where it used to take 1.65 Francs to buy a Euro, but now might cost 1.50 (meaning that the Swiss Franc is stronger as it costs less to buy a Euro). But this movement is less dramatic if you take longer-term horizon and look back over the past 5 years….


If you see the chart above…leading up till the beginning of 2008, the Euro was strengthening vs. the Swiss Franc…making Swiss exports more competitive in their critical export market.  But, as the crisis began, the Swiss Franc began strengthening vs the Euro, making Swiss exports slightly less competitive (the basis for protectionist policies as was recently announced by the Swiss central bank).

But, this move in currency appreciation has hardly been dramatic when viewed from a historical perspective.  Over the past 5 years, the Swiss Franc has typically traded between 1.5 and 1.6 to the Euro, with a brief period during the 2007 year in which Switzerland benefited from a slightly weaker currency.   Then, in the end of 2008, the Franc strengthened a little beyond that 1.50 barrier, but is that enough to warrant triggering a protective stance in one of the world major developed economies?  Is that movement significant enough to risk triggering a world wide competitive devaluation competition?

How about vs the dollar?


Here again, the chart doesnt show much more than a return back to historical levels.  This really doesnt look like the kind of distortion that would normally lead to a quote like this:

  • quote from Swiss National Bank Vice President Philipp Hildebrand….where he  pledged to sell “unlimited amounts of the currency (Swiss Franc) to curb its  appreciation.”

Boy oh boy, I really hoped cooler heads would prevail in one of the worlds most developed economies!   (especially considering that the WTO, the very institution that is supposed to stop trade wars, is LOCATED in Switzerland!)

zurich%20switzerland.jpgJoin our Forum and add your comments:  here . Could there be good-side to all of this?

Effects on Eastern Europe:

Interestingly, the Swiss depreciation might actually help countries such as Hungary, which are facing a very serious economic challenge in 2009.   Many Eastern European nations borrowed heavily in Swiss Francs in the past in order to fund development back home.  But, as the Swiss Franc appreciated, their debts suddenly grew, and default risks rose.  So, perhaps the “beggar thy neighbor” of Swiss….may end up actually saving their (eastern Europe) neighbors…if allows them to be able to pay back swiss frank loans…

Originally published at Globo Trends and reproduced here with the author’s permission.