The unstoppable appreciation of the Swiss franc over the past three years reached its peak on August 9th, coming close to parity with the euro. What became achingly clear that day was that the Swiss National Bank would have to get its hands on the "superfranc" if it wanted to prevent the nation from slipping into recession. David Meier, a research economist at Julius Bär, the leading private bank in Switzerland, explains the reasons behind the recent rise of the Swiss franc and the consequences it may have for the domestic economy.
In the past 18 months alone, the Swiss franc rose by 20 percent against the euro. What are the main reasons for this dramatic increase in the exchange rate?
It is mainly due to scared investors who are troubled by uncertainties regarding the global growth outlook. They look at growth drivers in developed economies, but they cannot identify many. Their fears intensified over recent months with the eurozone and US debt situations escalating, and this added to turmoil in the financial markets. Investors want to place their money in a “safe haven” currency. They don’t expect large gains, as interest rates in Switzerland are close to zero, but they look for value preservation. In a sense, you could compare it to buying gold.
What are the consequences of an overvalued Swiss franc for the national economy?
The most important one is the erosion of the competiveness of our export sector, which has an extremely high contribution to GDP – one of two Swiss francs is earned through exports. If these goods, mainly high-tech manufactured products, get more and more expensive from an overseas perspective, demand will fall, and companies could leave the country and start producing in cheaper economies. Other sectors have also been hit heavily, like tourism. It is getting quite expensive for Europeans to travel in Switzerland.
So if industries shift their production to other countries and hotels are empty, companies will have to dismiss workers…
Yes, but maybe not as many as one expects. More jobs could be lost if a deflationary environment becomes a reality. From a macroeconomic perspective, a strong currency leads to disinflation, and that is more severe when growth in the economy is itself slowing down. The Swiss National Bank last week revised its forecast and said it is now expecting absolute negative inflation for the first half of 2012. This is dangerous for the economy because companies need to adjust to lower prices, lay off staff, try to reduce costs, etc.
In order to avoid such a dismal scenario and keep the value of the national currency under control, on September 6th the Swiss National Bank said it was determined to keep the exchange rate at 1.20 francs to the euro. Do you think that was the right decision?
They had to do something, under the circumstances. So far, it looks like a good decision, but we are just at the beginning and the longer-term success is yet to be seen. There was a lot of political pressure to do something, as many companies were getting quite nervous and there was a lot of criticism from trade associations.
But could this measure have negative consequences?
Of course there are risks attached to this. Something similar was done in the late 1970s with the German mark, when the Swiss National Bank also defended exchange rate floors. We ended up later with inflation of above 7 percent and quite a big recession in the early 1980s.
So Switzerland avoids deflation at the risk of high inflation. Is this why some analysts say it was only the best of many bad options?
Yes, I also think so. But what else could the SNB do? They were shooting the last bullet, which shows again the risks we have in Switzerland. We will have to see if this measure works in the long term. The SNB is on its own, it is isolated, and it cannot control the external factors that drive investors to the Swiss franc.
Is a Swiss franc at 1.20 euros a fair value or is it still overvalued?
1.20 is arguably not a very high exchange rate but it is still overvalued. Here at Julius Bär, we believe that to avoid a recession the Swiss franc should be at least 1.30 or above. So this measure will probably just delay things. It is important, though, to keep in mind that it is not just the exchange rate that can push Switzerland into a recession; it is also a decrease in global demand for Swiss products resulting from a global slowdown of economic activity.
But every cloud has a silver lining, and the high Swiss franc is also benefiting consumers who go shopping in bordering eurozone countries, where goods are already significantly cheaper…
We have to be careful. Of course, from a more egoistic consumption-related point of view, you can say that for the Swiss consumer this is an advantage; we can go and buy things cheaper abroad, or we can go on cheaper holidays… but here also lies the danger. For the economy as a whole, it is not that great, because the more we buy in other countries, the more we damage the national economy. If our shops sell less, they will start saving costs by reducing their staff. At first sight, it may seem to be a fun thing, but in the long term, it is not beneficial.
Investors see Switzerland as a safe haven, considering that public debt is at 4 percent, unemployment 2.8 percent and the government will probably end the year with a budget surplus. Yet, its economy is facing risks. Is Switzerland a victim of its own success?
Yes, that’s exactly the point. However, we should not see this only as a big problem, but also as a sign of our strength. A look at the past shows that Switzerland has been able to cope with an appreciating franc before. Switzerland is a small, open economy that is affected by what happens in other economies, and the consequences of this can also be troublesome. I guess [a high Swiss franc] is just one of the consequences of being too attractive, maybe [laughter].