Switzerland: Why It Is Scaring Us

Switzerland: Why It Is Scaring Us

By Shlomo Maital  

Last Thursday Switzerland did two scary things.  Scary for me – many (except for forex traders, who got creamed) did not take much notice.

    First, they cut the interest rate paid on bank reserves to  MINUS 0.75 percent.  Minus???  That means, deposit 1 million Swiss francs, at the end of the year you get back 992,500.  Why? To discourage money from flowing in.  

      Second, most important, the Swiss Central Bank announced it would no longer maintain the exchange rate vis a vis the euro at no more than 1.2 Swiss francs per euro, a policy announced in 2011.  It pegged its exchange rate, to keep the Swiss franc from getting too strong, because the euro was undergoing a series of crisis and losing value.  And each time the Swiss franc goes up relative to the euro, it makes Swiss exports more and more expensive.   In a surprise move, the Swiss now say they can no longer maintain this peg and the Swiss franc will be allowed to rise and strengthen, relative to the euro and of course relative to the dollar.

    Switzerland is one of the world’s most solid stable countries with by far the world’s strongest currency.  It is a safe haven – when things go wrong in the world, and they do all the time,  money flees to Switzerland, buys Swiss francs and sits mostly unnoticed in vaults and bank deposits.  

    Why is a strong Swiss franc a problem? Because Switzerland’s main trading partners are in Europe.  When its currency strengthens, its goods become expensive.  Amazingly, despite the enormously high wages and costs in Switzerland, the Swiss run an export surplus, exporting $308 b. yearly (over 70 per cent of their GDP) and importing only 288 b.  How do they do this?  By making and selling branded goods, high quality, precision machinery, and by selling value rather than cost.  But there is a limit. 

    What do we learn from Switzerland’s actions?

     First, no country is an island.  Europe is suffering from deflation, caused by absolutely stupid austerity policy.  EU policies, by bringing Greece to its knees, brought the euro to its knees as well; because again Greece threatens to leave the euro, and once one country does it,  many others may consider it.  Switzerland is paying the price not for its own mistakes but for those of Europe. 

   Second, deflation.   Economist Abba Lerner once said deflation (falling prices) is 100 times worse than inflation (rising prices).  He may have underestimated deflation.  The only way to dig yourself out of deflation is to stimulate demand. But Europe is doing the opposite.  So Europe is now exporting its deflation to Switzerland. The rising franc will make imports cheaper, and lower prices in Switzerland.  This will boost imports and hurt the economy, thus importing Europe’s folly to Switzerland against its will.

   Why are the Swiss no longer pegging the franc at 1.2 euros?  Because they no longer can.   To do this the Bank of Switzerland has to buy very large amounts of euros, and sell francs, thus expanding the money supply.  The Bank feels it can no longer continue to do this nad maintain Switzerland’s vaunted stability.  Switzerland has an absolutely balanced federal budget, and always does, because the Central Bank has the final say on the budget, and sends it back to the legislature if it is too loose. 

    Columnist Paul Krugman thinks a “fresh wave of safe-haven money was making the effort to keep the franc down too expensive.”     Imagine – you can ruin your country by causing money to flow out,  but apparently, also, by causing too much money to flow in (like Switzerland).    So far the Swiss have brilliantly reaped the benefits of trading with the EU without actually adopting the shaky, fragile, illogical currency called the euro.  But there is no way that the European sickness cannot spread to Switzerland too.  We learned that last Thursday. 

   This whole episode is scary, because it shows clearly that no matter how well run an economy is, and its money,   it cannot avoid the collapse, deflation and folly going on around it.  Sorry Switzerland.   You live in a bad neighborhood.  And you can’t really move those beautiful Alps to, say, the Caribbean.