Earlier this week, the Swiss rocked the global financial markets by suddenly ending monetary measures designed to prevent the Swiss franc from appreciating beyond a certain amount, relative to the euro. That a central bank which represents a country of 8.1 million people with a GDP ranked 20th in the world (behind such countries as Turkey, Mexico, and South Korea) could spark global financial unrest around the world and days of commentary comes as a huge surprise, even to those who follow such things. The action and the resulting turmoil provides a lesson to the dynamics involved in central bank intervention in international currency markets along with revealing Switzerland’s unique place in the global financial plumbing.
The first thing to notice is that Switzerland took the action that it did, likely because it feared that the Swiss National Bank (SNB) was printing too many francs to purchase euros, the value of which were continuing to decline. This means that holding large amounts of euros was a losing proposition over time. Another way to think of it is that the Swiss stopped buying a stock that was losing value and that looked to be losing value for the foreseeable future. A central bank that holds large amounts of foreign currency that loses value can eventually find itself in a position like any other bank that holds too many bad assets, i.e. on the verge of collapse. Given that Switzerland’s position in the global economic financial system is due only to the perception of fiscal probity and stability, allowing even the hint of doubt to be allowed to diminish that perception is not something Switzerland can afford.
The second thing to notice is that Switzerland’s actions caused its own stock market to lose 8% in a single day. The reason for this is that a depreciating franc helps Swiss manufacturers remain competitive with their E.U. competitors. With a rising Swiss franc as the result of this week’s action, Swiss manufacturers (most of whom are export-oriented) will face competitive headwinds resulting in lower economic growth.
The third thing to notice is despite Switzerland’s small size, the fact that it (and the Swiss franc) is seen as a safe haven means that what Switzerland does to its currency has an impact globally. The primary factor driving up the value of the Swiss franc is that instability around the world (Russia) and deliberate devaluation (the E.U.) means that investors are again looking for something stable that will hold its value. As long as this continues, the Swiss franc is likely to continue to remain strong.
So what is the matter with Switzerland? Really nothing. They are a country with a well-deserved reputation for fiscal sanity and stable political system. While this can create some economic headaches from time to time such as an over-valued franc hampering export, and hence economic, growth, it is a lot better than the alternative. Switzerland could do a lot worse.