How the Swiss Curbed the Uber-Franc

The Swiss central bank may have saved its economy by embracing Chinese-style currency policy. Faced with a surge in the Swiss franc that threatened to derail growth, the Swiss National Bank has bought euros aggressively, quadrupling its foreign-exchange holdings since March 2009 to slow the currency's advance and protect exporters. By comparison the Chinese, who buy dollars partly to keep the yuan down, look conservative. China, holder of the world's largest currency stockpile, increased its reserves by a mere 28 percent in the same period.

In times of crisis, investors seek out assets known to preserve value, like gold or the Swiss franc. So as the collapse of Lehman Brothers Holdings in September 2008 roiled investors, the franc began to rise. The danger was that a jump in the franc would throttle exports, which account for about half of Swiss gross domestic product. Then, with growth stalled, the Alpine economy would slide into deflation.

The Swiss central bank swung into action, buying euros while lowering interest rates to 0.25 percent from 2.75 percent in September 2008 to stimulate the economy and discourage foreign investors from buying Swiss bonds. The foreigners still piled in, and the Swiss franc rose 15 percent in the last 15 months through June, reaching a high of 1.30 francs to the euro on July 1. The central bank had a paper loss of $13 billion on its currency purchases in the first half. That's a big chunk of its $219 billion in foreign-exchange reserves.

Many economists say the Swiss came off surprisingly well. The franc's recent rise was a lot smaller than gold's 59 percent surge in the same period. Swiss manufacturers adjusted to the franc's strength while benefiting from low rates at home. Foreign sales at Swatch Group and ABB, the biggest builder of electricity grids, are rising, and manufacturing expanded at the fastest pace on record in July. In June, the Swiss National Bank raised its GDP growth forecast from 1.5 percent to about 2 percent, double what's projected for the euro region.

The Swiss National Bank can probably hold off from buying more foreign reserves for now. "Their policy was a success even if interventions reached extreme dimensions," says Frankfurt-based David Kohl, deputy chief economist at Julius Baer Holding, a 120-year-old Swiss private bank. "Ultimately, it didn't matter to them whether they suffered a loss."

The risk is that a further rise in the franc would force the Swiss to wade more deeply into currency markets, putting it on a "kamikaze mission," says Axel Merk, who oversees $500 million as president and chief investment officer at Merk Investments. "We'd rather have the SNB focus on sound monetary policy than a cat-and-mouse game with speculators they are bound to lose." For now, though, the Swiss have done a good job blunting the pain of the über-franc.

The bottom line: The Swiss central bank has bought foreign currency aggressively to keep the franc tethered to the ground.

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