Switzerland's Currency Conundrum

An appreciating franc is bad news for exports.

No tool for capping currencies, unfortunately.

Photographer: FABRICE COFFRINI/AFP/Getty Images

One topic currently dominates Swiss financial circles: Having abandoned its efforts to prevent the franc from appreciating beyond 1.20 to the euro, what does the Swiss central bank have left in its toolbox to prevent an economy-crushing drift toward parity for its currency?

QuickTake Currency Wars

The big worry in the financial community is that the franc is a one-way bet in the direction that will trash the country's exports. The Greek drama in the euro zone, combined with the global currency war among countries seeking to devalue their way to greater prosperity, amplifies the Swiss currency's haven status. And there might be nothing the Swiss National Bank can do to halt an appreciation that has made the franc the world's best-performing currency against the dollar by far this year:

Source: Bloomberg

SNB President Thomas Jordan, who has called his currency "markedly" overvalued, said his traders intervened to sell francs this week, trying to arrest its ascent as worries about Greece worsened. But having conceded defeat once, it's hard to see the monetary authorities winning this time around. And with the benchmark central bank interest rate already at minus 0.75 percent, there's little scope for further rate cuts to deter people from owning the currency.

Here's a reminder of the violence of the franc's Jan. 15 move, which came just days after central bank officials assured the world that capping the currency would remain the mainstay of monetary policy. Abandoning the defense -- which had been in place since September 2011, with the central bank intervening to sell its own currency whenever it threatened to breach 1.20 per euro -- spurred an unheard-of 30 percent gain against the currencies of the Group of 10 industrialized nations:

Source: Bloomberg

The consequences have been dire. The franc's jump destroyed exports by making made-in-Switzerland products more expensive; exports of goods slumped 2.3 percent in the first quarter. The economy shrank by 0.2 percent in the first three months of the year, its worst performance in six years. The second quarter, meanwhile, will probably see the nation slide into recession; a further contraction of 0.2 percent in gross domestic product is anticipated by economists in a Bloomberg News survey.

And, of course, whenever you see the words "Swiss exports," naturally your thoughts turn to horology; sales of Rolexes and other watches account for more than 10 percent of the country's exports. But in May, shipments of timepieces dropped 8.9 percent, according to the Federation of the Swiss Watch Industry, the biggest decline since November 2009:

Swiss Watches
Source: Bloomberg

The correlation between watch exports and GDP, mind you, isn't as strong as that chart suggests. From June 2006 to the first quarter of this year, the relationship has been about 0.15 percent, where 1 percent would suggest the pair moving in lockstep while zero would indicate no mathematical coupling. Moreover, as my colleague Leonid Bershidsky wrote in June, declining exports can be explained by the crackdown on corruption in China, which has annihilated demand for glitzy timepiece bribes, and the fact that May 2014 had two more working days than May 2015.

But there's another aspect of global trade that's rattling Swiss financiers. A new trade deal between the European Union and the U.S. -- the proposed Transatlantic Trade and Investment Partnership, or TTIP for short -- could wipe as much as 0.5 percent off Swiss GDP, a study by the World Trade Institute showed. If the European Free Trade Association, which includes Iceland, Liechtenstein, Norway and Switzerland, joins TTIP, on the other hand, Switzerland could boost GDP by as much as 2.9 percent, the study suggested.

Harry Hohmeister, the chief executive officer of Swiss International Air Lines, said this week he expects the Swiss parliament to put up "massive" opposition to joining the trade deal. That would be a mistake. With the Swiss central bank effectively powerless to steer the value of its currency to the advantage of exporters, and with a recession looming, Switzerland needs to adjust to the new reality. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

    To contact the author on this story:
    Mark Gilbert at magilbert@bloomberg.net

    To contact the editor on this story:
    Paula Dwyer at pdwyer11@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.