They All Said a Strong Currency is Bad …

We feel absolutely certain that the people running the SNB won’t be convinced by any evidence, whether theoretical or empirical, that puts their misguided assessment of the alleged dangers of “deflation” and a strong currency into doubt. In spite of Switzerland’s reputation as a nation of that holds conservative values in high esteem and is among the economically most free in the world, its central bankers are almost by necessity strong believers in central planning and assorted Keynesian and monetarist shibboleths.

We say "almost by necessity" because admitting to the truth of the matter, namely that the institutions of fiat money and central banks are utterly alien to the market economy and are harming it more than just about any other human invention, would be tantamount to conceding that they themselves are surplus to requirements – which of course they are. Among other things, these walking and talking impediments to prosperity and economic progress continually assert that nations can somehow be made richer if only they devalue their currencies. This is typical Keynesian logic: You can get richer by becoming poorer!

Photo credit: Daniel Rohr

As is widely known, the wise sages running the SNB were ultimately forced to abandon the previously enforced minimum exchange rate against the euro in the face of the looming threat of Mario Draghi’s equally nutty QE operations. Not because they actually wanted to give up on it. They simply got cold feet upon pondering the prospect that their bloated balance sheet would have to be blown up even more.

The Swiss monetary base reflects the vast bulk of the liabilities on the SNB’s balance sheet. Even the inflationism of the Fed, BoJ and ECB is thus far dwarfed by this – click to enlarge.

The SNB, in concert with Switzerland’s export industry (in its role as a completely uninterested bystander thinking only about the welfare of the citizenry), was for a long time eagerly engaged in making apocalyptic pronouncements about what a stronger Swiss franc would do to the economy. A deflationary spiral would surely suck everything down into a kind of financial and economic black hole.

Incidentally, the SNB argued against the demands articulated in the Swiss gold referendum precisely on the basis of this very same unreflected scaremongering. Allegedly, an increase in the franc’s gold cover would have made interventions such as the imposition of the absolutely essential minimum exchange rate impossible. A little white lie there, technically speaking, but why then give up on the peg a scant ten weeks later?

EUR/CHF cross rate, before, during and after the peg. Surely Switzerland is now a poorhouse? – click to enlarge.

What Really Happened So Far

So what has happened thus far, apocalypse-wise? Has the Swiss economy imploded as swiftly as the euro against the franc? Have those poor exporters nothing to eat and pay the rent anymore? Hardly. Here is a preliminary assessment via Reuters (which somehow neglects to mention that SNB board members were for a long time among the most vociferous doomsayers of all):

"When the Swiss central bank abandoned its cap on the franc back in January, corporate Switzerland warned of an economic "tsunami" that would hit exports, hammer jobs and plunge the Alpine nation into a deep recession. Four months later, however, the country appears to be holding up better than the doomsayers had predicted.

At an annual gathering of business leaders in St. Gallen this past week, Swiss firms said they were weathering a sharp rise in the Swiss franc’s value against the euro since the cap was scrapped by adjusting prices, emphasizing new markets and seeking more flexible hours from staff.

A strong dollar has helped cushion the blow for some firms and those that import intermediate goods from the euro zone have actually benefited from the franc strength. There are sectors of the economy, notably tourism and machinery firms with a franc-heavy cost base and high sales exposure to Europe, that are struggling.

Swissmechanic, an employers’ association for companies in the machinery, electronic and metalworking sectors, says that some 2,000 jobs have been axed in the sector since the Swiss National Bank (SNB) shocked financial markets in mid-January. But many firms say previous episodes of franc strength, for example in 2011 before the SNB introduced the 1.20 franc per euro ceiling, forced them to be nimble, and that has helped them weather the storm.

"Many companies have learned from 2011, many saw that if they have a concentration of risk, whether it’s in distribution, customer base, or the product, then it’s a major risk," Tobias Gerfin, CEO of Swiss kitchenware firm Kuhn Rikon, told Reuters in St. Gallen.

"We are going to raise prices in Europe, we’ve increased weekly working hours from 40 to 42 hours, we have taken measures, but the situation is not so bad that I can’t sleep at night," he said.

A stronger currency makes it more difficult for firms to compete on price abroad. Switzerland’s strong economic links to the euro zone make the franc-euro exchange rate the most important for Swiss firms. Still, despite the fact that the rate is now close to parity, with one euro buying roughly 1.04 francs, the hard economic data has been encouraging.

Swiss exports ticked up in March compared to the prior year, buoyed by sales to the United States, Middle East and Asia. And consumption appears to be holding up well thanks to a resilient tourism sector and a rise in car purchases.

"Besides the obvious shock to exports, consumption and investment that has hit the economy, households and industry seem to be flexible enough to weather the storm," said Karsten Junius, chief economist at bank J. Safra Sarasin.

Who would have thought? It sure seem that somehow, Switzerland failed to get "get hit by an economic tsunami" when the exchange value of its currency increased! At this juncture, readers should cast a brief glance in the general direction of Japan, and ask themselves in what way the cheapening of the yen has so far "helped" its economy. As far as we can tell, the main effect after almost three years of trying to get richer by becoming poorer has indeed made almost everybody poorer there, as the real value of incomes has nosedived.

How could any of this have been predicted? The application of economic logic can sometimes be helpful in such situations (not the strongest suit of the bureaucrats running the world’s central banks). This is an opportunity to repeat a brief quote by Ludwig von Mises, which summarizes the salient features of the topic in a few sentences (the British citizens used by way of example can be replaced by the citizens of any devaluing country):

"The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation’s welfare. In plain language it is to be described in this way: The British citizen must export more British goods in order to buy that quantity of tea which he received before the devaluation for a smaller quantity of exported British goods."

There really is not much more to say about it. Naturally, it is also necessary to throw the misguided mercantilistic notion that "the balance of trade is the yardstick of a nation’s welfare" overboard. People engage in trade because both sides to the trade regard it as profitable. Whether or not there is a national border between these people is economically utterly irrelevant. Is anyone worried about the trade balance between, say, New York and Chicago? If not, then there is no need to worry about any other trade balance either. Frederic Bastiat explained why almost 170 years ago already – you can read all about it for free here. Perhaps it is time some of our esteemed global policymakers were made aware of this text. Just saying.

Switzerland’s Real Problem

We can conclude from the above that a strong exchange rate is not harmful to the Swiss economy. However, that unfortunately doesn’t mean that the Swiss economy is out of the woods. Its central bank has not given up on interfering with the economy and has introduced deeply negative interest rates (it is targeting a 3 month LIBOR average of minus 75 basis points, and almost the entire Swiss government bond yield curve has sunk below zero not too long ago).

This utterly absurd policy is continuing to foster asset price bubbles and will invariably lead to so much capital misallocation that a major bust down the road is an apodictic certainty. In short, the monetary policy shenanigans of the SNB will not be without long term consequences, and none of them will be good. As can be seen below, the narrow money supply M1 (equivalent to money TMS, consisting of currency, sight deposits and transaction deposits), as well as the broader measure M2 (which suffers from containing components that are technically not money) have soared right along with the Swiss monetary base (M3 is only marginally different from M2 and not a measure that in any way improves on M2, so we haven’t included it).

Swiss monetary aggregates M1 and M2 – both have soared by nearly 125% since summer of 2008 – click to enlarge.

Swiss apartment prices have been trending higher for many years.

The strong Swiss franc has likely kept Switzerland’s SMI index from soaring to even higher levels, but clearly the money supply explosion has affected stock prices as well – click to enlarge.

To be sure, Switzerland has a lot going for it, and there can be little doubt that it is a country in which genuine wealth creation continues in spite of the central bank’s mad-cap policies. One wonders though for how long the bizarre pretense that capital should be priced at less then nothing can be kept up without doing severe structural damage to the economy.

Conclusion

A strong currency is not a disadvantage. Exporters will have to be nimble to deal with it, but this can only increase their global competitiveness in the medium to long term. Meanwhile, for companies importing raw materials and intermediate goods as well retailers and consumers it is an unalloyed boon. No-one should be surprised that Switzerland is handling the allegedly "catastrophic" rise in the Swiss franc so well. However, a price will eventually have to be paid for the willy-nilly expansion of the money supply instigated by the SNB and the adoption of negative interest rates in its misguided attempt to suppress the exchange rate of the franc.

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