Safe-Haven and Resource Currencies Lead Off 2011 With Warnings of Currency Wars

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Spare a thought for snow-covered, tranquil and prosperous Switzerland, as I frequently find myself doing, having just returned from several weeks in our Swiss office. On the surface all seems Utopian: a high standard of living, clean lavatories, trains and buses that run to the second, respectable growth rates, negligible inflation and such robust, well-managed public finances that Switzerland even managed a surplus last year, according to an FT article.

But beneath the surface, all is not quite so rosy. Such well-managed stability comes at a price everyone wants a bit of it, especially in times of global upheaval, debt crisis and fear. The result has been Little Switzerland, with a population estimated at less than 7.8 million (when I’m not there), as the safe haven of choice for risk-averse investors. As a consequence, the currency has risen dramatically against the Euro, its main trading partner, the British pound and the US dollar. Ten years ago, my pound bought me 2.5 Swiss francs; in early 2008 before the financial crisis it bought me 2.0 Swiss francs; today it buys just 1.45. Switzerland is not a resource currency like Australia’s, Brazil’s or even Canada’s. Indeed, it has very little in the way of natural resources apart from some hydroelectric power and a highly educated and ingenious workforce. So how does a small country like this survive such a drastic degeneration in its competitive position? Not without considerable pain is the answer. In other countries such pressures would be met with riots on the streets, but such undignified expressions of unrest are not for the restrained Swiss. Nevertheless, business and civic leaders have been vocal in demanding action, unfortunately often in opposite directions highlighting the dilemma countries on the losing side of the currency war find themselves in.

On the one hand, some trade unions and business leaders have demanded currency market intervention to stem the rise of the franc. In 2010 this is estimated to have cost the central bank some SFr 21 billion in losses and foreign currency reserves that have ballooned to SFr 200 billion on which further losses will be incurred, even as the bank tries to diversify from dollars and pounds. These losses have a direct impact on every citizen, as the central bank is obliged under an established formula to divert SFr 2.5 billion of its profits as subsidies to the cantons every year, an arrangement that Thomas Jordan, the bank’s deputy chairman, said would come as no surprise if this had to be reduced, as reported in the FT.

Others, such as Paul Rechtsteiner, head of the trade union federation, who argues 90,000 jobs are at risk this year due to the rise in the currency and Nick Hayek, chief executive of Swatch Group, are calling for the Swiss franc to be pegged to the Euro, much as China’s Renminbi is pegged to its largest trading partner, the US dollar.

Daniel Lampert, the trade unions’ chief economist, and a member of the bank’s supervisory council, suggested last week that Switzerland should copy Brazil and introduce capital controls. But even as Brazil pursues multiple paths to combat a rising Real, many economists question the efficacy of capital controls.  In September Brazil imposed controls on foreign portfolio investments in Brazil aimed at slowing a 39 percent increase in the Real over the US dollar over the last two years. Guido Mantega, Brazil’s finance minister, is reported in an FT article as saying Brazil’s trade with the US had slipped from an annual surplus of about $15 billion in Brazil’s favor to a deficit of $6 billion since the US began trying to re-inflate its economy through loose monetary policy and the dollar started its slide. Mr. Mantega also mentioned the Chinese Renminbi as being in need of revaluation, but was careful to not upset his new friends in Beijing with any strongly worded criticism.

Unfortunately there is no easy answer to the problem of currency strength and 2011 will see no end of antagonism among trading partners as countries try to find solutions. Markets move such vast amounts of money that central banks lack the clout to have meaningful medium- to long-term impact. As central banks in Japan and South Korea, in addition to Switzerland and Brazil, have found last year, it usually results in throwing good money after bad, trying to sell the home currency and buy falling dollars, euros or pounds. Nor are capital controls, intended to stem the inflow of foreign “hot money into the economy, an easy card to play. Legislation is rightly aimed at trying to limit short termism, but leave open long-term investment, as Chile is currently implementing. If resource-rich or safe-haven currencies are not buffered in some way, the result will be at best a severe loss of growth and rising unemployment, and at worse the development of a bubble that will lead to a collapse as the hot money leaves when the global economy recovers and prospects look better elsewhere.

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–Stuart Burns

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