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Saturday, Sep. 10, 2011

EDITORIAL

Switzerland wages war

In a move that jolted currency markets, the Swiss National Bank, the European nation's central bank, pledged this week to drive down the value of its currency, the Swiss franc. The move was prompted by the rising value of the franc against the euro, a trend that has pummeled Swiss exporters.

While the move makes sense for the embattled nation, the question is whether it will unleash similar moves by other besieged export-dependent countries. If it does, the world risks a round of competitive interventions that will only end badly.

While Europe's main currency, the euro, has taken a beating in recent years as member economies battle their financial demons, the Swiss franc has climbed inexorably in value, appreciating more than 16 percent against a basket of nine major peers this year.

Over the same time against the same set of currencies, the euro fell 1.3 percent and the dollar tumbled 12 percent. Over the past year, the value of the franc increased 16 percent against the euro and 30 percent against the dollar.

For a country dependent on exports, that is deadly. A little more than one-third (35 percent) of the nearly $700 billion Swiss economy comes from exports; the sector employes several hundred thousand people. An economics think tank forecast a loss of 20,000 jobs if the currency's rise was not abated.

The more expensive franc also bruises the tourism industry: In July, overnight stays by tourists were down 4 percent compared with the previous year.

The Swiss government anticipates slower growth next year: The economy will expand 1.5 percent in 2012, down from 2.1 percent in 2011 and 2.7 percent the year before. (By contrast, Credit Suisse forecasts 1.9 percent growth this year.)

In this situation, the Swiss National Bank's pronouncement that the strong franc "poses an acute threat to the Swiss economy" makes perfect sense. Its announcement Tuesday that it "will no longer tolerate" an exchange rate below 1.20 francs to the euro, and "will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities," is more surprising.

The Swiss National Bank has a history of currency intervention — again that makes sense for a country that is so dependent on foreign trade. But the commitment to buy "unlimited quantities" is a stiff challenge to a global currency market that trades $4 trillion a day. Still, the move had an immediate effect. The value of the franc fell by more than 8 percent immediately after the announcement.

Whether it sustains the trajectory is another issue. The Swiss National Bank can, as a national bank, print as much currency as it needs to discourage those who want to hold Swiss francs as a safe haven at a time of global financial turbulence and uncertainty. The downside is that such a move risks inflation. (That also erodes the image of the franc as a safe haven, but few prospects unnerve central bankers more than that of inflation.)

The move is increasing pressure on the currencies of Norway and Sweden, which are also seen as safe havens. The Norwegian krone has already strengthened 4.5 percent against that same basket of nine currencies this year, and the country's finance minister and central bank governor have said that they will act to counter currency appreciation that hurts Norway's exports — although the governor did rule out direct intervention like that of Switzerland. On Tuesday, the krone hit its highest level against the euro since February 2003, while Sweden's currency also strengthened.

Other countries may be tempted to follow suit. Japan is battling a soaring yen which is knocking the breath out of exporters. The country last month spent ¥4.51 trillion ($58 billion) on yen sales, the biggest intervention in any month since 2004. The government has said that it will focus on the dangers of the rising yen at the meeting of G-7 finance ministers and central bank governors this week in France.

While Japan could copy the Swiss decision to print unlimited amounts of yen, the decision would have a much greater impact on the global economy: Japan is the third largest economy in the world, Switzerland is "just" 19th.

Moreover, Japanese exporters are bruised but not badly hurt. Most observers expect that they can weather a tighter squeeze — although it will not be comfortable.

The biggest reason Japan will not copy the Swiss is that it could encourage yet other countries to embrace currency manipulation to help their own economy. The prospect of a currency war is real, especially if manipulators can point to the world's third largest economy as doing the same thing.

Brazil is watching developments closely as it struggles with the effects of its currency appreciating 40 percent since 2008.

The biggest question mark is China. It has come under mounting pressure to let its currency appreciate — which it has — but the government in Beijing is making the process as slow as possible to mitigate the negative impact on its own economy. That is understandable from a Chinese perspective, but if it encourages other nations to take similar action, then the pursuit of self-interest could threaten collective destruction.

While we are sympathetic to Switzerland's decision, we worry — greatly — about the potential consequences.



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