Switzerland has made headlines of late as a potential candidate to be labelled a currency manipulator by the U.S. Treasury. For those countries at risk, a report recently published by the U.S Treasury sets out three key criteria the U.S. Treasury will use in order to assess whether a country is “pursuing unfair practices”. Firstly, the country would have a significant bilateral trade surplus with the United States defined as more than USD20 billion. Secondly, a country with a current account surplus of at least 3% of GDP would receive heightened analysis from the U.S. Treasury. Finally, persistent, one-sided currency interventions in excess of 2% of a country’s GDP over a 12-month period could be a sign that a country is manipulating its currency, and therefore imposing “hardship on American workers and companies”.
According to the report, Switzerland exceeds the threshold for two out of the three evaluation criteria defined by the Treasury and joins China, Japan, Korea, Taiwan and Germany on a monitoring list of countries which “merit close attention to their currency practices” according to the U.S. Treasury.
The report also recommends some concrete actions the Swiss authorities could take in order to come off the monitoring list. These include a return to more traditional monetary policy tools, a disclosure of currency intervention data, and a greater degree of fiscal easing in the Swiss economy. With regard to the latter, while it is true that Switzerland has room to use fiscal policy to stimulate growth, the Swiss economy is heavily linked to its major trading partners and very much dependent on a competitive exchange rate. Further and greater fiscal spending, not just as a replacement of monetary policy action, could backfire with an unwelcoming appreciation of the Swiss franc, especially if Swiss growth decouples too much from the Eurozone average.
The recommendation to use more traditional interventions is easier said than done. This card has been played by the Swiss National bank before it started to heavily intervene in the currency market. The Swiss benchmark interest rate is deeply negative at -0.75% and, as I’ve blogged before, continues to hurt the profitability of the financial sector, a key contributor to Swiss GDP.
The SNB is sitting on foreign currency reserves that are close to 100% of GDP, making its balance sheet vulnerable to currency moves. Importantly, despite all the interventions, the Swiss Franc looks expensive compared to the USD on a purchasing power parity basis so it would be odd to say that the Swiss economy is gaining an advantage from having an undervalued exchange rate from a U.S. perspective. When asked about currency manipulation, SNB Chairman Thomas Jordan recently said in an interview with newspaper Schweiz am Wochenende: “Interventions are not made to take advantage of an undervalued currency, rather the contrary, to protect Switzerland against a significant overvaluation of the Swiss Franc and its negative impact on the domestic economy. International authorities are aware of this and do acknowledge.”
Going forward, there is a risk that the SNB’s persistent exchange rate alignments will be used by the U.S. Treasury to set an example of its commitment to aggressively and vigilantly monitor and combat unfair currency practices. Should that be the case, the U.S. Treasury would address their concern via bilateral engagements and, if Switzerland does not take sufficient measures to solve the issue within a year’s time, potentially use tariffs to increase the price of Swiss imports into the U.S.
If this were to eventuate, the impact for the alpine country would be significant. According to the Federal Customs Authority, the total amount of Swiss exports reached CHF210 billion in 2016 of which CHF35 billion were exported to the US. While this number doesn’t seem to be significant in comparison with the CHF94 billion shipped to the Eurozone, the picture changes when looking at net exports. Having imported goods worth CHF110 billion from the Eurozone in 2016, Switzerland actually runs a trade deficit with the Eurozone, in contrast to the trade surplus with the U.S. The U.S. also marked the fastest growing export market for Switzerland last year with an increase of more than CHF4 billion, primarily driven by the pharmaceutical industry. Imports from the U.S. rose last year, but at a slower pace of CHF3 billion which, as a result, increased the trade surplus with the United States further.
Should this trend continue, Switzerland runs the risk of exceeding the defined threshold of a USD20 billion trade surplus, the only criteria in the report where Switzerland doesn’t tick the box. If Switzerland is deemed a currency manipulator, the more prudent path for the SNB may be to allow the Swiss Franc to appreciate in order to avoid the implementation of tariffs on Swiss exports to the U.S. This may be the lesser of two evils and will allow the Swiss to avoid the wrath of the U.S. Treasury.