Would the euro solve Switzerland’s problems?

April 1, 2011

By Kathleen Brooks. The opinions expressed are her own.

While some market commentators are questioning if the euro zone should even exist, authorities in Switzerland might be looking with envy at the 27-member currency bloc.

But why would a nation as renowned for political as well as financial stability like Switzerland desire the euro? The chief benefit is for its export sector.  Swiss companies including watch marker Hublot have complained recently about the strong Swiss franc weighing on their competitiveness. And watch markets are not alone. Exporters in sectors as diverse as cheese and chocolate to engineers, pharma companies and chemical firms are all suffering from the same problem: a strong franc.

In its last quarterly bulletin the Swiss National Bank (SNB) forecast weakening growth throughout 2011 due to increased competitive pressure and narrowing margins for many Swiss export firms. Indeed, it noticed a considerable slowing in momentum in exports since spring 2010, which it claimed was directly attributable to the Swiss franc. The currency has appreciated more than 20 percent versus the dollar in the last year and 10 percent versus the euro.

The Swiss economy relies heavily on exports to generate its wealth for two reasons. One, it has virtually no natural resources to rely on to generate income, and two, the size of its population is tiny at just under 8 million. So Swiss companies need to look abroad to generate demand. Luckily foreign markets love Swiss goods, which is why its current account surplus is more than 14 percent of GDP.

Finances like these as well as a stable political system and low inflation have boosted the attractiveness of the franc in an uncertain global environment. But these virtues are now eroding the country’s competitiveness.

Since the  euro zone and in particular Germany is the largest trading partner of the Swiss, sharing the same currency would negate this problem. But would the Swiss want to join the euro zone that is plagued with sovereign debt problems in its periphery? This is obviously the downside, especially since Switzerland would have to contribute to bailout funds including the European Stabilization Mechanism if it were to join.

However, the process to switch to the euro would take years and by then there is a good chance that the peripheral debt problems will be dealt with. Added to this, Europe’s sovereign debt crisis is mostly concentrated in the credit markets. In contrast the forex markets have been phenomenally resilient post the Greek debt crisis in spring 2010. Indeed the euro has been less volatile than the Swiss franc, which has experienced large moves to the upside while the single currency has been fairly range-bound.

For an export-based economy like Switzerland this is exactly the type of currency stability it needs. Obviously if Switzerland was to ditch its franc and centimes for the euro and the cent then it would cause a major shift in dynamic for the FX markets. The franc is the safe haven of choice right now and is bought with gusto when volatility hits financial markets. In a hypothetical world without the franc, investors would most likely move towards the euro.

The single currency would essentially act like a hybrid deutschmark/franc, an appealing prospect for investors looking for a safe investment. But this throws up a potential spanner in the works for Swiss entry to the euro. One can’t imagine Germany would be too pleased as its export sector is more international and would suffer from an erosion of its competitiveness if the euro was to surge on the back of financial market stress.

Although it is unlikely that Switzerland will join the euro any time soon, there is a persuasive case to be made that it might be in its economic best interest.

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Sounds like the right question at the wrong time. While pegging one’s currency to another may work beautifully in some cases (e.g. Panama’s Balboa to the US Dollar), it carries also major inconveniences. If the financial community does not believe that the set peg is right, it will continuously challenge the central bank to intervene. For Switzerland, in my opinion, only strict exchange controls and punitive taxes on speculative positions could solve the problem that has been haunting our export and tourism industry for the past three years.

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