The Value of the Swiss Franc Increases Suddenly: Making Sense of the
By Aaron Recksiek, CW21
On January 15, the Swiss National Bank (SNB) ended its policy of trying to maintain a cap on the value of its currency compared to the euro. The policy was put in place in 2011, the last time the franc was considered “overvalued,” in an effort to reduce the country’s currency deflation and to promote growth of its industry. With exports making up more than two-thirds of the Swiss gross domestic product (GDP), a lower-valued Swiss franc translates to a healthier export market and, overall, to a healthier Swiss economy.
To maintain the cap, the Swiss National Bank would purchase the amount of foreign currency, mainly euros, it needed to stay undervalued. The more Swiss francs that were exchanged for foreign currencies, the weaker the franc would be. If the SNB needed to purchase more currency, all it needed to do was print more of its own Swiss francs. By the end of 2014 the SNB had amassed foreign currency holdings worth over 500 billion francs—more than twice the amount it had in 2011.
The main problem with investing in foreign currency is that the value of holdings is subject to unpredictable fluctuations in the market. The European Central Bank (ECB), which is in charge of administering monetary policy for the eurozone, was working on a solution to counteract much of Europe’s currency devaluation. The plan was to help improve their ever-weakening euro currency and provide stimulus to the stagnant European economies that have still failed to rebound from the worldwide financial crisis of 2008, by purchasing over a trillion euros worth of government bonds. This would have essentially required the Swiss National Bank to double down on its efforts to purchase euros to continue its currency devaluation, which would amass them a stockpile of European currency of such grand proportions likely never seen before. Many saw this as an unsustainable practice that would expose the historically conservative SNB to an extremely large risk: holding so much foreign currency—the value of which would be mostly out of its control.
Another issue is the growing reserves of deposits held by lenders at the SNB. This only added to the strain of holding down the value of the franc. As the size of the deposits grew, so did the value of the Swiss franc. In December 2015, the SNB announced a plan to charge a negative interest rate of .25% on deposits of over 10 million francs, in an effort to reduce the amount of deposits. After the announcement to end the cap, the SNB official interest rate was lowered even further to a unprecedented -.75%. The Swiss franc has long been an attractive currency to invest in because of its historical stability. As the economic uncertainty in Russia and other European countries mounted, the investment in the Swiss franc had become excessive as of late.
The rationale behind the decision of the Swiss National Bank to abandon the effort to cap its currency and essentially lose vast amounts of money based on the size of its foreign currency holdings has not been completely explained. It is believed by most that continuing to purchase foreign currency that had already grown to about 75% of its GDP would have grown a reserve too large, and the faith that the euro would do anything but decrease in value even further prompted the bank to cut its losses early and avoid the risk of losing even more in the future. The SNB also feared that its credibility would be hurt more by holding a greater amount of liabilities than assets and becoming insolvent than it would by going back on a promise it had made to buy “an unlimited amount” of foreign currency.
So far the SNB stands by its decision to remove the cap. Jean-Pierre Danthine, vice-chairman of the SNB, was quoted as saying, “The risks of the policy to the economy had begun to outweigh the benefits.” He claims that the Swiss franc is no longer overvalued, and foreign markets will need time to adjust to the new flexible exchange rate. He also said the SNB is not going to completely abandon intervening in the foreign exchange market. They are reevaluating their strategy and have yet to announce their new plans.
Obviously, this decision has consequences that will echo in all areas of the Swiss economy. In one day, the value of the Swiss franc jumped by 20%, and the value of the Swiss Stock Market (SMI) decreased by nearly 15%. Swiss watch brands’ stock value that traded on markets outside of Switzerland also fell on average 10–15%. The deflation within Switzerland, which had already dropped to -.25%, is expected to continue to deepen. Deflation is worrisome to modern economies because it increases the real value of debt and can lead to or aggravate an economic recession.
What this means to the watch industry is immediately apparent to everyone involved. Swiss exports immediately became at least 20% more expensive, and the cost will either need to be absorbed by the margins of the Swiss companies or passed on to the consumer. The Swiss watch industry, which was already showing stagnant growth over that last couple of years, will inevitably show negative growth for the immediate future, something that has only happened once since the resurgence of Swiss watches in the early 2000s. Swiss-made parts and tools for watches will now be more expensive, putting strain on after-sales service and on watchmakers. The news of the cap removal came just days before the annual SIHH watch convention in Geneva, where several executives of Swiss watch brands were quoted as not knowing the exact repercussions the new exchange rate would have on the prices that were already predetermined in Swiss francs and euros. Many dealers reduced their orders or cancelled them completely. The most notable quote to come from a Swiss watch executive was Swatch Group’s CEO Nick Hayek, who said, “Today’s SNB action is a tsunami; for the export industry and for tourism, and finally for the entire country.”
The fine-watch industry has become more reliant on the Swiss for tools, parts, movements, and complete watches. The silver lining is that now the cost of manufacturing and innovating outside of Switzerland has become more appealing than ever. It may now be cheaper and more stable to invest money in the growing industry in Germany, where certain brands have been investing in all facets of watch-parts manufacturing, and in the United States where the long-dormant industry has finally started to show signs of resurgence under a few pioneering brands that have vowed to lead the charge to restore American watch manufacturing back to the glory of the 1940s.