Wednesday, April 8, 2009

Problems of Swiss Economy

It's a little surprising to find myself writing a post about the problems of the Swiss economy. Traditionally, the Swiss economy ran as calmly and soundly as - well a Swiss clock, well oiled by the billions of inflows to private Swiss banks.

However, not only is the international community trying to crackdown on tax havens like Switzerland, but the economy displays signs of real problems.

The main problem in the short term is the impact of deflation. Swiss CPI recorded an annual price falls of 0.4%. This rate of deflation is expected to fall to 1% by mid summer. Unlike the UK where 0% RPI reflects falling mortgage payments, this deflation reflects a fall in general prices. It is every Central Banks worst nightmare. Swiss GDP is forecast to contract by 2.2%, but, the danger is that this decline in output could be exacerbated by the deflation. As mentioned several times, deflation can be one of the most damaging effects on the economy as it discourages spending and investment. If not tackled quickly, the impact of deflation can be difficult to dislodge - as Japan found out.

The response of the Swiss has included attempts to devalue their currency, through intervention on the foreign markets. This involves basically selling Swiss Francs to reduce the value. The hope is that this devaluation reduces deflation because:
  • Exports are cheaper, increasing demand
  • Price of imports rise.
The problem of this approach is that many other countries are looking to devalue their currency too. If the Swiss France depreciates against the Euro. It makes Eurozone exports less competitive and reduces price of many goods in the Eurozone.
Japan has also suffered from the strong Yen and will be looking to weaken the Yen. China is likely to look to depreciate the Chinese Yuan to boost a lagging export sector.

Relying on a weaker Swiss Franc is problematic because:
  • Other countries will also try devaluing their currenciess (this is sometimes known as beggar Thy Neighbour Economic policies)
  • Switzerland has a current account surplus, which tends to increase value of currency.
Switzerland may be forced into more unconventional policy methods which will undermine the status of the Swiss France as a strong currency.

Even Swiss banks got burnt by the subprime crisis. UBS, the Swiss financial giant, has so far been forced to write down about $43 billion.

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