Did the US just declare war on Switzerland - and lose?
Economic Analysis by Sandro Joseph Azzam, Staff Writer
December 29th, 2020
On December 16th 2020, the US Department of Treasury labelled Switzerland with the unenviable title of “Currency Manipulator.” Washington said that the Swiss National Bank (SNB) was holding the franc lower to prevent effective balance of payment adjustment. Let’s delve deeper into what this means and how Thomas J. Jordan landed the coup de grace to Mnuchin’s stateside team.
For the US to label a country “currency manipulator”, 3 criteria need to be satisfied. First, the country needs to be running a large trade surplus with the US ($20bn+). Second, a country needs to be running a large current account (more than 2% of its GDP) and finally, it needs to be heavily intervening in foreign-exchange markets to artificially weaken the currency. Let’s explain each of those criteria.
What does a trade surplus mean? Switzerland runs a trade surplus with the US when it exports more than it imports. Think of it this way – The Swiss are selling more Patek Phillip watches to Americans who in turn aren’t selling enough Ford cars to Switzerland. What’s the consequence? Swiss watchmakers are being put to work whereas American assembly lines are stalling. Think of a country’s GDP, that is, the final value of all goods and services produced in any given nation. Switzerland’s GDP comprises 2 elements – local consumption and foreign consumption. When foreign consumption increases, GDP increases as well leading to economic growth and prosperity. When foreign consumption decreases, GDP shrinks and it’s generally seen as a negative sign for the national economy. Now back to the US and Switzerland’s bilateral trade. The surplus in trade that Switzerland ran with the US over 4 quarters through June 2020 was north of 49 billion dollars. To put it simply, Switzerland “robbed” the US of 49 billion dollars worth of economic output. Why?
Let’s simplify and assume that one Swiss Rolex watch costs $20.000 and one Ford car costs the same $20.000. Let’s also assume that demand for Rolexes and Ford cars is the same and that these are the only goods that the countries produce. What does a 49-billion-dollar trade surplus mean? Switzerland exported 49 billion dollars-worth of Rolexes more than it imported Ford cars, meaning Switzerland exported 2.45 million more Rolexes than it imported cars. To look at it from an American perspective, the way they’d see it is that Ford missed out on selling 2.45 million vehicles. You can see why this would anger the folks over at the Department of Treasury…
Moving onto our second point: a country needs to be running a large current account. For the sake of simplicity, let’s assume that a country’s current account amounts to the difference between how much it imports from the entire world and how much it exports to the entire world. We can think of Switzerland’s current account as the sum of its trade surplus with the US, France, Italy, Tuvalu, Australia, Singapore, Cambodia, Luxembourg, St. Kitts and Nevis – you get the gist of it. Remember that an individual trade surplus can be negative! Switzerland imports more Volkswagen cars from Germany than it exports Rolexes, thus, on a macro level, individual elements in a country’s current account tend to cancel each other out. The US Department of Treasury begins to sound the alarms when a country runs a current account surplus above 2% of its GDP. If Switzerland’s GDP is $700 billion, the US Treasury criteria is that the Swiss current account remain below 14 billion, meaning that it exports $14 billion more worth of goods to the rest of the world than it imports. Why does this matter to the US? Well, for the same reason we stated above. When foreign consumption increases (meaning a country runs a positive current account), GDP increases as well – leading to economic growth and prosperity. For years Switzerland has been running surpluses of over 10% of their GDP and the US saw this as an unfair advantage.
Last but not least, a country needs to heavily intervene in foreign-exchange markets to weaken their currency. What does this mean? Let’s simplify everything and go back to basics and back to the beautiful, wonderful and dysfunctional Lebanese economy. The lira depreciates when dollars leave the country because it’s harder to find the greenback. The solution? Well, the central bank can intervene in the market to inject more dollar liquidity to provide the dollars that the market is looking for. This leads to a reversal of the depreciation because supply of dollars now meets demand for dollars. Now let’s move from the Switzerland of the Middle East to the original version. When the COVID-19 pandemic hit, investors feared the worst. They moved their money out of Dollar-denominated deposits into Swiss Franc denominated deposits. This is a common sighting in financial markets – the Swiss Franc is seen as the “Safe haven” of currencies in times of uncertainty. Think of it this way – everyone is looking for Swiss Francs now. Demand for Swiss Francs is very high and supply for it is constant. What happens to its price (aka its exchange rate)? It goes up leading to an appreciation of the currency. To put it simply, Swiss Francs are now worth more. This is a problem for Switzerland if left unregulated.
When a currency is worth more, the purchasing power of Swiss residents increases. Think of it this way – if you had cash dollars in Lebanon, your purchasing power is much larger now than it used to be. The situation in Switzerland is the exact opposite – to draw an analogy, too many people have “Fresh dollars” (read: Swiss Francs) meaning their purchasing power is very high. Foreign goods become less expensive to Swiss residents and the consequence of lower prices is negative inflation – deflation – which can trigger a vicious cycle of economic contraction lasting years. Deflation is just as bad as high inflation. This is why the Swiss National Bank targets its level of inflation and tries to keep it constant between 0% and 2%. The increased value of the Swiss Franc creates complications for this inflation target and essentially works antagonistically. With Swiss policymakers struggling to keep inflation above 0% pre-pandemic, the appreciation of the Franc has just made their job much more difficult. How do they fix the problem? They intervene on the open market and devalue their own currency. The consequence of a devaluation is an increase in price level and in turn, inflation (just compare 2018 supermarket prices in Lebanon to 2020 and you’ll see how powerful of a tool this is).
When a country purposefully devalues its own currency, the international economy is thrown out of balance as discussed in previous articles here. Devaluing our own currency gives you an unfair advantage. Now that importing goods from your country becomes cheaper, you export more to the world thereby increasing your level of economic output and in turn GDP. With Washington accusing the Swiss National Bank of “artificially holding the franc lower to prevent effective balance of payment adjustment”, what they meant was that if Switzerland let the Franc appreciate, it would become more expensive for Americans to buy Rolex watches (for which prices are set in Francs). This in turn would reduce demand for Rolex watches and reduce Switzerland’s output. Reduced Swiss GDP leads to a rebalancing of the value of the Swiss Franc allowing it to depreciate naturally only after leaving the Swiss economy with the consequences of an overvalued currency. The Trump administration claimed that “The Treasury Department has taken a strong step today to safeguard economic growth and opportunity for American workers and businesses” adding that they will follow up on the matter “to work toward eliminating practices that create unfair advantages for foreign competitors.”
Mnuchin and his team want to make sure that the rebalancing process occurs naturally, over a long time horizon whereas Jordan’s team at the SNB want to reduce the damage being dealt to their economy and the massive potential long-term effects that deflation would have on Switzerland.
Calling another country a currency manipulator is no joke – the only other country the US has labeled as a currency manipulator since the early 90s is China with which they’re engaging in a trade war. The SNB rejected the label stating that it “denied any form of currency manipulation” and that it would “continue to intervene more strongly in the foreign exchange market,” hinting at their commitment to keeping the Franc on a tight leash. They added that “Foreign exchange market interventions are necessary in Switzerland’s monetary policy to ensure appropriate monetary conditions and therefore price stability.” As a consequence of Jordan’s firm stance, trading activity on the Swiss Franc remained unchanged following Mnuchin’s remarks.
https://www.ft.com/content/9bcd4d84-fdec-4f03-9560-dc58f2721899
https://www.bbc.com/news/business-55337323
https://search.treasury.gov/search?affiliate=treas&query=currency%20report
https://home.treasury.gov/news/press-releases/sm1212
https://home.treasury.gov/system/files/206/December-2020-FX-Report-FINAL.pdf
https://wits.worldbank.org/CountryProfile/en/Country/CHE/Year/LTST/TradeFlow/EXPIMP