The Strength Of The Swiss Franc

| About: CurrencyShares Swiss (FXF)
This article is now exclusive for PRO subscribers.

Switzerland currently has one of the strongest currencies in the world, the swiss franc. The swiss franc has appreciated significantly as investors continue to seek a safe haven to hedge against the instability surrounding the European sovereign debt crisis. However, this appreciation is potentially damaging to the Swiss economy. The increasing strength of the Swiss franc does not bode well for the competitiveness of Swiss exports, which in turn become more expensive and thus less competitive in the global marketplace. The Swiss economy is very export-driven and Switzerland has maintained a very positive balance of payments, so the Swiss National Bank is actively seeking to keep the Swiss franc undervalued.

The strength of the Swiss franc is also similar to the strength of the Japanese yen from late 2011 to early 2012. Just like the Swiss franc, the Japanese yen has been considered a safe haven for investors due to global economic uncertainty. Moreover, Japan is also an extremely export-driven economy, just like Switzerland, and as a result the Bank of Japan has intervened multiple times to attempt to deflate its currency. However, the yen has continued to remain strong: the yen appreciated 5.6 percent against the dollar since mid-March. The Swiss National Bank, perhaps taking note of the ineffectiveness of the Bank of Japan's repeated interventions, has taken a much tougher stance against the strength of its currency.

The resulting capital inflow into Switzerland led Switzerland to impose a floor of 1.20 francs to the euro in September. However, as Spain's banking crisis worsens and Greece teeters on the verge of a Eurozone exit, the Swiss National Bank's ability to maintain the floor is being increasingly tested. Switzerland's foreign currency reserves have increased significantly as the Swiss National Bank tries to maintain the floor: the value of its reserves increased 28% from 237.6B in April to 303.8B Swiss francs worth of foreign currency in May. The Swiss National Bank is prepared to use every weapon in its arsenal to defend the floor, and SNB Chairman Thomas Jordan has even suggested the possibility of using capital controls in the event of a potential euro breakup.

The policies the Swiss National Bank has taken and are currently considering have in turn led critics to label Switzerland as the new China, a nod to China's policies of artificially devaluating its currency until recently. The price floor is a blatant example of Swiss currency manipulation, and if the Swiss National Bank institutes capital controls, there may be significant backlash among the international community. This is because capital controls take currency manipulation to another level. Such options include residency-based capital controls, in which the Swiss government would implement a tax on all foreign-held Swiss franc assets/deposits and even prohibit outright purchases of Swiss francs by foreigners. Instead of passively increasing foreign currency reserves, the utilization of capital controls would lead the Swiss National Bank to actively intervene in the trade and purchase of Swiss francs by foreigners. However, implementation of capital controls by the Swiss National Bank, as of now, is still a remote possibility.

It remains to be seen if the Swiss National Bank ultimately succeeds in keeping the floor, an issue which has divided analysts. Paul Meggyesi, a currency strategist at JPMorgan Chase , is confident the floor will be broken, stating that "We are more comfortable in predicting the ultimate demise of the floor…than in calling the timing of such a shift." On the other hand, George Saravelos of Deutsche Bank, believes that the floor will remain intact, noting that "the SNB has unlimited firepower to defend the floor." Either way, it will be interesting to see how the Swiss National Bank responds to future developments in the Eurozone crisis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.