Market speculation is heating up that the US Treasury, in its next semi-annual foreign exchange report, may designate Switzerland as a currency manipulator. Treasury brought back the Swiss onto the monitoring list in its last report in January.
Whether Switzerland manipulates the franc is a question landing repeatedly on my desk. Reaching conclusions about harmful currency practices and manipulation entails judgement. Distinguishing between Switzerland and east Asian nations – often Treasury’s focal point – isn’t straightforward. While I have no insights into whether Treasury will issue a report soon or what it might say, I think Treasury won’t designate the franc and that the balance of evidence supports not doing so.
The standard for designation essentially is that a country manipulates its currency to gain unfair competitive advantage in international trade. For better or worse, this involves an element of intent.
The logic of the Treasury report is that, if a major US trading partner has a large current account surplus and intervenes heavily and builds up reserves, its currency practices merit close scrutiny. Treasury is required by law to look at bilateral balances, even if economists disregard them.
The Swiss National Bank argues special factors push up its massive current account surplus. Regardless, it is enormous. Switzerland’s foreign exchange reserves are very high relative to its economic size and have been rising strongly as a result of heavy intervention earlier this year. The January report put Switzerland’s bilateral surplus with the US at just above the Treasury’s $20bn threshold.
Hence, Switzerland may trigger the Treasury’s three criteria. However, Treasury under the 2015 statute does not automatically have to designate such a country as a manipulator.
There are mitigating factors in Switzerland’s case relating to the capital account and monetary policy.
Switzerland is highly integrated into the global financial system, far more so than east Asian countries. The franc is a ‘safe haven’ currency, frequently facing upward pressure as risk-off sentiment drives surging capital inflows. That happened during the European sovereign debt crisis, and earlier this year. Treasury reports have repeatedly recognised these characteristics of the franc.
The distinction between current and capital account-driven developments might be less meaningful if there was significant, clear evidence of currency undervaluation. Modelling under- and overvaluation provides valuable information, even if valuation cannot be precisely measured. For Switzerland, more so than east Asian nations, valuation estimates range widely. Current account-based estimates, such as those by the Institute for International Finance, point to undervaluation. The International Monetary Fund’s three models point to both undervaluation and large overvaluation; on balance, the IMF has seen the Swiss external position in recent years as in line with medium-term fundamentals and desirable policies. The SNB views the franc as ‘highly valued – a point between overvaluation and ‘fair’ value.
The exchange rate in a small open economy plays a greater role in monetary policy transmission than in a large closed economy. Swiss inflation has been close to zero in past years; Switzerland is now in deflationary territory. Exchange rate appreciation for the franc passes through more strongly into price pressure than it would for the dollar.
The SNB cut its policy rate to minus 0.75% in January 2015. Though this is unproven, economists contend that, if central banks went deeper than this into negative terrain, it might bump up against a cash hoarding constraint. The Swiss allege that, given Switzerland’s small franc-denominated government and corporate debt, the SNB’s ability to buy domestic paper to conduct domestic open market operations is limited. Hence, to undertake quantitative easing, Switzerland argues it needs to resort to foreign exchange intervention purchases.
A crucial test is whether foreign exchange purchases translate into central bank balance sheet expansion. Swiss intervention shows up in an increase in sight deposits on the SNB’s balance sheet. Sight deposits are published weekly and the balance sheet monthly. The intervention does appear to be unsterilised, that is, it is not reabsorbed, for example, by the Swiss authorities selling government paper to the market. Thus, it boosts market liquidity.
Constraints on lower policy rates, surges in safe haven inflows potentially exacerbating deflation, and unsterilised intervention suggest that Swiss foreign exchange intervention is geared more towards monetary than exchange rate policy.
In recent currency discussions with Korea, Vietnam, and China, Treasury pushed for more transparency to address harmful currency practices. Even though markets can largely discern Swiss intervention from weekly sight deposit data, the SNB publishes intervention data only once a year in its annual report. Switzerland is also highly transparent about the currency and investment breakdown of its foreign reserves. Nonetheless, an explicit monthly statement on intervention could further improve transparency.
In its January foreign exchange report, Treasury observed that greater use of Swiss fiscal policy could help unburden monetary policy and support domestic demand. Switzerland has made active use of fiscal policy in the crisis.
Designating the franc amid the crisis could upset global financial stability, which would seem ill-advised. The strengthening euro – up to Chf1.08 in recent days on new optimism about the single currency after the European recovery fund agreement – has eased safe haven pressures on the franc.
On balance, there may be room for Switzerland to allow the franc to appreciate. But the case for designating Switzerland for currency manipulation isn’t convincing.
Mark Sobel is US Chairman of OMFIF.