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Switerzerland’s protectionist move unlikely to pay off

The Swiss government has been under strong pressure from exporters and the tourist industry to prevent the franc from continuing to rise

The Swiss have clearly had enough. After months of watching the franc appreciate remorselessly on the foreign exchanges, the Swiss central bank has announced that it would do whatever was needed to prevent the currency dropping below 1.20 against the euro.

This was a big and decisive move, which has implications beyond the narrow confines of intervention in the financial markets. It is an indication of the stresses and strains in the global economy as it battles to emerge from recession, and it shows an increasing willingness on the part of central banks and finance ministries to insulate their economies from problems elsewhere. Currency intervention is protectionism by the back door.

Anybody who has been to Switzerland recently can understand why this action has been taken. The cost of a cup of coffee, let alone a meal or a hotel room, in Geneva, Zurich and Berne, has become eye-wateringly expensive and the government has been under strong pressure from exporters and the tourist industry to prevent the franc from continuing to rise. Europe’s sovereign debt crisis has been the catalyst for the surge of hot money into Switzerland, which is seen as one of a handful of safe havens at a time of global turbulence.

The over-valuation of the franc threatens Switzerland with recession and deflation: hence the commitment to buy other currencies in “unlimited amounts”. Within 15 minutes, the franc had lost 9% of its value against the euro, a huge move on the foreign exchanges, which tend to operate with much smaller fluctuations.

Despite the short-term success in driving the franc lower, many analysts were sceptical about the chances of the intervention working in the long-term. Phrases like “the last roll of the dice” and “last ditch effort” were being bandied about as the markets mused on whether the Swiss central bank had the ability permanently to stem the speculative flows. Paul Mackel, currency strategiest at HSBC, warned that the precedents were not encouraging: something similar was tried by the Swiss in 1978 but led to a sharp increase in inflation.

It is unlikely that Tuesday’s dramatic action will end in success either. Even if the Swiss authorities manage to cap the franc at 1.20 against the euro, the exchange rate will still be extremely high and that will feed through into lower growth. Unless the crisis in the eurozone is resolved soon, it is also inevitable that speculators will test the resolve of the Swiss central bank to keep intervening. The glacial pace at which Europe operates means that the problems of sovereign debt are likely to get worse before they get better.

Mackel warned that the upward pressure on the franc only started to abate following the 1978 intervention once Paul Volcker, the then chairman of the Federal Reserve, started to get tough with America’s high inflation rate. If they are serious about capping the franc, the Swiss are in for a long haul.

There are three final points worth making. The first is that the disappearance (even if only temporary) of one safe haven means speculative flows into those that remain will be all the greater. Expect gold to test the ,000 an ounce level pretty soon. The second is that the problems faced by the Swiss and the Japanese highlight the logical absurdity of every country seeking to use a cheap currency to export their way back to economic help. For one currency to go down, another has to go up.

Finally, if the world’s two biggest economies — the United States and China — hold down the level of their currencies, either by printing money or by a deliberate policy of under-valuation, other countries will inevitably retaliate. Brazil is using capital controls to halt the rise of the Real. Japan and now Switzerland have intervened unilaterally to stop their currencies intervening. The temptation for others to follow with their own protectionist measures is strong and growing. © Guardian News & Media Limited 2011 | Use of this content is subject to our Terms & Conditions | More Feeds