Over the past 3 years, the world of currency exchange has witnessed an exponential increase in the rate of Swiss Francs vis a vis any other currency, whether it be Euro or Dollar. Switzerland is a part of Schengen area but is not signatory to Euro-zone. As a result, after the creation of Euro, CHF has always been pegged against Euro. The exchange rate between Euro and CHF was initially 0.67 Euro per CHF. But this rate was disturbed subsequent to the recession of 2008 in US. Since then, this rate has been continuously rising and the current situation is that with 1 CHF you can obtain 0.92 Euro as on 5th August, 2011 in Switzerland. This significant rise of over 35 % for CHF means that the currency of Switzerland has become very strong in Europe. Naturally, several question arises, what is the cause for such an imbalance ? Is the strength in currency driven by economic progress ? Is this increase in ratio creating any stress in Swiss economy ?
To answer any of the above questions, we have to first accept that this is an imbalance because the rise in the currency has far outpaced the growth of the economy of Switzerland. This is an artificial situation which is called “bubble” in the vocabulary of Economics. An economic bubble occurs whenever a commodity is traded at a much higher “price” than its intrinsic “value”. This could be understood in very simple terms of demand and supply. Whenever the demand for any commodity increases in the market and the supply is fixed, its value increases. If the supply rises, and demand is reduced, the value of the commodity falls. This is a universal concept and it extends to any commodity that is being traded in the market. This is the reason for high price of limited goods such as gold and other precious metals. Now, coming back to currency trade with CHF in focus, presently there is great demand for CHF, and hence this demand is driving the rise of CHF with respect to other currencies. However, we need to understand how this particular demand for CHF arose and not other currencies.
In 2008, the world saw a global slowdown in economical terms, which we popularly call as recession. This happened because the largest economy, i.e., United States of America suffered from property crises. The crises dented the status of US Dollar which exposed its weakness during the rough times. The world started to search for alternative reserve currency in case Dollar falls. Although, the switch from Dollar to any other currency is not simple and straight, but the interest of the investors have grown considerably in other currencies. Presently, apart from US Dollar the other major reserve currencies are Euro, Pound, Japanese Yen and Swiss Francs. However, the global slowdown affected all these economies except the Swiss. Switzerland remained largely unaffected in the periods of crises which demonstrated its robust economy to the world. Switzerland emerged as a stable platform where investors could safely park their investments without much worries of losing it. Hence, there has been a constant buyout of CHF after 2008 which can be easily seen from the transaction chart of EUR/CHF given below.
|Graph Showing exchange rate of EUR/CHF over past 3 years (Click the graph to see the clear picture).|
Switzerland is currently in a very difficult economic situation with respect to its currency. Although CHF is strong, but it is becoming increasingly difficult for Switzerland to trade with other economies. Switzerland is primarily an export oriented economy with 50% of its GDP dependent on exports. Import is becoming cheaper while exports are falling. This has a very serious consequence on internal economy as the local producers are now facing the wrath of cheaper good that could be imported from euro-zone. The tourism industry is equally at its bottom as tourist have changed their preferred destination. The largest bank UBS has recently published its recommendation for Swiss investors to divest their assets in CHF into Euro or other currencies to free some CHF for the market's rising demand [read here]. The situation is critical and it is expected that Swiss National Bank would intervene to dissipate some heat. But is the Swiss economy ready to see an inflow of CHF from the bank which can have serious consequences at a later stage when the same CHF would return in the market leading to inflation ? Switzerland doesn't seem to be interested in printed more CHF as US is doing with Dollar. Indeed, it cannot afford to do the same as the scale of economy is incomparable to US. It is catch-22 situation. Time will tell how this story unfolds in the coming weeks.