ECONOMIC MYTH NUMBER TWO
Swiss Francs are the world's strongest currency. Fundamental reality? Swiss francs can be economic death traps!
This myth may bother you considerably if you have piled your mattress money in Swiss francs, hinged your future on Swiss franc annuities or hold wads of Swiss cash. Before you ignore this warning completely, (just as investors ignored recommendations to invest in Hong Kong 20 years ago did), consider these facts:
Fundamentals in a country are what make a currency strong. The fundamentals of America's great economic expansion from 1949 through the 1960's (plus the Bretton Woods Agreement) made the dollar strong then. Switzerland's economic prudence, efficiancy and isolation made the Swiss franc the bastion currency through the 1970's and 1980's.
Now the Swiss fundamentals have changed, because of EMU! The European Monetry Union started when a treaty was signed in Maastricht, The Netherlands , December 1991. This Maastricht Treaty was signed by Spain, Germany, Belgium, Britain, The Netherlands, Luxumbourge, Denmark, Italy and Portugal to create a single, new currency to replace their currencies. Sweden, Finland and Austria planned to join later. All the countries agreed to limit their current deficits to 3% of Gross Domestic Product, to cut government debt to 60% of GDP, plus keep inflation at a low level and maintain agreed interest rate parities.
In 1991 the countries pegged their currencies to not fluctuate more than 2-5%. Investors flocked to soft currencies such as the Swedish kroner and Italian lira because they paid much higher interest rates than German marks, Dutch guilders, etc. Investors said "Now the soft currencies are as good as the hard, why not earn extra interest?"
The problem was few governments kept their promises to lower debt and deficits. The entire agreement blew up! The Swedish kroner and Italian lira were seriously devalued. Millions of investors were ruined.
EMU was such a fiasco that Britain and Italy suspended their currency from the peg. An era of currency turmoil followed in 1993 and 1994 causing interest rates to fluctuate, ecomonies to slow and stock markets to crash. This fluctuation was the root of many economic disasters such as the bankruptcy of Orange County.
The Swiss had stayed out of EMU and the franc rose to its highest level versus the U.S. dollar, yen and German mark ever during this turmoil. This peak, fortified the myth that the Swiss franc was a totally safe currency. As a myth this idea grew more deadly by the hour!
EMU is an incredibly fundamental currency change which will affect the strength of the Swiss franc wether you, I Europe or the Swiss like it or not. The simple economic truth is that governments, no matter how much they wish, cannot wipe out centuries of economic and social development overnight. After the EMU treaty, a German will still be a German, an Italian an italian. Each will still be different in social and economic expectations, work ethics, savings patterns and spendiing habits.
The Masstricht Treaty utterly and totally failed, seriously weakening the EEC. Now the politicians have decided the cure is to have more! Even more countries set a timetable for shifting to one currency, the Euro, in 1999. The beginning of this shift is 1997.
Here's why EMU now will wreak such havoc on the Swiss franc: Many EMU governments (including Italy and Spain) claim to meet the requirments of entry, but don't really. A Financial Times article entitled " EMU, Lies, damned Lies and Statistics" summed this up, pointing out that each country has fudged ecomic figures rather than solve economic issues. Even if EMU governments could meet the treaty guidelines through an all out push, they can't keep up the guidelines over the years. Timing also could not be worse. Europe's economy has been slow. Unemployment is extremely high. Interest rates are at an all time low. Because of this economic crunch, governments have been spending more than usual. At this time, even Germany does not meet the EMU guidelines.
Here is why the Swiss franc can no longer be treated as bastions against all bad currencies. Switzerland has been hit by the slow European economy too. The franc was so strong after 1994's turmoil that Swiss industry had a hard time exporting, especially to Germany. Switzerland is economically in a mess. The economy has not grown for four years. Swiss tourism has been hit hard and Swiss banking has been clobbered by the holocaust investigation and by bad loans throughout Switzerland. This problem has grown to the point that the big three Swiss banks all reported losses in 1996. The unthinkable has happened, one of the big three even had its credit rating lowered!
To weaken the franc and rekindle the economy, the Swiss National Bank lowered interest rates to very low levels. Earnings on Swiss franc savings are below 1%!. Yet the Swiss GDP is still expected to fall in 1997.
Switzerland as a nation does not have adequate land to feed itself. The country has no energy resources at all. This tiny nation must export to earn enough foreign exchange to buy its food and energy. Switzerland must keep the Swiss franc pegged to the German Mark beacuse Germany buys almost half of Switzerland's imports!
Yet EMU almost guarantees the german mark will weaken. being the strongest currency in EMU, the German mark is almost certain to fall as it helps strengthen the rest of Europe's currencies (just as the dollar helped strengthen the yen and mark 20 years ago). If there is currency turmoil in 1997 and the Swiss franc begins to rise in value, expect a negitive interest rate to one again be imposed on the Swiss franc.
Don't get me wrong. The Swiss franc is not necessarily a bad currency. Nor is Switzerland a bad economy. Swiss banks are still incredibly strong. To reinforce this point let me assure you that I still keep much of my wealth in Swiss banks. But certainly not all and especially no longer much of it in Swiss francs.
Do not ignore this reality and fact. 17 years have changed fundamentals which made the swiss franc the number one bastion of safety. These changed fundamentals have turned the strength of Swiss francs from reality to myth. Now the franc is just another currency. Hold it along with others by all means, but realise it too can crash dangerously any time.
