The continuing role of Switzerland and the Swiss franc in international finance.
Groux, Sebastien ; Jesswein, Kurt
INTRODUCTION
Given the growth in globalization over the past few decades,
international trade has become increasingly important. The use of
foreign currencies is an unavoidable consequence of engaging in
international trade in the highly-globalized and integrated world
economy. For most of the twentieth century and beyond, the U.S. dollar
has been THE leading international currency, both in terms of its role
as the leading foreign reserve currency and its presence in
international transactions.
Other currencies, most notably the British pound, Japanese yen,
Deutsch (German) mark, and Swiss franc have also played significant
roles in the global economy. Since 1999 the Euro has operated as the
common currency within the European Monetary Union, thereby replacing
the Deutschmark and other European currencies. (Seventeen nations have
so far adopted the Euro: Austria, Belgium, Cyprus, Estonia, Finland,
France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, The
Netherlands, Portugal, Slovakia, Slovenia, and Spain, while ten other
members of the European Union--Bulgaria, Czech Republic, Denmark,
Latvia, Lithuania, Hungary, Poland, Romania, Sweden and the United
Kingdom--have chosen not to adopt it).
The Euro has consequently become the second most important currency
in international trade and finance behind the U.S. dollar. Given its
geographical proximity to various members of the European Union (EU) and
economic ties to its neighbors, increased scrutiny has been directed at
the likelihood of Switzerland joining the EU, as well as the possible
future of the Swiss franc, vis-a-vis, the Euro. Switzerland has also
come under a lot of political pressure with respect to its bank secrecy
regulations. Such political affairs could have an impact on
Switzerland's status as a leading economic power and concomitantly
the use of the Swiss franc in global finance.
What follows is an examination of the Swiss economic system and the
Swiss franc. Because the present situation cannot be understood without
reviewing the past, we begin by offering an historic view of the Swiss
economy, looking at major events that impacted the role of the Swiss
economy and the Swiss franc. This includes an examination of factors
that have led the Swiss economy, and more specifically, Swiss banking
and the Swiss franc, becoming so dominant in world affairs. The
conclusion will focus on what can be expected with respect to the future
position of Switzerland and the Swiss franc in global finance.
SWITZERLAND AND THE SWISS FRANC
It is commonly acknowledged that "modern" Switzerland
began in the 1840s with the acceptance and implementation of a new
constitution. This constitution gave the country a more centralized
administration, transforming the formerly independent canton regions
into a single economic area. Important aspects of the constitution
included the creation of a strong, unified banking system and the
adoption of a common currency, the Swiss franc, for all of the Swiss
cantons. The economy encountered some early difficulties, but overall
Switzerland has flourished under the new constitution.
It did suffer through some unflattering times during and between
the two World Wars. Switzerland did not take an active part in either of
the wars, but some argue that Germany could have invaded Switzerland
relatively easily and did not invade because it proved to be very useful
as an independent state. For example, the Swiss National Bank bought
gold from the German Reichsbank, with Germany then using the Swiss
francs received in return as payment to buy raw materials from other
countries that would not accept its gold. Swiss banks were also very
heavily involved in providing financing to various German enterprises,
as documented in the Bergier Report (Independent Commission of Experts
Switzerland).
After the Second World War, the Swiss remained neutral but began to
join international bodies such as the European Free Trade Association
and the Council of Europe. Indeed, with Switzerland having limited
natural resources and being landlocked, it depended heavily on foreign
trade. However, Switzerland stayed out of the European Union to maintain
its independence and strived to facilitate trade with its international
partners. The Swiss government continues to maintain that its interests
can be guaranteed without joining the European Union due to the various
bilateral agreements it has with its neighbors, along with the benefits
of operating under the Free Trade Agreement of 1972 (State Secretariat
for Economic Affairs).
THE SWISS FRANC: TRADING, RESERVE, OR INVESTMENT CURRENCY?
The Swiss franc (internationally recognized as the CHF, from the
Latin Confoederatio Helvetica franc) has been and continues to be a
major international currency. But to what does the term "major
international currency" refer? Indeed, one can look at currencies
from at least three perspectives. First, one can examine the volume with
which individual currencies are traded in the global markets. Only seven
currencies, the U.S. dollar, Euro, Japanese yen, British pound,
Australian dollar, Swiss franc, and Canadian dollar, make up the bulk
(87.6 percent) of foreign exchange trading worldwide. The list is
dominated by the U.S. dollar and the Euro, which make up approximately
sixty percent of all foreign exchange trading. Currently the Swiss franc
is currently the sixth most highly traded currency in the world,
accounting for around 6.4 percent of daily transactions (Bank for
International Settlements).
Second, one can look at the amount of currency held as bank
reserves by foreign banks. For this perspective the Swiss franc is
clearly not among the most widely held foreign reserve currencies.
According to current statistics the Swiss franc comprises less than 0.1
percent of the total official foreign exchange reserves (International
Monetary Fund). Nonetheless, given its historical importance, it is
interesting to note that despite its relative lack of use, the IMF
continues to list the Swiss franc within its statistical summary of
international reserve currencies.
And third, one can focus on the amount of money invested in
accounts labeled in a specific currency such as the size and scope of
investments made by non-Swiss entities in Swiss securities accounts. It
probably goes without saying that Switzerland is best known as a haven
for foreign investment. However, investing in a country does not always
mean investing in that country's currency so one usually refers to
"assets under management" when examining the issue of
investments managed within specific countries. The total volume of
cross-border private banking at the end of 2009 was $7,400 billion with
Switzerland being the global leader with approximately $2,000 billion
under management, or 27 percent of the market. In comparison, the
rapidly growing financial centers of Singapore and Hong Kong have only a
9% share ($700 billion) between them (Swiss Bankers Association).
Although not all of the assets managed by Swiss banks are held in Swiss
francs, the existence of vast holdings within the Swiss banking market
indicates the important role that Switzerland maintains in global
finance.
THE CONTINUING IMPORTANCE OF SWITZERLAND AND THE SWISS FRANC
The importance of Switzerland and the Swiss franc can be attributed
to various factors. First and foremost, Switzerland offers a strong and
stable economy. The Swiss have managed to foster steady economic growth
while consistently maintaining low rates of inflation. Indeed, the
stable Swiss economy is a key factor explaining why investors look to
invest in Swiss francs. Even with the introduction of the Euro, the
Swiss franc has lost little of its influence, thanks largely to its
approach to monetary policy (Fischer). Furthermore, it has been noted
that the volatility of the Swiss franc remains little changed since the
introduction of the Euro, and in fact, the Euro appears to have had a
stabilizing effect on the Swiss franc (Reynard).
A second factor helping the Swiss franc maintain its importance is
the presence of many large and globally-diversified companies domiciled
in Switzerland. Looking at the number of corporations headquartered in
Switzerland and knowing that one-third of Swiss GDP comes from the
activities of multinational corporations, one can see why Switzerland
and the Swiss franc continue to play major roles in the global economy
(Swiss American Chamber of Commerce).
The important role that commerce plays can be explained from
several perspectives. First, Switzerland's business-friendly legal
and fiscal environment is commonly cited by many international firms as
factors in moving their world or regional headquarters to Switzerland.
The Swiss-American Chamber of Commerce reports that remaining
competitive on the tax front is among the key steps necessary to ensure
that multinationals move to and then stay in Switzerland. Second, the
stability of the Swiss economy and of the Swiss franc is attractive to
multinational corporations looking at investment locations. Third,
Switzerland has geographical benefits as it is centrally situated within
the European Union area and has easy access to the major European
markets. Furthermore, the Swiss proclivity toward maintaining high
standards results in it being a very good test market for businesses
hoping to introduce products in Europe (Parsons). Using Switzerland as a
base for operations often leads companies to rely on the Swiss franc as
a trading currency. This use of the Swiss franc is bolstered by Swiss
accounting standards that are specially adapted to facilitate the
currency translation process.
Switzerland is well known as a location that attracts wealthy
investors from around the world. This can be explained by various
aspects of the Swiss constitution that appeal to rich investors (Federal
Department of Finance). For example, bank secrecy is a policy under
which the identity and amount of money invested by people in Swiss
financial institutions are kept private. Likewise, there are specific
Swiss cantons that are known to target wealthy investors. These cantons
offer tax breaks specifically designed to benefit the wealthiest from
around the world (Kirchgassner). The number of wealthy individuals who
have emigrated to Switzerland over the years is a testament to their
success.
Furthermore, Switzerland has a state-of-the art banking
infrastructure. It is likely that Swiss banking know-how, together with
its technological expertise, are leading criteria for global investors
looking to transfer money. Investors trust the Swiss banking system as
one of the safest places to invest money. It is impossible to know to
what extent the quality of the Swiss bank infrastructure accounts for
Switzerland's success in banking. But Switzerland has always been
known for its use of the most modern facilities and technologies and has
always been able to anticipate market demands in terms of financial
products and technologies.
The stature of private banking within the Swiss economy has been
well summarized in comments attributed to Swiss private banker Hans J.
Baer who declared that private banking is the full range of services
that a client may wish to obtain and this therefore extends way beyond
wealth management. Swiss private banking starts at the three
international airports at Zurich, Geneva and Basel and continues via the
railway stations and luxury hotels of our country right up to the doors
of Spriingli's cake shop. Swiss private banking encompasses our
hospitals, cultural institutions, media, lawyers, shops, schools,
universities and, of course, our banks and asset managers (Geiger &
Hurzeler).
FUTURE ROLE OF SWITZERLAND AND THE SWISS FRANC
What will become of Switzerland and the Swiss franc? This is a
complex issue that can be examined from many perspectives. We have noted
that Switzerland offers a complex mix of factors than explain why
investors have historically looked there for investment purposes.
However, in the near term, the current financial crisis has likely had
and will likely continue to have a negative impact on the Swiss banking
system. This may reduce the prominence of Switzerland and the Swiss
franc in the global marketplace. We find that since 2007 there has been
a significant outflow of funds from Switzerland. As seen in Exhibit 1,
foreign investments in Swiss securities accounts have declined by almost
40 percent since the peak in 2007 (a loss of some $460 billion) while
domestic investments are down only around 25 percent (a loss of $145
billion).
[GRAPHIC 1 OMITTED]
Similarly, Swiss economic policies have come under fire, most
notably from the U.S. but also from some of its European neighbors. The
main target has been UBS (the Union Bank of Switzerland), probably the
largest manager of private wealth assets in the world. For example, the
U.S. Treasury department has recently negotiated the transfer of names
of many American customers who allegedly had illegal investments in UBS
bank accounts. The crucial importance of bank secrecy is therefore being
pierced with unknown consequences for the future role of Swiss banks
managing the financial affairs of foreign investors.
The long-term fortunes of Switzerland likely revolve around whether
or not Switzerland would be willing to join the European Union and the
ability of the Swiss franc to remain independent of the Euro. We have
shown that Switzerland offers unique advantages in promoting itself as a
financial center, advantages that can only be maintained if it remains
neutral and stays outside of the EU. Indeed, joining the EU would force
the Swiss to abide by its requirements. Even if, as with the British,
Switzerland joined the EU without joining the currency union, a variety
of costly adjustments might endanger the role Switzerland plays as a
leading economy and the role of the Swiss franc as a major international
currency.
But what is the likelihood of Switzerland to join the Euro? Joining
the euro would likely benefit the Swiss economy in two key areas: lower
transactions costs from not having to exchange currencies and less
uncertainty in valuing transactions, as the majority of business
activities would be denominated in Euros. However, adopting the Euro
would cause Switzerland to lose a significant amount of seigniorage that
it currently exploits due to some of the boutique value placed on Swiss
francs. Investors may not be as willing to look at Switzerland if some
of the unique benefits of the Swiss franc and Swiss banking system are
negated by a move to the Euro.
SUMMARY AND CONCLUSION
This paper highlights the importance of Switzerland in
international trade and finance. The Swiss franc is among the most
widely traded currencies and has a very distinct role in international
money management. Four explanations for the level of importance placed
on Switzerland were given. First, investors trust the stability of the
Swiss economy and the Swiss franc. Second, Switzerland attracts many
multinationals due to its competitiveness on the tax front and its
facilitated access to nearby European countries, which has an impact on
the commercial utilization of the Swiss franc. Third, wealthy
individuals look at Swiss banks because of their famous bank secrecy
laws as well as the special tax benefits offered by specific cantons.
Fourth, the quality of the Swiss banking infrastructure has a positive
impact on the overall level of trust in the banking system.
The continued role of Switzerland and the Swiss franc has been
questioned due to the current financial crisis that has damaged some of
the reputation of the Swiss banking system. Even as the Swiss franc
continues to be heavily traded in the global foreign exchange markets,
we observe massive capital outflows from Switzerland, particularly from
foreign private investors. Although still viewed as one of the safest
financial markets in the world, it does not exist in isolation and is
not sheltered from global contagions, which may have caused Switzerland
to lose some of its stellar reputation. It is difficult to say if this
drop in confidence in the Swiss financial markets will last long term,
but if it would, the survival of Switzerland as a major, independent
player in the global financial markets will be in jeopardy.
If this happens, Switzerland might need to consider joining the EU.
If it would join, even without adopting the Euro as its currency,
Switzerland will likely suffer from losing some of its comparative
advantages in making itself relevant in the global marketplace. The
Swiss banking system and the Swiss franc might therefore become nothing
more than components necessary for maintaining well-diversified
international portfolios rather than as significant players attractive
to corporate and private investors alike.
The Swiss banking market is fully aware of the challenges it faces.
In a recent study, Swiss bankers overwhelmingly acknowledged the need to
become more tax and regulatory transparent (KPMG). While some resent the
imposition of outside regulatory pressures that can put pressures on
their profitability, the majority appear to be willing to let their
historical competitiveness in providing financial solutions to global
customers adjust to the new realities; they look forward to adapting
their business strategies to thrive in the new global financial
marketplace.
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Sebastien Groux, Sam Houston State University
Kurt Jesswein, Sam Houston State University