The Secret of the Swiss Miracle

As Europe prepares for a summer of discontent, the Swiss growth engine seems even more resilient than before as to embraces the European Union, without embracing the euro.

At the recent European Pensions and Investment Summit, a slate of fund managers expressed their growing concerns about adequate yields. Weeks before the UK’s Brexit referendum, asset managers around the world scrambled to raise cash levels in their portfolios, while employing defensive trades to cope with what is now widely called a “summer of shocks.”

And yet, in Switzerland, Europe’s worries seem more distant. Nevertheless, the small country is amid a huge transformation – the most critical one since the postwar era.

With some 8.4 million inhabitants, the Swiss population accounts for 0.11 percent of the world total. And yet, the Swiss economy is the world’s 20th largest and the Swiss franc the fifth most widely used currency in international loans. These simple facts mock monetarist assumptions about the implications of a nation’s money supply and inflation. In fact, it shows how peace and stability can boost prosperity. Switzerland has not been in a state a war since 1815.

As a historical financial center, Switzerland is about to begin a new life. Total financial assets represent nearly five times the GDP, stemming mainly from the two largest Swiss banks, UBS and Credit Suisse. In the past, the small, neutral country was seen as a sort of pre-Panama tax haven. But those days are fading. In July, Switzerland implemented a new law that would assist authorities in seizing and repatriating illicit assets parked in its banks by foreign dictators. The move is the latest in a mass clean-up that has accelerated as the Swiss wealth-management industry seeks to shake its image as a financial haven.

A great deal of public attention has focused on three ordinances that led to the seizure of assets belonging to former Egyptian president Hosni Mubarak ($540 million), former Tunisian president Ben Ali of Tunisia ($61 million), and former Ukrainian president Viktor Yanukovych ($70 million). Recently, Swiss authorities also opened a criminal investigation into the Swiss private bank BSI for failing to prevent suspected money laundering and stem bribery relating to its dealings with Malaysia’s state investment fund.

In addition to tightening its money-laundering laws, Switzerland also now requires financial institutions to enforce “know your customer” rules, which include “politically exposed persons,” including government leaders, ministers, and military. Since 2000, the law has helped identify nearly $1.9 billion worth of assets, more than any other major financial center has managed to do.

After the global financial crisis in 2008-2009 and the European debt crisis in 2010, the Swiss National Bank (SNB) instituted its floor of 1.20 francs per euro. The franc did not face much pressure through 2013-14. However, as anticipation grew over the European Central Bank’s (ECB) anticipated quantitative easing (QE) increased, the SNB cut the interest in December 2014 from zero to -0.25 percent. Yet, the Swiss central bank had to resort to significant interventions to maintain the exchange rate floor. As the dollar began to rise in anticipation of rate hikes, the franc depreciated. To avoid speculation, the SNB exited from the floor in January 2015 and announced a cut in its effective rate to -0.75%.

However, keeping the franc at 1.20 to the euro was at that point increasingly expensive. As the SNB sold its own currency and bought up euros, U.S. and Canadian dollars, and yen, the ECB’s QE rounds were expected to cause the depreciation of the euro – and the franc – against the U.S. dollar.

The return to a floating exchange rate regime ensured greater flexibility, while repressing speculative flows. But the SNB took a sharp short-term hit in the first quarter of 2015, with a net valuation loss of 30 billion francs (or 4.6% of the GDP) on the back of sharp currency appreciation.

Today, Swiss central bank chairman Thomas Jordan is preparing SNB for a time of volatility. Last spring he warned that there were limits to how loose monetary policy could be. As the probability of Brexit increased, Jordan warned of turbulence and put the SNB on alert. After the Brexiteers’ triumph, the central bank and franc is faced with a defining moment.

Notwithstanding, Switzerland remains one of the world’s wealthiest, most competitive, and expensive economies. The Swiss GDP per capita is close to $59,000, as measured by international dollars.

While the United States and many European countries have lamented the “China prices” cause outsourcing and offshoring, manufacturing remains the most important economic sector in Switzerland. Yet, the Swiss manufacturing giants do not attempt to compete in low-price production. Rather, they excel in high-skill, high-value niche industries, particularly in specialist chemicals, health and pharmaceuticals, and scientific and precision technologies.

Across Europe, most economies are struggling with structural reforms because of antiquated labor arrangements. And just as many European economies, Switzerland suffers from an aging population and lacks immigrant labor. Unlike many, however, it has absorbed a relatively large numbers of immigrants from Africa, Eastern Europe, and the Middle East. Today, almost 25 percent of the Swiss population is a non-Swiss. In financial and business centers, such as Zurich, about 40 percent of the inhabitants have a foreign background. This effectively offsets some of Switzerland’s labor needs.

The influx of immigrants is not without cultural tensions, however. In 2009, Swiss voters banned the construction of minarets and last year one canton made the wearing of a burqa in public punishable by a $10,000 fine. But in the end, pragmatic realism prevails in Switzerland. Though the February 2014 referendum sought to limit immigration, recent polls suggest that most Swiss residents believe the requirements of EU integration are more important than the restriction of immigrant flows.

In Switzerland, European turmoil seems further away – not because the country does not suffer from mounting challenges, but because the Swiss are coping with them in a vastly different way.

Dr. Dan Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see