Stolid Switzerland’s Different Path

Both the United States and Switzerland are pulling out of the post-2008 global economic slump on the wave of speculative bubbles. But while Washington is stoking its bubble in the hope of achieving faster economic growth, the Swiss are working to prevent their bubble from getting out of hand.

It is by now evident that the economies of rich industrial nations grow in a boom and bust cycle that was previously a prerogative mainly of emerging economies. In the U.S., the bust after the dot-com-driven economic upswing was followed by a boom in housing. When that, too, came a-cropper in 2008—spectacularly so—it was replaced by the easy-money bubble of the past five years, which pushed the prolonged rally in Treasuries into a speculative phase and extended the bubble in oil and other commodities.

The economic consensus continues to allay our fears, claiming that there is no bubble either in U.S. government bonds or in oil prices. Treasuries look good in comparison to European and even Japanese government bonds, and the U.S. is in no danger of defaulting. And oil prices can be expected to stay elevated since we have reached the historic peak of oil production and output will now start to decline steadily.

However, with U.S. inflation averaging above 2% a year, the yield on the 10-year Treasury, averaging 1.75% over the past year, has been negative in real terms. In other words, long bond investors have been paying Uncle Sam for the privilege of lending it money. Meanwhile, the 30-year bond, with its 3% yield, incorporates wholly unrealistic expectations about U.S. public finances over the next three decades. Similarly, hopes that inflation-adjusted oil prices will remain at more than twice their 50-year average are illusory, given new sources of supply and energy-saving technologies.

In fact, assurances that these two bubbles will endure are uncannily reminiscent of the talk of the “new economy” in the 1990s and the belief that “homeowners never default on their mortgages” and that “house prices never go down” in the mid-2000s.

Of course, bubbles could emerge again in the same market after a while—just as they used to do in Hong Kong or South Korea. But it hasn’t worked like that in the U.S. More than a decade after the high-tech bubble burst, the Nasdaq Composite index stands at two-thirds of its 2000 high, while the number of issues traded today is less than half of what it was back then and continues to dwindle.

Similarly, the housing market and the construction industry, despite an uptick in early 2013, remain in the doldrums more than six years since house prices started to decline. Worse, each new bubble appears to produce a weaker recovery, with fewer jobs created, whereas busts have shown an alarming tendency to increase in severity and length.

Uneven Distribution

Speculative bubbles tend to distort the markets, attracting a disproportionate amount of financial resources to selected sectors while starving others. The Federal Reserve and other major central banks have created an unprecedented amount of liquidity—several trillion dollars’ worth since the advent of the global financial crisis in 2008. But only a small portion of the money has gone where it could be used productively, i.e., to make loans to businesses and consumers. The bulk of the newly created liquidity ended up in the U.S. Treasuries and in Switzerland, which has emerged as a safe haven of last resort.

The Swiss have experienced a massive inflow of funds from the crisis-ridden euro-zone, and not only from troubled economies on its periphery, but from stronger ones in the north, as investors fear the collapse of the single currency and financial chaos everywhere in the European Union. Since 2008, the franc has risen by one-third against the euro. And even against the U.S. dollar, which strengthened against the euro as a result of financial turmoil in the eurozone, the franc has moved up substantially over the past five years.

For Switzerland’s exceptionally open economy a strong franc is something of a catastrophe. Exports of goods and services account for almost 55% of the country’s GDP, compared to less than 15% for the U.S. Switzerland’s current account surplus, which measures 11% of GDP, is a key determinant of economic growth. An overvalued franc—and it is overvalued by some 60% according to The Economist’s Big Mac index—threatens to undermine Swiss manufacturing, hitting its exports and hooking consumers on cheap imports.