In the past ten months or so, the Swiss franc has been giving a new and unfamiliar meaning to the phrase ‘currency of last resort’. No matter which way the money markets have turned, the ‘Swissie’ has seemed to be at the bottom of everybody’s wish list.

When the dollar-sterling valuation slipped below 50 pence, it was gold that caught all the benefit, not the Swissie. And then, when the dollar got its strength back in August and September, rising by 15 per cent to 57p, Switzerland’s heroic currency fell right back below the rates of late 2007. It was infuriating, and not a little puzzling for many people.

Counter-intuitive
But not as puzzling as the way that all this bad news seems to fly in the face of the country’s economic performance. Switzerland’s projected two per cent growth rate in 2008 might not be particularly thrilling, but it’s a damn sight better than a possible one per cent growth for Britain and a probable shrinkage for the euro area. Meanwhile, the country’s 4.5 per cent growth in industrial output looks outstandingly good compared with a contraction of up to one per cent in the EU and in North America.

Switzerland’s lacklustre currency doesn’t square with the trade balance, either. The country is still notching up a huge US$91 billion (£51 billion) current account surplus – more than US$12,000 for everyone in the country. And it has a small budget surplus, too. Its consumer price inflation is actually moderating a bit, from four per cent in the summer to a projected 2.7 per cent for 2008 as a whole. Unemployment is just 2.6 per cent, less than half of the level we accept as normal in Britain or the US.

But appearances can be deceptive. The main SMI stock index in Zurich lost 16 per cent in the first eight months of 2008 – equivalent to 13 per cent in dollar terms and roughly 15 per cent in sterling terms. The government’s projection of 1.3 per cent growth for 2009 is regarded as optimistic, and some independent observers would be surprised to see any growth at all. Even the 2.7 per cent inflation forecast compares with just 0.4 per cent a year ago. And the job figures ignore the fact that Switzerland is already sending foreign workers home in their hundreds of thousands.

What’s it all about, then? Well, partly it is because of the growing slowdown in Eastern Europe, which in turn has been caused by the oil price slump and growing instability of Russian businesses. Like Austria, Switzerland has been making a lot of money in recent years from brokering Eastern Europe’s foreign trade deals, and the recent cooling of relations, combined with the not inconsiderable likelihood of a slump in demand for the region’s other consumer goods exports, has undoubtedly had an effect.

Banking carries the blame
But it is the world-famous banking system that is causing the most concern at the moment. Until last spring, Switzerland could look us all in the eye and reassure us that it would never have got into all that unpleasant sub-prime borrowing business that had caused such distress in the US. Discretion, good taste and a reputation for sound decision-making would always mark it out as an honourable exception among its peers, it said.

Alas, that was before we discovered that Swiss banks had, indeed, been buying their share of the dubious mortgage bonds that ratings agencies such as Standard & Poor’s had been mistakenly classifying as Triple-A.

And when the blow struck, it struck with horrific force. Union Bank of Switzerland (UBS) lost 65 per cent of its share valuation in the 11 months to September, after admitting that it had lostUS$38 billion on sub-prime loans, and Credit Suisse was down 30
per cent. Not even a Sfr15 billion (£7.5 billion) recapitalisation programme had been enough to save UBS’s face in any really convincing way. Meanwhile, it just so happened that the US tax authorities had chosen that particular moment to grill a number of senior UBS officials on suspicion of setting up illegal trusts and bogus identities to help US taxpayers evade American taxes.

And there was even more to come. In an immaculately choreographed move, Brussels had simultaneously been getting its teeth into the famed secrecy of Swiss banking. With a certain amount of prompting from the US tax authorities, it is now toughening up its stance against evasion by tightening the reins on many of non-EU member Switzerland’s activities.

The pit and the pendulum
For the last few years, Swiss banks have levied withholding taxes on the accounts that foreigners open in their country, a sort of sop to the European Banking Directive, which had insisted that otherwise they would be required to reveal all their client details to the European Commission – an unthinkable situation for many. But regulators on both sides of the Atlantic are letting it be known that they are getting jittery about the acceptable limits of such secrecy. And the recent weakness of the banks’ share prices is due in no small part to investors’ fears that they might be forced to get rid of some of their most lucrative activities.

You see, one of the defining features of the Swiss banking system is that UBS, Credit Suisse and all the others offer their clients an ‘all-in-one’ integrated banking model that gives them an unusually wide range of customer services, and all of it happening under that trademark cloak of secrecy. But both Washington and Brussels are growing unhappy about the banks’ habit of combining mainstream banking operations with somewhat more risky advisory services, and the upshot of the situation is that, in order to stay within the Basel II international rules on capital adequacy for banks, Switzerland’s institutions may eventually be forced either to increase their capital or else to dispose of some of their lending arms. The pit is on one side, the pendulum is on the other, and everybody is watching to see which way they’ll jump.

Sustaining credibility
It is hard to overstate the importance of this unenviable situation. Switzerland’s banks hold assets worth nearly ten per cent of the entire country’s gross domestic product – compared with about 3.5 per cent in Britain and barely one per cent in the US – and the ratio has trebled in the past 15 years. UBS and Credit Suisse account for easily three-quarters of this money. We are talking about a loss of credibility for the whole economy.
 
Then there is the awkward fact that the currency itself isn’t what it was. The Swiss franc might have strengthened a bit against the pound this year, from 46p in January to 51p in September, but against the dollar it has been all the other way, down by an eye-watering nine per cent from 99 cents in March to just 90 cents in September. It has, at least, managed to hang onto its rating against the falling euro, at roughly 62 cents, but that is a rather poor consolation in the circumstances.

Promising sectors
So is there anything good to be salvaged from this situation? By all means. Switzerland’s exporters are set to gain from their relatively unattractive currency and offer attractive investment prospects. Switzerland particularly excels in pharmaceuticals, which are now coming back into favour after a long period in the doldrums. The market leaders include Roche and the Novartis group.

Then there’s the specialist engineering industry, including the gigantic ABB. Like other Swiss precision engineers, which serve the medical and machine tool markets, many of these high-quality specialist industries enjoy some degree of protection from price-chopping rivals from the Far East. Worth a look, especially when growth picks up again in the US.