In memory of Dr. Andreas Höfert

From St. Gallen to São Paulo, the same complaint

Being a chief economist can take you to quite different places within a very short time. Two weeks ago, I was meeting clients in São Paulo, Brazil’s economic capital and the largest city in the southern hemisphere with roughly 20 million inhabitants. A few days later, I was meeting other clients in St. Gallen, a picturesque town in northeast Switzerland almost 300 times smaller than São Paulo. Yet the Brazilian megalopolis and the Swiss town have something in common: The strength of the local currency is bothering and even frightening many people.

In Brazil, you often hear the complaint that the real is heavily overvalued against the US dollar at 1.82. Indeed, Brazil’s Finance Minister Guido Mantega has asked the World Trade Organization to establish rules against what he sees as unfair foreign exchange policies that hurt emerging markets. He has reiterated recent criticism of developed nations for flooding emerging markets with excess liquidity.

Switzerland is in fact doing exactly this, but that hasn’t managed to silence domestic complaints that the franc is too strong. That at 1.20 against the euro, the current floor defended by the Swiss National Bank, exporters are suffering. Swiss economy minister Johann Schneider-Ammann stated in an interview that he would “generally like” the franc to weaken toward 1.35 or 1.40 versus the euro. He also stressed that while the SNB is independent, purchasing power parity “is higher” than 1.20.

Given Brazil’s and Switzerland’s shared currency complaints, it is striking that both countries also enjoyed positive trade balances in 2011. So as much as we Swiss, for example, complain about the strength of our currency, we also look at US consumers and southern European governments with a certain amount of disdain, thinking that they don’t know how to manage their money. This attitude blithely ignores how much our exports depend on these “spendthrift” consumers, not just the strength or weakness of our currency.

When it comes to international trade, many politicians take the same myopic view, feigning ignorance of a few basic principles: For every country with an export surplus, there must be another country with a deficit. A country’s trade balance reflects more than the value of its exports and imports; it also shows the difference in value between what a country produces and what it – and its households, companies, and government – consumes. Not to mention that a trade surplus shows that another country just indebted itself to yours. And as Greece’s difficulties suggest, it is not necessarily a given that you will get your money back, or at least not its purchasing power.

Exchange rate interventions, like protectionist measures, ultimately come at a cost. This is another one of those “dismal” economic rules. By engaging in such interventions, governments are in fact supporting one part of the population – exporters and producers – at the expense of another part of the population – consumers, who are forced to pay higher prices. If this were better understood, I am not so sure that the complaint heard from St. Gallen to São Paulo would be as loud.