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Switzerland Makes a Move on Competitive Devaluation

European markets came back a little bit after the crash from earlier in the week, mainly because of a favorable court ruling in Germany that will allow for the previously agreed-to Euro bailout. But the crisis is far from over, and this is mainly due to the weak banking sector, which is in the midst of an existential emergency:

As Europe struggles to contain its government debt crisis, the greatest fear is that one of the Continent’s major banks may fail, setting off a financial panic like the one sparked by Lehman’s bankruptcy in September 2008.

European policy makers, determined to avoid such a catastrophe, are prepared to use hundreds of billions of euros of bailout money to prevent any major bank from failing.

But questions continue to mount about the ability of Europe’s banks to ride out the crisis, as some are having a harder time securing loans needed for daily operations.

Well, if securing loans for daily operations is the only problem, it shouldn’t be much of a worry! It’s not like that’s exactly what felled Lehman Brothers and triggered the financial crisis or anything!

In case you wanted to know why US Treasuries were selling at essentially negative rates, this is it. There’s no trust in European banks, and that will have a spillover effect into the US as well.

If the banking sector does go down, all bets are off. And Eurozone countries continue to somehow think that crushing austerity on their populations will allow them to pay banks and stave off the crisis. But in addition to causing general strikes and popular unrest, this tactic has sunk European economies, bringing growth to near-zero rates and increasing budget deficits for many countries, because of lost tax receipts.

But there is another way, a way to boost growth and production that will help sector-wide, and Switzerland struck forward yesterday.

Switzerland’s move to set a cap on the franc’s exchange rate against the euro sent the currencies of Poland and Hungary surging upward Tuesday and provided households in both countries indebted in the Alpine currency with some relief.

“This is very, very good for both countries,” said Daniel Hewitt, a senior economist at Barclays Capital. “Both countries have Swiss franc-denominated loans held by households, and in Hungary’s case, by localities as well.”

Any strengthening of the zloty or the forint against the Swiss franc lessens the amount debtors would have had to repay this month and in the future in local currency if Switzerland hadn’t placed a ceiling on its currency.

Basically, Switzerland said that they would print as much money as necessary to keep their value against the euro at a certain level. And as a result, other currencies outside the euro went way up. Some would call this the beginning of a currency war, where countries devalue their currency in a race to the bottom for expanding aggregate demand. As Matt Yglesias explains, that would be great!

What happens is that countries experience a higher inflation rate, unless they don’t want to experience a higher inflation in which case they simply fail to participate in the “war.” At the end of the “war” countries that are experiencing below-capacity output are making more stuff, and countries that are already producing at near their current capacity end up with more stuff. Basically, everybody wins. It has basically nothing in common with a war and a great deal in common with internationally coordinated action to produce adequate demand and correct global imbalances. The difference is that it’s not actually coordinated, so things get a bit chaotic. But compared to what’s been happening for the past 36 months a currency war would be a boon to the world.

And it’s really true that everyone could win. It certainly beats the alternative, where everyone muddles through and productive capacity is held idle.

The Eurozone would have to act, of course, which just seems impossible, given the political problems with both fiscal integration (where policymakers could make the choice to devalue) or breakup (where the countries that need to devalue could immediately do so). But if the Federal Reserve is looking to do more than Operation Twist, they could just announce a policy like Switzerland, and say that their exports would be improved by a weaker dollar.

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David Dayen

David Dayen

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