In the first half of 2011, Novartis, a Swiss pharmaceutical company, had a 9% earnings gain in dollar terms. This gain turned into a 16% loss in Swiss-franc terms (Economist 7/23/2011).

This happened because the Swiss franc rose by 30% against the US dollars over 12 months since July 2010 (WSJ 7/26/2011). Similarly, the Swiss franc rose by 27% against the euro in the 10 months prior to August 2011 (WSJ 9/7/2011).

In theory, the exchange rate of a currency in a floating exchange rate system should reflect mostly the balance of trade in real goods and services. A country experiencing a persistent trade surplus will see its currency appreciating in exchange value as demand for it increases. Although Switzerland does enjoy an overall trade surplus, the rapid rise of the Swiss franc is in no way a normal response.

Rather this rapid rise is due to the inflow of hot money looking for a safe haven from the financial turmoil in the euro bonds market and the US cheap money policy.

While this flight to safety is understandable, the collateral damage to the Swiss economy is real. The strong Swiss franc has pushed some weaker exporters into bankruptcy. Others have been forced to lower prices to hold on to their export markets. Tourists have stayed away and asset bubbles have started to form (9/7/2011).

So in a desperate move to stem the rise, the Swiss National Bank has instituted a ceiling to the exchange value of the Swiss franc. As of 9/6/2011, it will no longer tolerate the euro falling below 1.20 francs. In other words, it will buy an unlimited amount of euro with Swiss franc to keep the exchange rate at 1.20 franc per euro. To further discourage speculative capital inflow, the SNB slashed interest rates to close to zero.

Switzerland is by no means the only destination for hot money. Japan, Brazil and Hong Kong are similarly affected.