SPBA Presents Financial Markets And Economy Analysis
Monday, January 24, 2011

During a recent press conference in Bern, Vice President of the Swiss Private Bankers Association (SPBA) Nicolas Pictet presented his analysis of both the financial markets and the economic climate in a bid to anticipate what 2011 holds.

According to the SPBA’s Vice President, in 2009 the risk of a possible collapse of financial systems in the West was presented, a risk that was averted as a result of economic policy. In 2010, Pictet continued, there was a real threat of a deflation in industrialized countries, averted once again by means of a targeted monetary policy. This year, he added, there is a risk of threatening inflation in developing markets, set against the backdrop of a world marked by a two-fold divide.

The first division, Pictet explained, exists between industrial countries, with their deflationary pressures and lack of sustainable growth, and between emerging markets, which show in stark contrast inflationary pressures and solid growth. The second divide, a result of a conflicting approach to monetary policy, exists between the US, with the American Federal Reserve having introduced a second quantitative easing policy, and Europe, with the European Central Bank (ECB) adopting a restrictive approach, leading to palpable tensions in the international monetary system.

Pictet maintained that ECB will, however, eventually be forced to introduce a quantitative easing policy, given the financial problems of the euro zone and the fact that saving the euro requires “unlimited” financial plans and an accommodating central bank.

Alluding to the fact that several states have a very high need to refinance in 2011, Pictet stated that, although the EUR750bn in the euro rescue fund should sufficiently meet requirements for this year, no more will be available. Consequently, if it becomes necessary to extend financial support to other countries, such as France, then there will be insufficient funds.

In view of this, Pictet emphasized the need for a crisis mechanism to be created, designed to cover the whole of the euro zone, and the need for the ECB to adapt its policy in the direction of quantitative easing. There are no economic reasons for an implosion of the euro, Pictet added, noting that any necessary financial means can be obtained, in particular through the issuing of a supra-national European bond.

Highlighting the fact that debt problems in both Europe and America are the result of structural debt and debt in connection with the banking crisis, Pictet pointed out that debt exploded thirty years ago, when it did not go hand in hand with economic growth but was used instead to support household consumption by financing the creation of a whole series of security nets. In a rapidly aging population and an economy suffering from a lack of growth, this debt presents a huge problem, Pictet continued.

Convinced that the crisis in Europe is both a banking crisis as well as national crises, Pictet explained that the banking crisis arose due to extended credit granted for over-inflated property prices, affecting countries such as Ireland, Spain and the UK, whereas national crises occurred in countries with high public deficits and/or whose debt as a percentage of GDP to weak economic growth is proving unsustainable. The European crisis is therefore a debt crisis, he added.

Pictet revealed that the debt level of industrial countries is currently around 90%, pointing out that this level is due to increase to almost 100% in 2011 and to 130% in 2013, according to figures from the International Monetary Fund. European states therefore have to tighten their belts, he continued, noting that the aim now is to reduce the debt level to 60% by 2015, to be achieved by reducing state expenditure.

Warning that the possibility of a new crisis in Europe does indeed exist, Pictet explained that for a solution to the crisis, there are three possible approaches:

• An exit out of the euro – the worst case scenario, since if one state exits the euro zone, the risk of an implosion strongly increases;
• Debt restructuring, whereby no country leaves the euro zone, but there is a so called “haircut” or debt waiver to the detriment of creditors;
• Stabilization: The best possible scenario, whereby any countries experiencing difficulties receive financial support from the others. According to Pictet, this approach appears to be emerging, as euro zone countries have apparently united on plans for a permanent EU rescue fund, the mechanisms of which are due to be discussed in detail in 2011.

Referring to the quantitative easing policy of the US Federal Reserve, Pictet explained that while it does not lead to monetary inflation, it does, however, cause investors to seek refuge elsewhere, as demonstrated by the appreciation of reserve currencies, including the Swiss Franc, and by the appreciation of gold and emerging market currencies. This appreciation results in tensions, Pictet stated, alluding to the Brazilian Finance Minister’s mention of a currency war.

Although the strength of the Swiss Franc is not a new phenomenon, Pictet pointed out, the extent and in particular its rapid increase is problematic. There are very real concerns, Pictet stated, about the possible effects of the appreciation on a large part of the Confederation’s export industry, and, therefore, on the Swiss economy in general.

Pictet explained that the Swiss financial centre and industry are very much joined, forming one economy. The banks do not profit from an export industry experiencing difficulties and visa versa, he clarified.

Given that banks provide services for foreign banks, they are an integral part of the export industry, Pictet noted, adding that the sharp weakening of the major currencies against the Swiss Franc poses a big problem for Switzerland, given that managed wealth, and with it the revenues from the finance industry, shrink accordingly.

Yet, although the strength of the Franc certainly poses problems, the SPBA do not consider that this can be prevented by intervention measures, as the problem lies not with Switzerland but elsewhere. In an open economy, Pictet explained, it is illusory to believe that Switzerland can protect itself from indirect problems arising from its powerful trading partners.

According to Pictet, Switzerland has a significantly better economic dynamic than the euro zone. GDP stands just above the pre-crisis level, while in the euro zone it stands 3.5% below the pre-crisis level, marking a considerable difference. While the unemployment rate in Switzerland was 3.8% in 2010, in the US and Europe, this figure was 10%. The unemployment rate in Switzerland is due to sink this year to 3.1%. The Confederation’s public finances are also significantly better than in other industrial countries. State debt in Switzerland amounts to 39% of GDP (end of 2009) against 43% in 2007 and 55% in 2003.

In summary, Pictet stated that the current economic environment is characterized by strong and valuable growth in emerging markets and a weak growth in industrial countries. A “Double Dip” is not likely, however, Pictet added. The US adopts an economic policy, which is stimulating, whereas in Europe, the policy is restrictive. According to Pictet, the crisis in Europe and the pressure on the euro will not diminish until the destructive spiral of doubts is dispersed. The rapid rise in the value of the Swiss Franc, which looks set to continue, will undoubtedly affect growth in 2011 due to exports. Pictet said that the implications of such an environment for investors are as follows:

• Positive for shares;
• Unfavourable for state bonds, which at the current interest level are risky;
• Positive for corporate bonds, benefiting from the decrease of risk premiums;
• Favourable still for gold.