Switzerland's 39% shock

A 39 per cent tariff on Swiss exports to the United States took effect on 7 August, and it caught Switzerland off guard. Zurich and Basel were badly shaken, and the core of the Swiss export economy is now exposed.

The rate was announced on 31 July, on the eve of the Swiss national day, after negotiators in Bern had expected something far lower. The president, Karin Keller-Sutter, and the economy minister, Guy Parmelin, flew to Washington before the deadline and came home without a deal. Among big economies only Brazil, and India from later this month, face higher rates. The European Union, whose luxury and engineering firms compete directly with Swiss ones, secured 15 per cent in its agreement in July.

Pills and watches

Switzerland does run a large merchandise surplus with the United States, but two narrow sectors account for it: high-value pharmaceuticals and luxury watches. Specialised Swiss medicines, such as cancer treatments and immunology biologics, are not commodities, and demand for them barely responds to price in the short run. American hospital networks and purchasing groups will pay more as soon as the duty reaches medicines, because domestic makers cannot replace drugs protected by Swiss patents.

That moment has been deferred rather than cancelled. Pharmaceuticals are exempt from the reciprocal tariffs while a separate national-security investigation into the industry runs its course, and President Donald Trump has said drug imports could eventually face duties as high as 250 per cent. Watches, machine tools and precision instruments carry the full 39 per cent now. The United States is the largest export market for Swiss watches, and a buyer choosing between a Swiss and a European luxury brand faces a tariff gap of 24 percentage points.

A surplus inflated by gold

Part of the surplus that provoked the tariff is an artefact of gold. Switzerland refines much of the world's bullion, and in the first months of the year large quantities of gold bars were shipped to New York as traders feared that metals would be tariffed. Those flows swelled the Swiss export figures without saying anything about the competitiveness of Swiss industry. This month a customs ruling suggested that some bar sizes could fall under the tariff, before the president said gold would not be taxed. The episode shows how much of the dispute rests on a trade number that overstates Switzerland's industrial surplus.

Tariffs and drug prices collide

The tariff sits awkwardly with the administration's other demands on drugmakers. On 31 July, the same day the Swiss rate was announced, the president wrote to 17 pharmaceutical companies, Novartis and Roche among them, demanding that they cut American prices to the levels paid in other rich countries. A duty on imported medicines pushes costs in the opposite direction. Drugmakers cannot both absorb a tariff and cut list prices without squeezing the research budgets that justify their patents, and the letters give them a reason to resist concessions on either front.

Drugmakers move production

The companies with the most at stake have already responded. Novartis said in April that it would invest $23 billion in American manufacturing and research over five years, and Roche announced a $50 billion programme days later. New plants take years to build, so exports from Basel will carry the load in the meantime. The strategy moves the cost rather than removing it, because duplicate capacity at higher-cost American sites raises what American patients eventually pay. Smaller Swiss makers of machinery and instruments have no such option: they lack the balance sheets to build American plants and must either cut prices or cede orders to German and Italian rivals paying 15 per cent.

The franc goes the wrong way

The Swiss National Bank also had a currency problem on its hands. The franc did not weaken. It attracted fresh safe-haven buying as geopolitical uncertainty rose, which made life harder still for exporters.

The central bank's tools are limited. It cut its policy rate to zero in June, and a return to negative rates would hurt savers and pension funds while doing little against a tariff that dwarfs any plausible currency move. Heavy sales of francs, its other weapon, risk accusations of currency manipulation from the same administration that set the tariff. Swiss manufacturers have absorbed a shock of this kind before: when the SNB abandoned its cap on the franc in January 2015, the currency jumped overnight, and exporters answered with cost cuts and, in some cases, longer working hours, sparing the economy a prolonged downturn.

Winners and losers

The clearest losers are American patients and insurers, once duties reach medicines, and the Swiss makers of watches, machine tools and instruments who pay the full rate now. German, Italian and French competitors gain a 24-point price advantage in the American market for goods that Swiss firms used to sell on quality alone. Swiss equities are less exposed than the headlines suggest, because the biggest listed companies, such as Nestlé, Roche and Novartis, produce much of what they sell abroad outside Switzerland. The pain falls on the smaller, unlisted exporters that employ most Swiss manufacturing workers.

Where a deal could come from

The case for calm is that the rate is a negotiating position, and the Swiss government says it will keep talking. An improved offer, perhaps involving Swiss investment pledges or purchases of American energy, could cut the rate as abruptly as it was set. The SNB's quarterly assessment in September and the outcome of the pharmaceutical investigation are the two events most likely to move Swiss assets. Until then the tariff will weigh on watchmakers' order books and on a franc that refuses to act as a shock absorber. A 39 per cent tariff aimed at a trade surplus will mostly raise the cost of American healthcare, while Swiss drugmakers and watchmakers, also squeezed by a strong franc, will see their cash flows suffer in the months ahead.