One of the features of the credit crunch era has become the way that the economic landscape has become marred by similar moves to the competitive (currency) devaluations which so marred the 1920s and 30s as they became factors in the Great Depression. When the phrase “Currency Wars” was first used by the Brazilian Finance Minister back in 2010 the main issue was the impact of US Dollar moves. However now we find ourselves in a situation where two major currency blocs have devaluation as a policy with one being explicit and the other more implicit. The explicit player has been Japan under the banner of Abenomics as it has pushed the value of the Japanese yen lower. No doubt Japan’s establishment will be crowing today as the Nikkei 225 equity index reaches 18,466 which is a closing level not seen since May 2000. If only the real economy was the same! However I wish today to look at the implicit devaluer which is the Euro and the implications of that which have emerged for the nations attached to it and in particular Denmark.
Why is the Euro an implicit devaluer?
The European Central Bank now has a flagship policy of 60 billion Euros a month beingspent on Euro area bonds or Quantitative Easing. So far only a small frigate has gone ahead of the main fleet as relatively minor purchases have been made. But the supporting references are full of euphemisms about boosting inflation which is most easily done via a lower exchange rate and in particular a lower exchange-rate against the US Dollar. Odd that this does not get any mention don’t you think??!
Rather ironically if there has been a boost to inflation it has come from the rebound in the price of oil (Brent Crude) to around the US $60 per barrel level! But the oil price is very volatile as we await the next move. If we return to the Euro I also note that after a fall it has now stabilised. If we compare it to the Yen then after pushing through 145 into the high 140s in early December the Euro fell to around 135 where it now remains. The initial response to the flagship QE announcement was for the Euro to fall but now it is at 1.13/14 pretty much back where it started.
A problem for Denmark
As the Euro has moved into a phase where the ECB is implicitly encouraging it to fall pressure has come on Denmark which is not in the Euro but instead pegs the Krone to it in a 2.5% band. The Danish elite argue that this brings the benefits of being in the Euro whilst avoiding some of the problems. Before this is over I suspect that the Danish people will wonder exactly what the benefits were.
In an attempt to keep the Krone within its band the Danish central bank has found itself cutting interest-rates four times already in 2015. After initially dipping its toe into the world of negative interest-rates in a similar fashion to the ECB (-0.2%) it then went to -0.35%,-0.5% and then -0.75% in even more extreme attempts to maintain an exchange-rate status quo. In addition to this it spent some 106.5 billion Krone in January trying to keep its price down. We can conclude that even the Nationalbanken did not think the intervention was a success as otherwise it would not have continued its series of interest-rate cuts. In addition it suspended government bond sales to try to halt flows into the Krone.
What about the Danish economy?
What I mean by this is that if you deploy monetary policy to deal with the external constraint or exchange-rate it is not available to deal with internal economic issues. Of course on rare occasions they may coincide so let us investigate. From the December International Monetary Fund staff report.
Danish household debt is the highest among the OECD countries, standing at about 300 percent of disposable income.
So we have an immediate problem as the conventional response to high debt levels is to try to reduce them rather than encouraging even more borrowing via ever lower interest-rates! As we look deeper more issues emerge.
The recent upward trend in household debt started in the late 1990s, reaching 300 percent of disposable
income by 2008. This coincided with the period of rapid house price appreciation that peaked in 2007. The housing boom eventually ended with large house price corrections, but household debt remains elevated with only moderate deleveraging having taken place so far.
As you can see there are a multitude of issues here. The concept of a house price boom based on a debt expansion seems much more southern than northern european in terms of stereotypes although as I have discussed before the Netherlands is in a similar boat. The official response is that the debt is backed by solid household assets.But whilst bricks and mortar are solid in a physical sense the financing around their valuation starts to look much more like a house of cards. Denmark’s private-sector has assets but the housing stock is something that can only be realised relatively slowly and the pension system is supposed to be for the future rather than the present except on a more minor scale. So liquid debts and illiquid assets what could go wrong?
Especially if we now see a surge in borrowing at these negative interest-rates as over time they seep through the Danish financial system. To be more specific I expect different impacts from different groups as some expand their debt and other continue to deleverage although the latter impact has so far been small according to the IMF.
Also I spotted that phrase which brings terror to those who have examined the Irish experience, mortgage product innovation.
“Interest only” (IO) loans—these are called deferred amortization loans in Denmark as they normally
come with a deferred amortization period of up to 10
years—were introduced in 2003, …..The use of deferred amortization loans grew rapidly since then, and these loans account for a little over half of outstanding loans by MCIs in recent years.
What could go wrong?
Are capital controls a sign of desperation?
I think that the hint in this area which was released on Friday is exactly that. In case you have not read it here are te full developments. From Bloomberg today.
In reports by Reuters and the Telegraph, Hans Joergen Whitta-Jacobsen, the head of Denmark’s Economic Council, is quoted as saying the country could impose capital controls. Whitta-Jacobsen, who doesn’t advise the central bank, has since said he doesn’t think such a measure is necessary or likely.
Never believe anything until it is officially denied ( Otto Von Bismarck and Jim Hacker).
Also the denials come with claims that capital controls would be illegal which seems odd when you consider that Cyprus which was in the Euro area suffered from them.
There is much to consider here as we see a central bank wedded to a pegged exchange-rate. Firstly can it keep the peg? Probably not as I expect the Euro situation to rumble on. Of course events will ebb and flow and on the better days we can expect many establishment cries of triumph. However the hint of capital controls may well have been a type of ” Open Mouth Operation” from an increasingly desperate Danish establishment. On the day it worked as the Krone plunged but there will be other days.
On the other side of the coin there is the situation regarding household debt, mortgages and the housing market. There are genuine fears about what may now happen here as puncturing a bubble with negative interest-rates is pretty unique or to use a word much abused in the credit crunch era innovative.
Meanwhile Denmark appears to be offering something to the world of football which is arriving in the UK at Brentford football club which with apologies to its supporters seems unusual to say the least. From the Guardian.
What Quinn may not realise is that the blueprint for Brentford’s future is already being stress-tested 800 miles away at FC Midtjylland, who lead Denmark’s Superliga by six points and are on course for the first trophy in their history. And who is the majority shareholder in Midtjylland? Matthew Benham, the former hedge fund manager and professional gambler who also owns Brentford.