How the Northern European Central banks can make a killing out of the crisis.

Savvy speculators have been making billions from the European crisis by second-guessing the politics. For instance, whilst big banks were forced to take a 70% haircut on their Greek bonds in March, some savvy investors that bought them up simply refused the haircut and got paid in full just 2 weeks ago, like these Japanese investors and these hedge fund managers. The hedge funds made up to 70% profit on the 435 million Euros paid out, just as I predicted last October that some indeed would do. If only I had followed my own advise and had hundreds of millions to gamble with at the time!

The game is of course still afoot. Some current investors are now betting on the implications of Greek elections, others on the French, and they are not mincing words in their advise to their shareholders, openly talking about posturing politicians and blundering bureaucrats. Whilst most other commentators are moralising, these boys are just making money for themselves and their shareholders.

So, is there any way that the Central Banks of Northern Europe could make a profit out of the current situation? Absolutely, and it’s childishly simple. All it needs is guts, so it probably won’t happen, but has unusually low risks.

What should they do? Simple. Ten year German bond rates now come at 1.35%, Swedish bond rates at 1.13%, Dutch bond rates at 1.77%, etc. This is incredibly low. Just the dividend yield alone in the S&P 500 is in the order of 3%.

It is hence so low that now is the time for these central banks to borrow at their incredibly low rates and invest the money outside Europe. That way they get a double whammy: they in all likelihood make a killing and they will also drive the Euro exchange rate down, immediately making the investments good ones from a book-keeping point of view and stimulating competitiveness in the short-run.

How can this be done? Easy. Their respective governments have to set up ‘future funds’ that are ostensibly there to fill some future policy need that they can pretend they need to siphon off money for now. There are many that are suitable fig-leafs, including future pension needs, future health care needs, etc. Governments then borrow money to put into these future funds, which are then invested by the Central Banks abroad. Holland could easily park, say, 500 billion in Euros outside of Europe. Germany could park trillions. At an expected 10-year-pay-off differential between these bonds and the rest of some 4% per year, the Dutch Central Bank alone would be making an estimated 20 billion per year off this scheme for their country.

What would essentially be going on from a macro-perspective? Well, the bill is essentially footed by investors and savers too scared to invest in (Southern) Europe, including populations in those countries. These risk-averse Greek, Spanish, and other savers are supplying their savings to the Northern European Central Banks at these ridiculously low rates, who in turn can channel those savings to economies doing better in this world. It is even good for the world economy, certainly much better than government consumption, which is the main alternative at the moment.

Are there risks involved in such a scheme? Yes, but not the obvious ones you would think of. If the whole Eurozone would collapse, then this scheme is great for the countries involved because the money is parked elsewhere and the assets would still belong to the Northern Europeans. These central banks would then owe bonds denominated in Euros which they would then at some conversion rate have to pay off in re-introduced currencies for which they are the monopoly provider (hence no actual loss), whilst the overseas asset holders were paid in euros, not in the reintroduced currencies! One would then effectively have an immediate export boom in Northern Europe if the Euro collapses, exactly when you want it. Now, if the whole world financial system would collapse and no-one pays off their bond debts, then all bets are off anyway and again there is no loss in this scheme and quite probably a huge gain. It is hence a hedge against systemic risk.

The real risk involved is that in a period of 10 year the yields would actually be less than 1%, but without a collapse of either the Eurozone or the world financial system. Then the Dutch and German Central banks could be out by 20% or some other such magnitude when there is a severe downturn in the whole world economy but no collapse of the Euro. It is the ability to weather that kind of loss that limits the size of the scheme. Considering that Japan is able to have 200% of its GDP in debt at very low rates and Germany and the Netherlands owe less than 100%, this still leaves a huge potential gain.

The scheme is a clear no-brainer that thus is a win in nearly all scenarios: with a collapse of the Euro, the scheme turns from merely good to excellent since the purchase was then free-riding on the whole of the Eurozone whilst the eventual costs would be in reintroduced currencies for which they are the monopoly providers. It couldn’t be done after the collapse, but only before. This is also why the US Fed or other sovereign states in charge of their own currency cant do this trick: it would undermine the US dollar and amount to inflation eroding the value of local savings. No such issue for the Northern European central banks who would basically be free-riding off the whole of the Eurozone savings.

As said before, this kind of scheme would take guts and financial nous but if ever Northern European central bankers had an opportunity to do something worthwhile for their countries, it is now.

Author: paulfrijters

Professor of Wellbeing and Economics at the London School of Economics, Centre for Economic Performance

2 thoughts on “How the Northern European Central banks can make a killing out of the crisis.”

  1. Hmm – I wonder if Germany pursued this policy if Merkel would continue her self-righteous lecturing of the Greeks. In your scheme the more profligate the southerners are the more quick profit the northerners make at their expense …


  2. yep. And Merkel should indeed stop lecturing others, as I keep saying. She should let others be responsible for their own choices and just make money for Germany.


Comments are closed.

%d bloggers like this: