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Tuesday, 10 February 2015 00:00

It's All Out War, Pt 3: Is the Danish Krone Peg to Euro More Fragile Than Glass Beads? The Danish National Bank Infers So! Featured

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The Guardian reports: Danish central bank 'will maintain krone's euro exchange rate':

Denmark has no plans to change its fixed exchange rate policy and the central bank has the tools to react “at any given moment” to keep the krone stable against the euro, a central bank spokesman said on Tuesday.

The comments came a day after the bank cut interest rates to weaken the krone. That followed the abandonment last week of the Swiss franc’s cap to the euro, which had raised speculation that Denmark could follow suit.

I commented, at length, on this topic about 3 weeks ago and warned that it is highly unlikely that the Swiss will be the only nation that realizes it can't run lockstep with the behemoth that is the ECB in devaluing its currency.

Nordic deflation

Expect to see practically all of the nordic countries to do what Switzerland did, of course they will be rather late to the party... Then again, better late than never.

It appears as if more than one macro fund manager was paying attention, as I will demonstrate later in this article - but first, back to the Guardian piece:

“We have the necessary instruments in the form of interest rate changes and intervention to maintain the fixed exchange rate and we at all times look at market conditions and determine what to do,” central bank spokesman Karsten Biltoft said.

Hmmm.. We have heard that before, and more than once, no? If you recall, similar rhetoric was bandied about the pound - the 1200 years old currency born when "sterlings" or silver pennies were the main currency in Anglo-Saxon kingdoms. For those that don't know, if you had 240 of them, you had one pound in weight. A pound was  humongous fortune back in the 8th century, but thanks to British monetary policy, inflation brought sterlings, and eventually pounds to even the poorest of the poor. Alas, I digress... In the late '80s and early '90s Britain attempted to peg the pound to the Deustchemark in anticipation of joinig the ERM, with a central banking mandate of keeping the pound withing a +/-3% band of the DM. The problem with that promise is, like with Sweden and Denmark, and many of the countries whose CB attempt to peg to the euro is that their economies do not run in lockstep with that of Germany's - and Germany is, by far and large, the economy that calls the shots in the euro area. Everyone wants to reproduce Germany's economic success, but it's not as easy as just saying so - alas, many will try anyway. Britain tried by attempting to peg its currency to the DM in an attempt to reduce its interest rates (then at 15%) to match Germany's 9% (does this interest rate cue thing sound familiar?). Of course, this backfired as Germany's economy boomed while Britain's fell into recession, while the pound sterling exacerbated the problem by remaining strong relative to the DM, hurting exporters even more.

George Soros and his Quantum Fund (and to be fair, many other global macro currency speculators) recognized the unfavourable entry point the United Kingdom joined the ERM, using simple math to determine the unsustainably high rate at which the United Kingdom was brought into the Exchange Rate Mechanism, the high inflation relative to Germany's and the pain the exporters and asset prices were feeling. So he did what anyone who reads Reggie Middleton would do, he levered up and shorted pounds for deustche marks. The rest was history (Black Wednesday) as the British Central Bank insisted on keeping an unsustainable peg. As per Wikipedia:

The currency traders act

The UK government attempted to prop up the sinking pound to avoid withdrawal from the monetary system the country had joined two years previously. John Major raised interest rates to 10 percent and authorised the spending of billions worth of foreign currency reserves to buy up the sterling being sold on the currency markets but the measures failed to prevent the pound falling below its minimum level in the ERM. The Treasury took the decision to defend the sterling's position, believing that to devalue would be to promote inflation.[7]

George Soros' Quantum Fund began a massive sell-off of pounds on Tuesday, September 15, 1992. The Exchange Rate Mechanism stated that the Bank of England was required to accept any offers to sell pounds. However, the Bank of England only accepted orders during the trading day. When the markets opened in London the next morning, the Bank of England began their attempt to prop up their currency as per the decision made by Norman Lamont and Robin Leigh-Pemberton, the then Chancellor of the Exchequer and President of the Bank of England respectively. They began buying orders to the amount of 300 million pounds twice before 8:30 AM to little effect.[8] The Bank of England’s intervention was not effective because Soros’ Quantum Fund was dumping pounds far faster. The Bank of England continued to buy and Quantum continued to sell until Lamont told Prime Minister John Major, the man responsible for making the controversial decision to bring the United Kingdom into the Exchange Rate Mechanism while he was serving as Chancellor of the Exchequer, that their pound purchasing was failing to produce results. Major ordered Lamont to wait for further data later in the trading day, hoping the trend would pass.[6]

At 10:30 AM on 16 September, the British government announced a rise in the base interest rate from an already high 10 to 12 percent in order to tempt speculators to buy pounds. Despite this and a promise later the same day to raise base rates again to 15 percent, dealers kept selling pounds, convinced that the government would not stick with its promise. By 7:00 that evening, Norman Lamont, then Chancellor, announced Britain would leave the ERM and rates would remain at the new level of 12 percent (however, on the next day interest rate was back on 10%). It was later revealed that the decision to withdraw had been agreed at an emergency meeting during the day between Norman Lamont, Prime Minister John Major, Foreign Secretary Douglas Hurd, President of the Board of Trade Michael Heseltine and Home Secretary Kenneth Clarke (the latter three all being strong pro-Europeans as well as senior Cabinet Ministers), and that the interest rate hike to 15 percent had only been a temporary measure to prevent a rout in the pound that afternoon.

 George Soros is rumoured to have made $2 billion in his bet against streling and was titled "the man who broke the Bank of England" by the Daily Mail. Of course, that was 23 years ago. Central bankers have much more crediblity and smarts now, right? Right?!?!?!

September 15 2011 - SNB Vows To Defend Franc-Euro Peg, Hold Rates Close To Zero

PARIS (MNI) - The Swiss National Bank said Thursday it will continue to keep short-term interest rates as low as possible and defend the peg of the Swiss franc to the euro in order to counter the currency's appreciation resulting from inflowing capital in search of a safe haven amid the Eurozone debt crisis.

June 7, 2012 SNB spends billions defending the franc -

The SNB in effect pegged the franc to the euro last September after a surge of ... The bank has vowed to defend the franc's value at SFr1.20, ... that the SNBhad spent as much as SFr65bn buying euros to keep the franc weak  ...

January 15, 2015 Switzerland 'capitulates' on franc as global currency wars ... Daily Telegraph

The franc soared 30pc in one of the wildest days in Swiss history ... The move came three days after a top SNB official vowed that the peg would “remain a ...bitterly that it would make it even harder for exporters to keep afloat.

and... Rinse... Wash... Repeat...

Jan 21, 2015 Denmark vows to keep currency peg, likely to cut rates ... Reuters

Denmark vows to keep currency peg, likely to cut rates on Thursday ... The Swiss franc has leapt almost 20 percent against the euro since last week when the Swiss National Bank out of the blue ended a three-year-old.

Jan 22, 2015 - Denmark Ready to Dump Kroner on Market to Tame Hedge Funds... Bloomberg

Jan 30, 2015 - Denmark Suspends Bond Issuance to Protect Krone's Peg... Wall Street Journal

Feb 3, 2015 - Denmark Increases Krone Sales to Protect Peg... Wall Street Journal

Feb 6, 2015 - Is Denmark facing a speculative attack?... CNBC

... and the currency brokers get nervous, you know... after FXCM and all (FXCM to Forgive Majority of Clients Who Incurred Negative Balances) - 

Feb 6, 2015 - Dukascopy cuts leverage on pairs with Danish krone to 1:10

Dukascopy Bank and its arm Dukascopy Europe will reduce the maximum leverage on currency pairs with the Danish krone to 1:10. The changes will be effective as of February 8, 2015 (Monday) and will affect positions with EUR/DKK (Euro vs Danish krone) and USD/DKK (US dollar vs Danish krone), the company said in an announcement.

The company attributes the change to “the possibility of recalibration of the trading range of EUR/DKK which may lead to significant price gaps and cause negative equity on client accounts”.

Denmark’s national bank (Nationalbanken) has been taking action to weaken the Krone in order to maintain its peg – the watchdog sold record amounts of Krone during the month of January. The bank is obviously trying to avert “Black Swan” events.

Dukascopy is not the first retail Forex broker to axe leverage on DKK pairs lately – over the past couple of weeks we have seen other companies adopt similar measures too. (GAIN Capital’s retail Forex brand) also announced a reduction of maximum leverage on instruments with Danish krone to 1:10 earlier this month.

Other companies, like Australian Forex brokers AxiTrader and Pepperstone have been even stricter and temporarily ceased trading with currency pairs with DKK in the end of January.

As a matter of fact, FXCM, the brokerage that nearly collapsed due to the  Swiss National Bank (Switzerland's Central Bank and the oldest central bank in the world) pulling its peg from the EUR unannounced, is outright banning 13 currency pairs. Check it out, and more importantly, check out the reasons...

With the memories of the Black Swan event still fresh in the minds of investors and FXCM, the company has opted to target thirteen exotic currency pairs that structurally are more prone to rampant fluctuations of volatility given their currency floors, pegs, or bands in placeFXCM will discontinue trading on 13 currency pairs on Friday, February 20, 2015. Many of these exotic currency pairs carry significant risks due to over-active manipulation by their respective governments, either by having a floor, ceiling, pegs, bands, etc in place. As such, FXCM will be removing the 13 currency pairs below:

        • GBP/SEK
        • NOK/JPY
        • HKD/JPY
        • EUR/PLN
        • USD/ILS
        • CHF/SEK
        • SEK/JPY
        • USD/SGD
        • EUR/CZK
        • CHF/NOK
        • SGD/JPY
        • USD/PLN
        • USD/CZK

Despite all of the circumstantial (and not so) evidence above, if we return to the Guardian piece that we opened with...

Economy minister Morten Ostergaard said after Monday’s rate cut that the policy was not in doubt and that “no serious politician” would propose leaving or changing ERM.

Mayhap we should focus a little less on politics and a little more on macroeconomics and fundamental analysis. I will show in just a few paragraphs that these guys really, really don't know what they are doing!

The central bank aims to keep the krone pegged within a narrow band of 7.29252 to 7.62824 kroner to the euro. “The policy remains the way it has been – namely that we maintain it close to central parity,” Biltoft said. Analysts expect a further cut as soon as this Thursday should the European Central Bank announce a widely anticipated quantitative easing package, which they say could lead to the euro weakening and the krone strengthening again.

Central bankers who can't print in bulk (and that's essentially all central banks save the Fed, ECB, Bank of Japan, The People's Bank of China and the Bank of England - and you see what happened to them vis-a-vis Soros, et. al.) essentially have no nucelar arsenals in their toolchests. They do have a few mini-atomics, primarily their credibility. Once that's shot, its the equivalent of their shooting a hand gun in a nuclear war. That leads us back the Danish central bank. These the same people who said "Bitcoins are like 'glass beads', warns Danish national bank":

The Danish national bank has released a briefing note firmly declaring bitcoin to not be money, noting that the currency is more like “glass beads”.

“Bitcoins are not money in a proper sense as there is no issuer behind them,” the report states. “Instead, bitcoins display the characteristics of a commodity to which users attach value. Unlike precious metals such as gold and silver, bitcoins have no actual utility value, bearing closer resemblance to glass beads.

...  “Bitcoin is a virtual currency without any value anchor and hence it may rise sharply or fall very suddenly. A core property of money is that its value is stable so that its purchasing power does not change markedly from day to day,” argued Hugo Frey Jensen, the governor of the central bank.

“In spite of the considerable focus, use of bitcoins as a means of payment remains very limited,” Jensen continued. “Against that background, the risks linked to their use are currently assessed to be limited to the individual user.

The Danish bank’s warning also comes three months after a European Banking Authority warning on cryptocurrencies which stated that “you need to be aware of the risks associated with virtual currencies.

These are statements borne out of pure, unadulterated, uncut ignorance. It is obvious that the issuers of the statements don't understand what Bitcoin is. A quick rundown:

Bitcoin (with a capital "B") is a protocol driven, value exchange platform designed to have applications written on top of it to take advantge of said protocol(s). It is similar to the Internet, which is a protocol driven, data exchange platform upon which many applications run. As such, bitcoin (with a lower case "b") is the earliest and most rudimentary of said applications, and application of digital currency. It is not Bitcoin, but an application written on top of Bitcoin. This is akin to email, being and application written on top of the Internet, or YouTube, Facebook, etc.

To asset that Bitcoin, or even bitcoin, has no value is to ignorantly fly in the face of evidence before you. I will give you a very pertinent example right now, of how applications written on top of Bitcoin, in bitcoin, can not only prove the Danish central bank wrong, but allow funds and individuals to profit immensely from their taking actions without knowing what they are doing. 

My startup, Veritaseum, programs bitcoin to allow you to speculate in the markets (any market) by trading derivative value through smart contracts (unbreakable, self-executing agreements). Below is a screenshot of a setup using the UltraCoin client to take a leveraged long position in Danish Krona exposure. This is a gamble that the Danish central bank, like the Swiss central bank, and the British central bank before it, cannot hold true to its promise to keep a peg to a currency that is tied to an economy that is essentially different from its own. In keeping with the theme that Bitcoin has no value, I want you to pay close attention the pertinent aspects of this smart contract summary, and then I wll use our illustrative tutorial spreadsheet to walk you though a scenario analysis of what can happen if this trade goes in the money and out. 

Long the Danish Krona in UltraCoin client 

So, why buy the Krone, even if you can command $2.1 million of price movement action with $5,561 reports? Well, there are a few more reasons that I haven't mentioned above.

  1. Well, I did mention this one above, but it's worth mentioning againg. They cut interest rates deeply negative and will keep cutting. This shows that they are already under attack as:
    1. Scared money flows in as they are considered a safe haven, and;
    2. Hot money flows in as macro-types pile on for the exact reasons delineated in this article.
    3. The ECB is about to announce another leg of their QE program which will put even more pressure on the Krone to shoot upward, requiring even more capital to keep down.
  2. The Danes don't intend to join the EMU, thus, despite all of the rhetoric that you hear, ex. (and I quote from above), "Economy minister Morten Ostergaard said after Monday’s rate cut that the policy was not in doubt and that “no serious politician” would propose leaving or changing ERM".  Ahem, if that's the case, then why not join the EU? Denmark is the only country that apparently wants to permanently ties its currency to the euro without joining the block. In other words, its seeking euro stability (that's actually quite relative) and ubiquity, but at the same time it wants to retain its economic sovereignty - quite likely looking over at Greece, shaking its head. If at any time Denmark wants to actually behave like an economically sovereign nation, it can do so by abandoning the euro peg (which Greece cannot do, since it gave up its currency) and not have to bother with re-denominating assets and liabilities, re-introduction of an old, but now new currency, and the credit risks, downgrades from uncertainty and strife that is bound to go along with it. So, despite what Danes are saying, what they are doing tells a totally different story!
  3. Denmark has pegged its official interest rate to that of the ECB's (with a slight premium) to finance its currency peg. Since my warning of the Pan-European sovereign debt crisis, Denmark has been forced to materially trail the ECB official rate. This has added materially to the cost of funding the euro peg. Chart source, the Economist.
  4. We all know the peg can break. After all, many funds and retail speculators thought the CHFEUR peg was stolid, and you see how that turned out. If you remember from part 1 of this series and the impossible Triangle, or the trilemma...

    The Impossible Trinity or "The Trilemma", in which three policy positions are possible. If a nation were to adopt positiona, for example, then it would maintain a fixed exchange rate and allow free capital flows, the consequence of which would be loss of monetary sovereignty.

    I think it's clear that Denmark prefers monetary sovereignty. Another possible angle is that breaking the peg once it comes under XXXX euros of pressure is that domestic imbalances will be rectified, at least on paper. The Danish current account surplus spiked over a  5 year period, implying the current exchange rate band has become undervalued. Do you catch any similarities between this and the British pound from the 90s?:
  5. The Economist reports (graphs below) that the Danish central bank's foreign currency reserves are up more than 3x's during the so-called recovery from the great recession through 2012, coinciding with Mario Draghi saying he would do “whatever it takes” to save the euro:
  6.  It's a safe bet to assume that the vast majority of this balance sheet ballooning (accumulation of euros) came from currency manipulation through came from central bank intervention. Remember, parts 1 and 2 of this series :
    1. Despite What You Don't Hear In The Media, It's ALL OUT (Currency) WAR! Pt. 1,

    2. and, Stab, er... I Mean... Beggar Thy Neighbor - It's ALL OUT (Currency) WAR! Pt 2

  7. The Swiss, who unpegged due to fright of being run over by a train, monetary policy was(is) unilateral in nature and not tied to the whims of the ECB, thus the Swiss National Bank had the lattitude to change course at will. Both the ECB and Danmarks Nationalbank are bilaterally mandated to defend the peg due to adherence to the rules of ERM2. The assistane from the ECB means a lot, something that the Swiss didn't have. In addition, this quote from the Danish central bank resonates with me...

"(Bloomberg) -- Lars Rohde, the governor of Denmark’s central bank, addressed speculators in what he said was a verbal intervention designed to stamp out any lingering doubts that he can preserve the krone’s peg to the euro.... Rohde said the central bank hasn’t coordinated its steps to date with the ECB, which is contractually obligated to support the peg should it ever breach its tolerance band. Denmark doesn’t need help from the ECB when the challenge is preventing the krone from appreciating, he said. The question of whether the ECB will step in is a “non-issue,” Rohde said. “This is a very special situation, because as everyone knows, we are all in negative territory in Europe but we are the only supplier of kroner. And we have unlimited access to Danish kroner, so we don’t have to have any coordination with anybody else.”"

Of course, there's always two sides to every story.

Caveat Number 1

All Danish government debt, up to 5 years out is NEGATIVE! That's extreme, that's unprecedented (meaning you have to guess at what the negative consequences are because you really don't know) and most importantly, that's extremely damaging to the Danish banking system! Here's an example re: Mortgage Yields. As mortgage bond yields are trading negative out to three maturities, mortgage banks are offering insanely low fixed-rate 1.5 percent bond-backed loans with a 30-year maturity. Just so we are clear, not just 30 year amortization, 30 year MATURITIES at 1.5%. This is not only the lowest rate in Denmark’s history, it's rate that offers mere basis points in raw return, and if we adjust for the significant risk of the mortgage and real estate industries, this is a materially negative risk-adjusted return. In other words, from an economic profit perspective, Danish mortgage banks are pretty much guaranteed to lose money on every loan that they make. Oh yeah, these are nominal returns. We haven't adjusted for inflation yet. Yes, inflation is currently quite paltry, but when you only have basis points to begin with, you really can't afford much - now can you?

What Mr. Rohde is not including in his rhetoric aimed at backing off speculators is that he is essentially racing against time. The fractional reserve banking system is built upon stacks and theories of debt and lending. When it can't lend profitably, it dies. Mr. Rohde is hoping his peg bears fruit before his banks start dying, but that is highly unlikely from a fundamental perspective. The ECB JUST STARTED its QE program, and is likely to ramp it up some more. In other words, we're just in the first inning of this game (my apologies for an American sports reference in this global article) and whatever suffering the banks may be going through will have to be maintained for a much longer time.

Caveat Number 2

The mandated assistance of the ECB to maintain the Krone/Euro peg comes in the form of unlimited credit lines to be drawn upon in times of insufficient FX reserves from the target central bank's balance sheet. Apparently, the ERM2 didn't anticipate the effects of European Bubble, Bubble, Toil and Trouble. You see, as is show in the Danish central bank balance sheet chart above, the problem is the exact opposite of such - the Danes are accumulating too many euros, with the spectre of having to buy many, many more. Credit lines do nothing for you when the problem is not depreciating currency digging a hole that needs to be filled, but appreciating currency building a mountain that needs to be moved. So, yes Mr. Rohde, you do have access to all of the Krone that you need since you own the printing press, but that's really not your problem, now is it? You have to sell Krone and buy Euro and related (and likely highly unwanted and rapidly depreciating) assets in increasing amounts, putting you right smack dab back where Switzerland was when they broke their peg, no? Buy high and sell low, that's the way to fend off us speculators, right?

Tell me how long can you keep that up while your banks are suffering negative economic profits and the ECB is in the beginning of a long-haul QE to never-ville?

The Economist recommends buy:

"a put option on the EURDKK exchange rate at the current price of about 7.43. Our preferred way to think of the cost of that option is to look at the amount of volatility in the exchange rate implied by the costs of hedging. As you can see in the chart below, the cost of protection has gotten a lot more expensive since the SNB’s policy change last week:

Implied volatility has jumped by more than 10 times — about what happened to 1-week implied volatility in EURCHF, despite the fact that not much has happened to the actual EURDKK exchange rate. This doesn’t necessarily mean that the cost of protection is expensive relative to the risks. While the implied 1-week volatility in EURDKK is a lot higher than it used to be, it is about the same as 1-week implied volatility was in EURCHF back when everyone thought the currency floor was unbreakable.

Of course, I recommend using those glass beads that the Danish National bank was referring to above. There is no price increase or implied volatility spike to measure. Let's take a look at how that would work if modeled out using Veritaseum's UltraCoin Trade Modelling Spreadsheet Version:1.0 Beta.

Revisiting the Swiss Franc uncoupling using the chart above...

Nordic deflation

We see a 22% jump in price relative to the euro. If a similar spike were to happen while the trade setup illustrated above were in place (actually, the trade setup above with the monetary amount at risk x 10, to allow for a bigger trade), it would look something like this.

Krona lonb model results

In case your wondering, the absolute net payout is bounded by what you put in (principal+collateral). If you increase that amount, you increase the amount you are able to claim from your counterparty. The leverage allows this (or the opposite, a loss) to happen very, very quickly if you ratchet it up. The collateral is just that, collateral - and is return to you as yours if it is unused. It's purpose is to allow you to stay in the trade if your orignal principal is eaten up and to guarantee that your counterparty gets paid up to the "smart contract"ual limits. The more you pay, the more can play!

Now, I'm sure many of you should be amazed at these glass beads, as the Danish Central Bank proclaims (because they apparently read the Satoshi whitepaper very, very carefully before going on record. Of those that are amazed, there are probably some of you saying, "That's cool and all, but  I don't want to trade through or have any exposure to bitcoin price volatility." Well, for one, the entire interface can be expressed in the (major) fiat currency of your choice. More importantly, the sytem does a lot to quell the noise of bitcoin. It's almost as if it wasn't there.

This is the result of this trade when bitcoin drops 10% mid-trade...

bitc drops 10 on Krone long trade

 This is what happens if BTC were to go catastrophic and collapse 40% during the trade...

bitc drops 40 on Krone long trade

Yes! You still profit roughly 9%. There are a plethora of other advantages to these "Glass Beads" as well...

UltraCoin summary


Download the UltraCoin Value Trading client, tutorial and trade modeling spreadsheet for free, no registration, no account activation, not even an email. Address. Just lock and load, and trade. 



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