Should you pay Denmark to take your money?

I’ve been watching the Danish bond market (with prompting from a Danish friend) for some time now. It’s been getting odder and odder.

Even as the world’s hedge funds have begun to accept that all is not necessarily well in Germany and have started betting on a bund sell-off (the ten-year benchmark yield now rises sometimes), they’ve been pouring money into Denmark.

The result? You now have to pay to lend money to Denmark – not just in nominal terms but in real terms too.

Denmark is now issuing debt with a negative yield (ie, the bit of paper you get when you lend the country money promises to return to you less than you have handed over).

What you might ask is going on? The answer is relatively simple. Denmark has more or less OK economic fundamentals – something that differentiates it from almost everyone else. So if you lend it money, you can be fairly sure you’ll get it back (well, most of it at least). It also has a good default history – that’s important given that history suggests that the more often a country has already defaulted, the more likely it is to default.

But the real point is that it has a currency that it voluntarily pegs to the euro. However, while that means it effectively uses the euro, it is not in the euro and it still has its own currency. It also isn’t on the hook for bailing out Italy, Spain, Greece, Portugal and so on. That means that speculators can use it to hedge against a euro break-up.

If you hold Danish debt and the euro doesn’t break up, you pay a pretty small price for protection. If it does, you make a killing as the Danish krone rises against the new/old European currencies. If the eurozone ends up dividing into a strong part and a weak part, you can be sure that the krone will be going with the strong part (such as it is), so you win there too.

And if the Danes are forced to let their peg go, thanks to the sheer weight of money pouring over their borders, those already in the krone will also make the kind of currency gains that will make the -0.08% yield on their original purchases look like chicken feed.

There is a suggestion that the flood into Danish debt represents a flood of investors forecasting the end of the euro. But it isn’t quite that. It more shows that they are setting up insurances against the relatively small risk that the euro might end and also against the much larger risk that it will continue, but that in doing so, it will weaken Germany’s fiscal position considerably.

The safe haven choice between Denmark and Germany is between two countries with reasonably strong economies, one of which has almost no choice but to take on financial responsibility for at least five other economies and one of which does not. Which would you choose? Quite.

The only thing to bear in mind before you too dive in to pay to lend the Danes your cash is that the Danish aren’t too keen on being used like this – rather, as is the case in Switzerland, they don’t want to be a safe haven and they certainly don’t want a rising currency.

And like everyone else they have tools they can use to stop it happening. They can print money just like us and just like Switzerland and they can make interest rates as negative as they fancy. That means that whatever happens in Europe, the krone might be a good bet, but it is not a one way bet.