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Comment: In negative yield land– Denmark (Part two)

Investors are so enamoured with this country as a safe haven that they are willing to pay the Danish government to hold their money for two years. In part two of this featured comment, Marcelo Ballvé, discusses more possible reasons for Denmark's unique status

What is so special about Denmark, what is the secret ingredient that allows it and an elite group of other countries to pay negative interest rates on their bonds?

For part one of this post click here.

In the case of Denmark, a few statistics and facts emerge rather quickly. Most importantly in my view, there’s the credit report embedded in the annals of financial history.

Prudent policy-making

Denmark is a “default virgin,” the rather humorous term Carmen M. Reinhart and Kenneth S. Rogoff use to refer to the surprisingly few countries in the world that have never “outright failed to meet their external debt obligations.” Default virgins include all of Denmark’s Scandinavian neighbors: Finland, Norway, and Sweden. But also: Belgium, the Netherlands, Malaysia, Thailand, Hong Kong, Singapore, Canada, New Zealand, and Australia.

In other words, Denmark finds itself in the most conspicuously default-free part of the world– Scandinavia. And history matters. When a country or a region perseveres in paying debt through thick and thin, it earns the respect of sovereign debt market-watchers who never tire of reciting heroic historical acts of repayment (such as the fact that Colombia, even as the rest of Latin America declared default, paid all its obligations through the 1980s debt crises).

And Denmark has had its troubles, including banking and inflation crises. Most recently Denmark had a bank crisis in the late 1980s and early 1990s, when nearly one in every ten loans went bad in the aftermath of a credit spree. To clean up the mess, forty problem banks were merged, according to Reinhart & Rogoff.

When ratings agencies celebrate a country’s tradition of prudent economic policy-making, they mean that monetary and fiscal policy haven’t thrown things out of whack because of incompetence or been distorted for political purposes. But they also mean that the country has penny-pinched enough to pay what it owes without a Herculean effort.

Similar to Sweden

But Denmark is not so special in this respect, as I’ve mentioned. All of the Scandinavian countries have the same sterling history of honoring their IOUs, and all have “AAA” ratings assigned to them by S&P. And yet currently, out of the European default virgins listed by Rogoff and Reinhart (Switzerland is not in their sample), only Denmark has a negative yield on its two year bonds.

Sweden isn’t too far from negative territory, but still– why are markets rating Denmark significantly “safer” than Sweden?

So perhaps this is where other factors come in, like Denmark’s diversified and export-oriented economy, and its healthy current account surplus that is 4.6% of GDP. Also, Denmark’s debt-to-GDP ratio is a relatively OK 46.5%. And its manageable government budget deficit is about 3.5% of GDP– a deficit that has emerged only after stimulus policies post-financial crisis dented years of surpluses (by comparison in the United States the budget deficit is about 7.6% of GDP).

But Sweden has a very similar profile in all these macro statistics (and is more diversified than Germany-oriented Denmark in terms of its trading partners). So these factors might definitely help explain why Denmark has lower bond yields than the United States or Britian, both twin deficit countries, but again it doesn’t really explain why Denmark is further into negative yield territory than Sweden. Neither is part of the debt-laden Eurozone, and both have their own strong currencies.

Future exchange profits

Arguments can be made that Denmark has a deeper deposit base than Sweden in its banks, relative to the size of its economy. This liquidity in the form of household savings, is the last line of defense against a country’s insolvency. Also, Danish home prices have fallen recently while in Sweden they remain worryingly sky-high and rising (a too-steep fall could lead to problems for overextended Swedish households).

But these reasons don’t really explain the Denmark-Sweden spread, I don’t think. It may be just a wrinkle, a result of a complicated markets-based equation. Traders balance inflation, expected future exchange rates, and bond yields one against the other, and conclude that they’ll make some money off Denmark’s currency appreciating over the term of their investment.

Hence, they accept a negative yield, because when the bonds mature and they take their money out of Denmark they’ll make money once they exchange the Danish money into their own currency.

Conclusion: what matters in sovereign debt is nothing more mysterious than a track record, a history as a good borrower. In the last part of this post, I’ll veer completely off from the numbers and speculate irresponsibly on cultural theories of creditworthiness, and discredit them.

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