What’s up with Denmark?

February 26, 2015 | Kara Lilly Print

For a country whose population is smaller than that of NYC, the Kingdom of Denmark is getting a lot of press these days.

The Danish Krone has faced continuous pressure ever since the Swiss National Bank abandoned its peg in January. Speculators are betting that Denmark must also abandon its peg to the Euro and allow its currency to appreciate. And, like an old, favourite record, what we’re hearing is both a little funky and nostalgic.

First, the funky part. In response to sustained currency pressure, the Danish central bank has had to resort to creative tactics to dissuade investors from buying the Krone. Not only has it been selling the Krone to keep its value down, it has cut the interest rate on certificates of deposits four times (!) since the beginning of the year to negative 0.75%. Investors are now paying to deposit money in Denmark. And if that wasn’t enough, the bank has simply stopped selling new government bonds to investors.

Unfortunately, these tactics have not wholly waned investor speculation. Like the girl who turns down all the boys at prom, the Danish Krone has become more desirable.

Second, the nostalgia. Denmark’s current situation is intriguing but not new in the history of central banks. In fact, it reminds us of one fateful Wednesday in 1992; a day when investors and the Bank of England learned a valuable lesson on the power of currency markets.

Black Wednesday

In the early 1990s, the UK was part of an exchange rate system with Europe called the European Exchange Rate Mechanism (ERM). The predecessor to the Euro, the ERM was a semi-pegged system in which a country’s currency was fixed within a narrow range to another country’s currency. For example, the Pound Sterling was allowed to trade within a certain range of the German Mark. (Incidentally, Denmark never adopted the Euro and is now the last European currency still pegged to the original ERM mechanism – one krone is allowed to trade within 2.25% of the Euro.)

Because involvement in the ERM meant that interest rates became a currency tool instead of an inflation tool, the Bank of England had to set interest rates so that the Pound Sterling floated within its designated band—instead of being set to target inflation or economic growth.

Unfortunately, the UK’s entry into the ERM was not well timed; their economy was plunging into a deep recession triggered by a doubling of interest rates from 7.4% in the summer of 1988 to 14.9% in 1989. Nominal GDP fell between 1990 and 1992, unemployment reached 10%, the budget deficit was growing above 7% of GDP and company earnings were falling by double digits.

Meanwhile, Germany’s reunification led to rapid growth and upward pressure on inflation in 1991 and 1992. When the Bundesbank raised interest rates, the Mark became more attractive to investors and its value increased. Countries that had their currencies pegged to the Mark were now under pressure to raise their own rates in order to keep within the ERM band—the UK included.

Consequently, the BOE spent much of the period between 1990 and 1992 struggling to keep the Pound Sterling within its agreed upon range of the German Mark. The economy suffered and some began to speculate that this path was unsustainable. Among these was George Soros.

Three days before the Maastricht Treaty referendum in France in 1992, currency speculators such as George Soros began an attack on the Pound Sterling. They borrowed UK gilts (bonds issued by the BOE), only to sell them and buy them back later at cheaper prices; thus pummeling the Pound Sterling.

The selling was so intense that morning that BOE officials were buying £2 billion Pound Sterling an hour just to keep its price up. The Prime Minister and his advisors convened and decided to defend against the attack, choosing to increase the interest rate from 10% to 12%.1

It didn’t work. Once a complete lack of confidence set in, the jig was up. By 7:40 PM England’s government conceded defeat and announced that Britain would suspend its membership from the ERM. Soros had broken the Bank of England. This day was dubbed Black Wednesday.

The Lesson

The lesson from Black Wednesday is that despite the considerable faith we put in central banks to cure all woes, they are simply puppies when compared to the wolves that are currency markets. These markets can be tremendously powerful and affect big change. The BOE discovered this in 1992; South East Asia learned it in 1997; and we have been reminded of it in recent times with the Swiss Franc unpegging, Russia retracting its interest rate hikes and the current situation in Denmark.

This should not be surprising. Central banks might be powerful institutions, but the global currency market simply dwarfs most of them in comparison. The daily activity on foreign exchange markets is around $4 trillion USD every day, compared to the total $4.5 trillion USD balance sheet2 of the most powerful central bank in the world: the U.S. Federal Reserve. Central banks can often fend off small currency attacks, but they almost always lose when currency markets go big or go home against them.

This is an important reminder to Denmark for two reasons. First, whether the Danish central bank can maintain its peg will depend on whether currency markets allow it.

If currency markets truly wanted to force the peg, the central bank of Denmark could fight the pressure for a while but not likely forever. Thankfully for the Kingdom, pressure has not escalated beyond their ability to control it. This does not mean the Danish central bank has won; it just means they have not yet lost.

Second, simply because Switzerland abandoned its peg does not mean that Denmark will follow suit, despite the fanfare of some speculators. Again, if the peg still stands, the broad sentiment towards the Danish Krone is probably not as extreme as some speculators are saying. Yes, some pressure against the peg exists. The Danish central bank sold a record kr. 106.3 billion in January. But the pressure has not yet compared to that which confronted the BOE on Black Wednesday. The level of speculation against the Krone certainly does not imply a done deal.

Ultimately, what is going on now in Denmark is fascinating. It is happening because the world as a whole is topsy-turvy, with big central banks like the European Central Bank and the Bank of Japan heavily distorting currency markets through their actions. But policymakers should realize that central banks are not always the omnipotent forces that they recently have been heralded. History teaches us that when central banks battle big currency forces, they often lose.



This is the exact tactic that Russia’s central bank recently attempted when it increased its benchmark rate from 10.5% to 17% overnight – and just as it was for the BOE, the Russians failed.

russia 1024x588


  • Behzad 28/02/2015 5:00pm (5 years ago)

    Great commentary - very insightful. It's a vicious cycle happening and can potentially risk the central bank's credibility.

  • Mike C. 03/03/2015 3:46pm (5 years ago)

    Note however that the Danish National Bank is faced with a different problem than BOE: BOE desperately needed foreign currency to defend the pound peg. The danes needs kroner and can print as many as they want. Obviosly that may create some problems, but if the Danish National Bank wants to, it can defend the krone from appreciating.

    • Kara Lilly 06/03/2015 10:48pm (5 years ago)

      Mike: the point you make is valid. There are problems with printing an infinite amount of money to sell Kroner, but you're right that it is easier to keep a currency down than support it (for the reason you mention).

Join the Discussion

Stay Curious

Subscribe to receive our latest insights and quarterly updates.

Popular Posts

Capitalizing on cloud migration | EP65

The enemy is us: Mitigating confirmation bias

Introducing the new Mawer EAFE large cap strategy | EP64

What the FAANG is going on? | EP62


(Not) Boring Links

Business Models

Investment Approach

Mental Models


This blog and its contents are for informational purposes only. Information relating to investment approaches or individual investments should not be construed as advice or endorsement. Any views expressed in this blog were prepared based upon the information available at the time and are subject to change. All information is subject to possible correction. In no event shall Mawer Investment Management Ltd. be liable for any damages arising out of, or in any way connected with, the use or inability to use this blog appropriately.

Stay curious

Subscribe to receive our latest insights and quarterly updates.