How Gangsters Are Saving Euro Zone

Getty ImagesSome €285 billion worth of €500 notes are in existence, an annual growth rate of 32% since 2002.

(Please see Corrections & Amplifications item below.)

Gangsters, drug dealers and money launderers appear to be playing their part in helping shore up the financial stability of the euro zone.

That’s thanks to their demand, according to European authorities, for high-denomination euro bank notes, in particular the €200 and €500 bills. The European Central Bank issues these notes for a hefty profit that is welcome at a time when its response to the financial crisis has called its financial strength into question.

The high-value bills are increasingly “making the euro the currency of choice for underground and black economies, and for all those who value anonymity in their financial transactions and investments,” wrote Willem Buiter, chief economist at Citigroup, in a recent research report. The business of issuing euro notes, produced at almost zero cost, is “wildly profitable” for the ECB, Mr. Buiter wrote.

When euro notes and coins went into circulation in January 2002, the value of €500 notes outstanding was €30.8 billion ($40 billion), according to the ECB.

Today some €285 billion worth of such euro notes are in existence, an annual growth rate of 32%. By value, 35% of euro notes in circulation are in the highest denomination, the €500 bill that few people ever see.

In 1998, then-U.S. Treasury official Gary Gensler worried publicly about the competition to the $100 bill, the biggest U.S. bank note, posed by the big euro notes and their likely use by criminals. He pointed out that $1 million in $100 bills weighs 22 pounds; in hypothetical $500 bills, it would weigh just 4.4 pounds.

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Police forces have found the big euro notes in cereal boxes, tires and in hidden compartments in trucks, says Soren Pedersen, spokesman for Europol, the European police agency based in The Hague. “Needless to say, this cash is often linked to the illegal drugs trade, which explains the similarity in methods of concealment that are used.”

A spokeswoman for the ECB declined to comment on who uses the bills.

The ECB and its member governments are beneficiaries of the demand.

The profit a central bank gains from issuing currency—as well as from other privileges of a central bank, such as being able to demand no-cost or low-cost deposits from banks—is known as seigniorage. It normally accrues to national treasuries once the central banks account for their own costs.

The ECB’s gains from seigniorage are becoming increasingly important this year.

The ECB has taken hundreds of billions of euros of assets of unknown quality on to its balance sheet as it has reacted to the global financial crisis.

It holds more than €600 billion in collateral from banks to which it has made loans, and more than €400 billion in securities it holds outright, including government bonds.

Overall, the ECB’s balance sheet has grown to almost €2 trillion. It has a capital base of €78 billion. That creates leverage that makes it look like a “hedge fund on steroids,” Mr. Buiter wrote. It wouldn’t need to lose much on these assets to wipe out its thin cushion of capital.

That’s where seigniorage comes in.

In recent years, the profits on its issue of new paper currency have been running at €50 billion. In 2008, the year of the Lehman Brothers crisis, it was €80 billion.

Even with conservative assumptions about future growth of currency in circulation—at, say, 4% a year, which is in line with the ECB’s 2% inflation target plus a margin for economic growth—Mr. Buiter estimates future seigniorage profits for the central bank between €2 trillion and €6.9 trillion.

Thanks to seigniorage, he says, the ECB is “super solvent.”

An ECB spokeswoman says there’s no plan to withdraw high-value notes, national equivalents of which were used in six member states before the euro was launched. They will be retained when a redesigned series is issued in coming years.

Replacing them with small denominations would increase production and processing costs, she says.

Corrections & Amplifications

The volume of €500 notes in circulation is €285 billion, accounting for 35% by value of all euro notes outstanding. An earlier version of this article incorrectly said the €285 billion figure represented all euro notes.

There are 570 million €500 bills in circulation. The scale on a chart accompanying an earlier version of this article misrepresented the number as 570,000.

Write to Stephen Fidler at stephen.fidler@wsj.com

Britain’s bullion dealers are struggling to source enough gold sovereign and Britannia coins to keep up with surging demand ahead of an expected rise in capital gains tax (CGT) in the emergency budget.

Published: 11:47AM BST 10 Jun 2010

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Sovereigns are exempt from CGT

Dealers are reporting a backlog of orders for bullion coins recognised as UK legal tender, which are exempt from CGT.

Anthony Baird, managing director of gold dealer Baird & Co, said the company could not deliver any Britannia coins until August because of lack of supply.

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“We buy directly from the public,” said Linda Warner of bullion merchant ATS Bullion. “In the last couple of weeks, supply has been drying up because people hold on to what they’ve got in a situation like this.”

The supply situation is worse from overseas sources, with European sales onto the market of coins and other forms of investment bullion particularly slack.

Gold is in high demand in Europe as investors there seek out the metal as a safe store of value amid fears over sovereign debt problems in the eurozone, meaning fewer coins are coming back to market.

“We have a backlog of orders at the moment for sovereigns and Krugerrands,” said Caroline Jewell of Chard, a Blackpool-based coin and bullion dealer.

“We buy quite a lot of our gold from Europe, and [among] the Europeans at the moment demand is much higher than it is in the UK. European dealers don’t have anything to sell to us at all.”

In Britain, dealers believe that tax issues are of higher priority to investors than haven demand.

The Government is expected to raise CGT, levied on items such as the sale of shares, from its current flat rate of 18pc to a level closer to the 40pc higher rate of income tax as part of a plan to tackle Britain’s hefty deficit.

Dealers say the plans have prompted a significant number of British investors to buy the coins as a store of wealth.

“We have a lot of people materialising capital gains on existing bullion and moving into gold coins that wouldn’t be subject to capital gains, such as sovereigns and Britannias,” said Mr Baird.

Gold sovereigns, which have been in production since the 15th century, historically had a nominal value of one pound. Their current price fluctuates along with the spot gold price and availability.

The Royal Mint lists its 22-carat 2010 gold bullion sovereign, which weighs 7.99 grams, for sale at £230 pounds, and its limited edition 2010 sovereign proof coin at £340.

Gold prices hit record highs on Tuesday in dollar terms above $1,250 an ounce, and have also reached new peaks in euros, sterling and Swiss francs as turmoil on the financial markets prompted buying of bullion as a haven from risk.

Demand for gold coins has been strong internationally, with rising sales reported in the United States, Russia and Austria

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At the moment it may appear to be unthinkable, but all European Union eyes are on Greece, which due to economic problems could find itself uninvited from continuing in the EU’s euro currency union.

European Central Bank President Jean-Claude Trichet recently called the suggestion an “absurd hypothesy,” but on Jan. 15 Greece presented the European Commission with a three-year budget plan with deficit-reduction measures aimed at reducing what is now Europe’s biggest budget shortfall. There is serious concern that the deficit led to downgrading Greece’s debt during December 2009, sparking a rout in its bonds.

Mitul Kotecha is the head of global foreign exchange strategy for Calyon in Hong Kong. His quoted in the Jan. 18 The Wall Street Journal newspaper as saying, “Although debt concerns are unlikely to dissipate quickly, especially given Greece’s inability to convince markets of its plans to cut its burgeoning budget deficit, the ‘risk on’ tone is likely to have a stronger hand later in the week, driven in large part by strong Chinese data.”

When asked only a day earlier by the Reuters news reporting service what he thought of talk Greece might be forced to leave the “euro zone,” Trichet said, “I do not comment myself on absurd hypotheses, so that would be my response.”

The Jan. 15 Bloomberg Business Week reported Luxembourg’s Jean-Claude Juncker, who is identified as the head of the group of euro-area finance ministers, as saying, “Two things won’t happen: Greece won’t go bankrupt; but it has to make enormous efforts. The second point is that the hypothesis that a country will leave the eurogroup or euro zone is not a question.”

Juncker continued that leaving the euro zone would “cause unmanageable problems for a country.”

Talk like that could be likened to saying South Carolina won’t secede from the Union if Abraham Lincoln is elected president. In this current situation the EU might have to bring in the financial troops to bail out Greece somehow.

And they might have to. Goldman Sachs analyst Themistoklis Fiotakis, based in London, told Bloomberg Business Week Greece’s economic plan “still leaves a number of sources for uncertainty, which could aggravate a nervous market,” continuing, “Part of the euro underperformance can be linked back t the evolving pressures around Greece’s fiscal challenges.”

Greece joined the currency union at its onset in 2001, dumping its drachma currency for the euro. Greece now issues coins and bank notes exclusively in euro denominations, but all this would have to change if Greece becomes officially ineligible to continue as a currency union participant. Should Greece revert to the drachma its currency would experience currency exchange rate fluctuations against the euro as does any other foreign currency, including the U.S. dollar.

Greece and Italy both struggled to fulfill EU economic requirements to join the currency union when the currency union was being initiated. There are a number of additional countries now waiting to join the euro zone, but no nation to date has opted out voluntarily or involuntarily. If Greece was to leave the currency union this could present another dimension to the future of the entire EU.