HOW GANGSTERS ARE SAVING EURO ZONE

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 EUR200 and EUR500
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 EUR500 notes outstanding was EUR30.8 billion ($40 billion),
according to the ECB.

Today some EUR285 billion worth of 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 EUR500 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.

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 EUR600 billion in collateral from banks to which it
has made loans, and more than EUR400 billion in securities it holds
outright, including government bonds.

Overall, the ECB's balance sheet has grown to almost EUR2 trillion. It
has a capital base of EUR78 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 EUR50 billion. In 2008, the year of the Lehman
Brothers crisis, it was EUR80 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 EUR2
trillion and EUR6.9 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.