Tuesday, April 18, 2006
From Iceland to The Promised Land
by David Yu
Hi David
I'm an avid reader of your posts and greatly admire the effort you put in to enlighten others.
I'm sure you don't have time to answer every email, but I'd love to know what you think of the situation in Iceland. I'm trying to understand what's going on. Firstly it's a tiny market so the whole story is massively overdone, but I can't help thinking that the rest of the developed (indebted) world will face the same issues.
Iceland's markets have been very strong of course following deregulation and massive foreign investment (cheap energy for Alcoa etc.). Carry trade was also a big factor, and now it's turned into an all out speculative attack against the krona.
So people have taken on a lot of debt (especially since the caps on mortgage lending were removed last year), but there is very strong wage growth there and they just can't get the staff they need to keep up with expansion. All debt (including credit cards, car loans) is index linked, so people are suffering as their CPI is rising at 5+% a year. Unlike other countries such as the US and Britain where it's in the governments interests to understate CPI, Iceland reports a more realistic number. The markets have lost confidence in the Krona/bonds, but the central bank there is promoting transparency, and talks very honestly and openly about the issues facing them. They welcome speculation against the currency and say that the current weakness will help in the long run. Rates are likely to rise to over 15% this year, (higher than Turkey), yet they are likely to maintain AAA rating. So it's quite unusual.
The charts are a mess, stock market looks like Naz 2000 again, but the FX charts, esp. EUR-ISK and GBP-ISK are extraordinary. A nice steady downtrend (strengthening Krona) has been smashed to pieces in recent weeks, and the monthly chart spells serious trouble for the krona now.
Do you have any views on the economy there, or even the FX charts (as I don't expect you to be familiar with a country the size of a large town in Oklahoma).
Personally, I'm using this weakness to pay off the rest of my mortgage there. The weak krona is going to boost tourism and fish exports, and I believe in the fundamentals behind the expansion (i.e. unlimited amounts of energy, hot water etc..). They are also a very technologically advanced young society, with zero unemployment and a very high standard of living.
All the best,
Paul
And, I'm an avid reader of your eloquently written letter. Thank you for sharing your thought process so generously with me.
It's hard not to notice when a stock market took as bad a beating as Iceland did over a short period of just a few weeks (Chart 1 below). You're right. It does look like the Nasdaq in 2000 (Chart 2). The trouble in Iceland stems from what I've referred to in my in my Competitive Tightening article as unregulated global capital flows and forces of banking and finance maintaining the rate of interest.
Chart 1
Chart 2
As I've mentioned in the article:
"Foreign direct investment and foreign private investment are now playing a more important role. Foreign private investment, in particular, is increasingly channeled to emerging markets by institutional investors and trans-national corporations. Together, they control increasingly large amounts of assets that they can move around globally in search of high profits."
These fast moving flows of global money has found lucrative investment opportunities in countries like Iceland, New Zealand, and Turkey, etc. where rates stood at 11.50%, 7.25%, and 13.50%, respectively. And, when this speculative money suddenly leaves theses countries, it leaves these economies and their currencies vulnerable.
Meanwhile, Sedlabanki, central bank of Iceland, set out on rate raising binge in order to maintain its currency value and to compete for global capital flows. Sedlabanki has thus far raised rates 12 times in less than 2 years. The last one was a surprising 3-quarter increase on March 30, 2006. That, to me, seemed like a desperate attempt trying to stop the sudden reversal of foreign capital flows that led to krona's skid.
With current account deficit grown to be 15% of its GDP and net external debt shot up to over 400% of its current external receipts, central bank of Iceland may have no choice but to continue the rate hike in order to import global savings to finance its investment. It has nothing to do with fighting inflation, with transparent policy or not. It's a matter of Competitive Tightening.
We know central banks are the cause of inflation. And, we know when the forces of banking and finance succeed in maintaining rate of interest, income inequality ensues and demand diminishes. If this Icelandic experience sounds all too familiar to us, it's only because we're seeing it happen right here right now in the promised land.
My best wishes to the people of Iceland.
email: david_3011 @ yahoo.com
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