from Follow the Money

Norway was against Iceland before it was for Iceland

May 17, 2008

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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In 2006, Norway’s Government Pension Fund (Global) -- managed by Norges Bank Investment Management – famously bet against Iceland’s banks.

Norway claimed this was just business; Norges Bank believed that Icelandic banks were more risky than the market thought, and thus produced a trading opportunity. Iceland claimed Norges Bank’s bet was a hostile act by another government. The Economist:

IN REYKJAVIK almost two years ago the Norwegians were throwing their weight around and the locals were furious. Having spotted that an Arctic boom was about to end, a government-owned fund from Oslo must have thought it had found an easy way to make money in a market it knew well. It began to sell short the bonds of Iceland’s over-stretched banks. Only common sense, you might argue.

Halldor Asgrimsson, then Iceland’s prime minister, did not see things quite like that. Why was the Norwegian state investing hundreds of millions of dollars to undermine Iceland’s economy? Had not both countries signed a Nordic mutual-defence pact against financial destabilisation? “We must protest against this action,” he told Morgunbladid, a newspaper.

In 2008, Norway’s central bank agreed to lend some of its reserves – also managed by Norges Bank Investment Management – to Iceland. Norway, Sweden and Denmark agreed to enter into a swap contract with Iceland’s central bank that allows the Iceland’s central bank to acquire euro 1.5 billion from the other Nordic central banks in an emergency. David Ibison of the FT:

Three Nordic central banks unveiled an unprecedented €1.5bn emergency funding package on Friday to support Iceland’s troubled currency and stabilise its banking system as the tiny north Atlantic nation tries to fend off the effects of the global credit crisis. The plan allows Iceland’s central bank to acquire up to €500m ($775m, £400m) each from the central banks of Sweden, Denmark and Norway in the case of an emergency, the first time the region’s central banks have joined forces to help a troubled neighbour.

Norway is now effectively long Iceland’s banks – since Iceland’s central bank would, in an emergency, act as the foreign currency lender of last resort to Iceland’s banks.

Presumably Norges Bank Investment Management got the message not to bet against itself.

Sovereign money ultimately is a little different than private money. Governments use their foreign assets to support their political objectives – helping a fellow Nordic country in its moment of need, for example – as well as to make money.

At times a government’s political and its commercial objectives may conflict. Making a commercial bet against the currency, equity market or banks of a friend, for example, can generate a bit of political friction.

Those tensions look set to increase over time. Many sovereign wealth funds claim that they want to morph in sovereign hedge funds. They don’t just want to hire external managers to get big returns. They want to learn the techniques their external managers use to get big returns. Those techniques include leverage – and going short as well as long.

It isn’t clear to me that countries struggling with concerns that their currency may already be too strong – take Brazil – really want sovereign wealth funds to join the world’s hedge funds and start betting on their currency. Would Brazil welcome a $10 billion CIC – or SAFE -- bet on the real? But it also isn’t at all clear that Brazil would welcome another country’s sovereign fund taking a massive bet against its currency …

I will be interested to see if the IMF’s best practices (or perhaps its set of good practices, as there is no agreement on what constitutes best practices) address these issues.

I bet not.

Iceland, incidentally, isn’t just a good test case for how a sovereign fund’s commercial bets (one assumes) can work against a country’s political goals. It also is a test case for how a small country can be buffeted by global capital flows – with money piling in when rates are high and the currency rising and moving out once the trend breaks. Iceland’s float has been anything but stable. But that is a topic for another time.

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