Scandinavian understatement …
from Follow the Money

Scandinavian understatement …

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Iceland, if you haven’t noticed, has been having a bit of trouble.

Macroman likes to note that you can’t spell risk without ISK -- the Bloomberg (or ISO) symbol for Iceland’s currency. Borrowing yen to finance the purchase of Iceland’s currency used to be an easy way to make a lot of money. This year though it has been an easy way to lose a lot of money. The yen is up. The krona is down. A lot.

The FT leader writers are sympathetic to Iceland’s plight.

Not so long ago, Iceland’s big problem was all the money that poured into high yielding Icelandic assets. Given the small size of Iceland’s economy, that created problems -- not the least (for the time) a very strong currency. The FT argues that Iceland’s underlying fundamentals -- including abundant fish and cheap zero carbon geothermal energy -- remain solid. Its current account deficit, while still large, is coming down.

But Iceland’s banks borrowed heavily to expand abroad. They seem to be having a bit of trouble rolling over their debt, and could face additional risks if depositors start to pull their deposits. A world that is deleveraging rather than gearing up isn’t good for them.

And, well, I am not entirely sure that are arguing that Iceland’s banks are in no worse shape than Wall Street banks is all that reassuring.

Thor Herbertsson, co-author of an influential report in 2006 on Iceland’s economy .... said Iceland could be thrust into crisis as a result of the global economic situation. "Let’s say Iceland is not in more danger than some Wall Street banks" .

There though is one key difference between Wall Street banks and Iceland’s banks: Wall Street firms -- broker-dealers as well as banks -- now have access to the Fed.

Iceland’s government does have access to some additional sources of liquidity if it wants to try to support its banks. David Ibison of the FT:

The government of Geir Haarde, prime minister, and central bank authorities have readily available liquidity resources of about €2bn, mostly official foreign exchange reserves held at the Central Bank of Iceland, but the bank and the government also have various committed and uncommitted back-up lines.

The authorities additionally can borrow up to €1bn under existing US dollar or euro commercial paper programmes. Iceland can also rely on support from other Nordic governments under a loose but significant memorandum of understanding with the four other Nordic central banks regarding co-ordination of financial crisis management.

In the past Norway’s government fund has -- famously -- taken a short position on Iceland’s banks. It would be rather amusing if Norway’s government fund was short Iceland even as Norway’s central bank was supporting Iceland ....

However, I would hope that Norway’s fund is following the FT’s advice and isn’t shorting Iceland this time around.

More concretely, though, it is hard not to notice the contrast between the United States’ policy response to its troubles -- lowering rates from already fairly low levels even as the dollar has weakened -- and Iceland’s policy response to its crisis -- increasing already high interest rates to support the krona -- is striking.

As much as I worry about the implications of the United States growing reliance on central bank financing, the willingness of the world’s central banks to bet on the US and the US dollar despite low US rates and an expanding US fiscal deficit does have some real advantages. Imagine how much trouble the US economy might be in if the Fed was raising rates as fast as Iceland’s central bank.

UPDATE: Claus notes that the Icelandic banks could access the ECB for financing through their European branches. 

Editor’s note: Edited for rather embarrassing spelling errors this morning; I should not post something quickly late at night!

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