Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


Scandinavian understatement …

by Brad Setser
March 27, 2008

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!


  • Posted by omar

    quick question: any posting on the Q4 current account coming soon? sorry for off-topic but interested in your thoughts

  • Posted by Mary Stokes

    Great post! While commentators have been focusing on the ability of Iceland’s government to bail out its banking sector (ex. FT and Telegraph point out banking sector assets have probably now grown to about 8 to 10 times Iceland’s GDP), the global implications of one of Iceland’s 3 big banks failing suggest that Iceland’s government might be able to secure outside help/funding, if need be, to prop up its banks.

    For example, Icelandic banks have their fingers in the UK banking market (two of Iceland’s three major banks have aggressively launched into the UK savings market over past 18 months.) So what role, if any, would the UK FSA play if one of these Icelandic banks were to fail? Could they just nationalize the UK subsidiary of the Icelandic bank or would they be involved in securing the health of the parent bank?

    On a related issue, there are clearly some issues in the financial sector – a case of the banks leveraging up – as you point out. Nevertheless, Iceland’s Supervisory Authority ran stress tests on the banks that showed them to be fundamentally sound. So there’s definitely speculation involved here.

    My question is: Why is Iceland being targeted and not Hungary or Romania (also relatively small, open economies w/ significant C/A deficits, flex. exch rates, and high credit growth) to the same degree? Is it the EU halo? Is it that Iceland is tiny and easier for speculators to influence so it’s a more attractive target or is it just a matter of time?
    A recent Evans-Pritchard piece also seems to indirectly be asking this question:

  • Posted by df

    why scanadavian ? Scandinavian ?

    well soooner or later the foreign countries will have to stop adding dollars to their reserves. Possibly even selling some. What will happen then to the US dollar ?

  • Posted by Anonymous

    I believe it’s the ISO code, rather than the Bloomberg code!

  • Posted by Guest

    If everything else in Iceland goes to pot, there are still all those fish. Edible, nutritious, delicious. LOL.

  • Posted by Anonymous

    might ms. stokes also hold an equity stake in rge?

  • Posted by Anonymous

    “…In fact, the countries of the European Free Trade Association (Norway, Iceland, Liechtenstein and Switzerland) and Russia are about to explore the feasibility and the scope of such a Free Trade Agreement…”

  • Posted by Anonymous

    “…The possibility of new charges is likely to prove embarrassing at a time when Baugur is preparing acquisitions in the US… Mr Johannesson was at a New York event on Thursday, outlining his investment strategy on the same platform as Geir Haarde, the Icelandic prime minister, who was issuing reassuring noises about the state of Iceland’s banks and the wider economy…”

  • Posted by bsetser

    df — thanks for catching my spelling error. I should never write something late at night without first running it through a spell checker.

    Absent dollar reserve growth, the dollar would fall v. a host of countries.

    Mary works for RGE.

  • Posted by bsetser

    p.s. long posts on the CADeficit data (q4) and chinese reserves are forthcoming.

  • Posted by Dave Chiang

    Let the Asians chew on fiat US dollar toilet paper while the Fed bails out Wall Street with irresponsible interest rate cuts. Does anyone think Bernanke is crossing the legal line by exchanging US Treasury bonds for subprime AAA-rated garbage? Is Ben Bernanke in the business of becoming the the largest subprime Slum-Lord of defaulting mortgage properties? – DC

    Japan Central Bank reports $187 Billion Losses in FX Reserves

    Losses on Japan’s $1 trillion foreign currency reserves amount to about 18.5 trillion yen (US$187.2 billion) when the dollar is around 100 yen, Finance Minister Fukushiro Nukaga said on Thursday.

  • Posted by bsetser

    DC — thanks for bringing the reported Japanese fx losses to my attention. China and india and a host of other countries that saw their currencies rise v the $ are also looking at large losses, tho china and india both hold more appreciating euros and thus will have somewhat smaller losses …

  • Posted by df

    I just signed a petition against free movement of capital across borders.

    For europeans it s here :

    I find it funny because … Frankly. The minute the asians and oil exporters stop pouring in money in the USA, do you think the USA will keep their borders open to free movement of capital ?

    Hey Brad.
    1 will you sign this petition right now ? (it is not restricted to europeans as far as I know)
    2 Let’s say we re in 2009 and Asians and oil exporters have stopped to add to their reserves. Indeed they are slowly selling them. THis drives up interest rates and pushes the dollar down. The FED is tempted to buy directly the treasury bonds (thus printing money) but it does not dare.
    Would you still be in Favor of free movement of capital accross borders ?

    The times they are uh changing.

  • Posted by Dave Chiang

    “South Korea pension fund says to shun US Treasuries
    Reuters, Thursday March 27 2008

    SEOUL, March 27 (Reuters) – South Korea’s National Pension Service (NPS), the world’s fifth-biggest pension fund, said on Thursday it was shying away from U.S. Treasuries because of falling yields and the weakening dollar.

    The move by the NPS could signal a big shift by financial institutions away from U.S. government debt into higher-yielding assets, the Financial Times said.”

  • Posted by df

    DC except Seoul has never been a fan of dollar reserve accumulation.

    I hope dollar reserve slows down. My fear though is that there are risks of a sudden run …
    And you DC are you in favor of free mobility of capital accross borders ?

  • Posted by Guest

    “…development economists made overmuch of the fact that developing economies would need investment in order to grow. That was also a convenient way to frame the problem, since international development agencies can hand out dough or arrange loans … this large-scale, not very successful experiment in financial globalization was a form of wishful thinking dressed up in economic rigor. And what is worrisome is that if a line of thought is appealing for ideological reasons (in this case, it conformed with conventional wisdom and pointed to a comparatively straightforward course of action) it is remarkably resistant to challenges until the counter-evidence becomes overwhelming…”

    “…authorities are increasingly going to have to consider a maxi-revaluation … the smallest possible revaluation that is nonetheless credible and likely to cause investors, especially speculative investors, to reconsider the direction of the RMB trade. This wholly unscientific approach suggests to me that we will need a 15-20% revaluation … It also means that a smaller revaluation will be a very poor policy choice…”

  • Posted by Guest

    “…it would be quite a milestone if China breaks 10% this month; it would be the first time in over 10 years. Let’s not kid around; things are getting expensive here…”

    “…In an unprecedented show of solidarity with Axl, everyone in America, except estranged GNR guitarists Slash and Buckethead, will receive a free can of Dr Pepper if the album [Chinese Democracy ;] ships some time — anytime! — in 2008…”

  • Posted by Guest

    “…It’s not that these risks didn’t exist before. It is that their confluence when experienced over a short period of time yielded results that were unforeseen to many…”

    “…It really was a perfect storm of bad judgment, malicious intent, a power structure out of balance, a weak Natl Sec Adviser, a marginalized secretary of state, an all-powerful veep, a lazy Congress, and outplayed British PM, a foolishly managed French foreign policy, an ignored military leadership, an Oedipal complex hall of fame President, and a media that focused on Rumsfeld’s funny press conference delivery instead of highlighting the fact that he was wrong, horribly wrong, on just about any point that mattered…”

  • Posted by Anonymous

    back to scandinavia: “Swedish prime minister Fredrik Reinfeldt said a ‘Yes’ vote in the proposed Danish referendum on the euro could impact Swedish opinion on the currency and pave the way for a fresh referendum here…”

  • Posted by DC

    The Fed cares only about the bailout of reckless and irresponsible Wall Street banksters by screwing the real productive economy across Asia and Europe. – DC

    Asian businesses and workers punished by Bernanke Fed’s “Cheap Money” monetary policies

    Anthony del Rosario, who crews an oil tanker plying the route between the Middle East and South Korea, is sending home less money to his family in the Philippines. Takeshi Okada, a shoe manufacturer in Japan, is concerned about the possibility of declining export sales.

    And Brenton Fry, who heads the import-export operation of an old Australian winemaker, Yalumba, is fighting to hold down retail prices for wine sold in the United States by cutting profit margins.

    All three have a common worry: The sliding value of the U.S. dollar against most global currencies is putting them under increasing financial pressure.

    The pain is felt well beyond Asia. President Nicolas Sarkozy of France said Wednesday that he wanted to work with Britain to press U.S. policy makers to put an end to the dollar’s decline.

  • Posted by Anonymous

    Why Retail Structured Products Depend on Iceland’s Economy: “Derivative based retail structured products (you know the type, give me 100 and I will give you 100 +/- “some market performance” in 5 years) have been with us for well over a decade. Until now, all of them have done exactly what they said on the tin. But as well as the payoff profile, investors now have to ponder a different issue: regardless of the product’s entitlement under the terms, will the issuer be solvent when this entitlement comes due? Is appropriate credit risk priced into these instruments? My example du jour is a Close Asset Management product: Japanese Accelerated Return Fund II… Two of these bonds, or 33% of the gross assets of the investment, are issued by the Icelandic banks Glitnir and Kaupthing (who? who indeed)… If one of these banks fail, Close will be hoping to avoid being added to that list [of retail financial disasters] courtesy of the Icelandic government pulling a Northern Rock stunt out of the hat…”

  • Posted by Anonymous

    re: “…Turkey is first in line for any stress test… “I wouldn’t want to keep any money in the Turkish lira: the puzzle is how it has stayed so high for so long…”

    “…From the Baltic to the Mediterranean, small local banks like Garanti are stepping in to finance corporate buyouts as big banks grapple with the running credit crisis. While the American mortgage crisis has metastasized around the globe — risky mortgage investments have turned up everywhere from Australia to Norway — many small European lenders have emerged relatively unscathed so far…”

    “In December 2005 General Electric Consumer Finance, owned by the well-known American corporation General Electric acquired 25.5% of our parent bank’s shares…”

  • Posted by Anonymous
  • Posted by Dave Chiang

    Is this a joke?

    ” Federal Reserve Chairman Ben Bernanke said in testimony before Congress that mark-to-market accounting is “one of the major problems we have in the current environment”. ”

    Excuse me, the reason for this systemic Enron-style fiasco is exactly because trillions of dollars in debt securities and derivatives are “not marked-to-market”. Now Bernanke wants to eliminate the “marking-to-market” which is the de facto equilvalent to destroying the capitalist marketplace.

    Perhaps someone can explain to me why we even need a capitalist system when nothing of real productive value is produced. Rampant Level 3 accounting fraud exists where assets are assigned an arbitrary valuation undisciplined by the marketplace. We can just make believe valuations of every asset class with the official blessing of Federal Reserve regulators.

  • Posted by Guest

    “…what’s the Securities and Exchange Commission doing now? It’s laying the groundwork to weaken the accounting rules for companies that can’t get their numbers right the first time… It wants to do this is by softening the longstanding benchmark for whether an error is “material.” …Here’s another doozie: “The determination of how to correct a material error should be based on the needs of current investors.” Got that? If you’re thinking of buying a company’s stock and haven’t yet, your needs don’t count, because you’re not a current investor…”

    “…Wall Street firms have become shockingly opaque… when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter… This isn’t because Wall Street CEOs are lazy, or stupid. It’s because they are trapped. The Wall Street CEO can’t interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile… At this point you have to at least wonder if Wall Street firms should be public companies…”

  • Posted by Guest

    Dave Chiang –
    Nice statement on Ben’s statement and the implied shortcomings of capitalist markets. Typical of his short-run (short-sighted) views.

  • Posted by Anonymous

    re: “Mary works for RGE”

    if you could persuade rge’s editor to update and complete this:,static/inc,bios/itemid,105/

    we wouldn’t have to ask quite so many questions.

  • Posted by Matt

    The most widely used definition of Scandinavia does not include Iceland. The term “the Nordic countries”, however, includes Iceland and the Faroe Islands.

  • Posted by don

    Brad –
    I really don’t think you have to worry about the failure of foreign central banks to fund our current account deficit. I think it much more likely that the U.S. would lose its taste for their currency policies, in which case we may see a replay of some scenarios of the great depression, where competitive devaluations led to outright protectionism. Bill Clinton’s “Japan bashing” may well give way to “China bashing” or “Asia bashing.” If the Asian nations refuse to allow their currencies to appreciate, we may see a reprisal Smoot-Hawley type trade measures.

  • Posted by gillies

    the japanese minister of finance sounds as though he would like mr. bernanke’s helicopters grounded. (url from DC above).

    fair enough. if the yen carry trade flows are reversed – who gets the job of foreclosing on the hot mud springs and the fish ?

  • Posted by psh

    ‘Imagine how much trouble the US economy might be in’

    Okay. If the US wanted to support the dollar, another 60bp on the 10-year rate would do the trick (or the equivalent in disinflation). That’s no big deal.

  • Posted by Judy Yeo

    don – no doubt protectionism will rise but it remains to be seen who will emerge as the bigger loser should punitive actions and reactions escalate.

    df- why wasn’t there a stop the free flow of capital across borders campaign in the mid 90s (pre Asian financial crisis) or even 2005-2007? Funny how these things always pop up when “capital flight” comes to mind! would you be a fan of malaysia’s mahathir? (just kidding)

    for all the angst regarding the losses on reserves, could the situation be read as merely putting up with losses on that front to avoid worst case scenarios where the US economy spirals out of control due to funding problems on a national level. Systemic disaster might make reserve losses look like peanuts, ‘cos when there are monkeys a plenty, you never know?!

    Early data points to record rise in reserves in China for January and February, wonder what brad makes of it?

  • Posted by df

    Judy I agree.

    I personnaly think we humans are muppets with little room to manoeuver the huge economic forces at play.
    RIght now the mood is protectionism, closing all borders, it s just a backlash for too much globalisation.
    All that is happening is happening along a deja vu scenario. And what can we do ?

    I look around and I don’t see any courageous leader around. Hey they ve all been kept out from political jobs these last years by private lobbyists.

    Now the time has come to chop some bankers heads.
    Then if things go on this way of course tarrifs will be put in place, some countries will turn fascist others communists anyway plannification is back. Markets have been proved a failure (except for austrians who ll blame the fed, congress, and of course will be right since no sane congress would have deregulated finance the way it has been…)
    It s nice to know that this crazy world is ending.

  • Posted by Guest

    Ok just to clear things up;

    Scandinavia (Geographical): Norway and Sweden only.

    Scandinavia (Cultural/language): Sweden, Denmark (east Scandinian language) Norway, Iceland, the Faroe Islands (west Scandinavian). This is the most widely used definition. Aland Island is essentialy Swedish speaking so should be included.

    Nordic (historical, modern day society, political): All of the above plus Finland. Baltic states? possibly Estonia because of their historical ties to Sweden and cultural connection to Finland, but it’s usually regarded as a Baltic state only.

    Useful knowledge no?

  • Posted by Anonymous

    I was recently going to buy some Iceland CDs through everbank. Very high rates and insured. I guess I should put that idea on hold. Anyone else considering it?