Norway was against Iceland before it was for Iceland
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.
May 18th, 2008 at 8:03 am
question: why people use foreign debt data when net data or IIP is, in my view, much better indicator? for example, ireland has huge foreign debt but they also have huge foreign assets. U.K. same thing! is there any reason why is foreign debt as a share of GDP so widely used? sorry for repeating question!
May 18th, 2008 at 11:53 am
I’m not sure this problem is unique to SWF’s. Plenty of people are mad at the “West” or the “United States” over the behavior of hedge funds and US multi-national corporations. You can say that US MNC’s are independent of US government control, but it really doesn’t matter.
When you deal with extremely large sums of money, there is no clear break between commercial and political decisions. The problem of a fund manager taking a short position in another company being regarded as a hostile act isn’t confined to SWF’s. Sometimes taking a short position in a company *is* a hostile act.
This creates a trade-off. If you insulate the fund management from the political leadership, you are going to run into situations where the fund management is going to end up doing things that conflict with perceptions of national interest of the politicians. On the other hand, if you don’t insulate the management, then people complain about decisions being “political” which they are.
(I should note that Norway is supposedly the model for how SWF’s behave.)
Again, one has to ask the question “what is the problem?” Personally, I don’t have any objection if Norway uses its cash to advance Norwegian national interests or if China uses CIC to advance Chinese national interests. The problem is the principal-agent problem. I do have a big problem if CIC uses its cash to advance the interests of the fund managers or the political leadership at the expense of the general national interest. This brings up the tricky question of defining national interest.
May 18th, 2008 at 3:37 pm
I think there are other occasions where an SWF risks being “political” even if it scrupulously avoids taking the other side of a government bet directly. The two that come immediately to mind involve shorts and overlay strategies. Some SWF-owning countries - China is a good example - don’t yet allow shorting of domestic stock (ok, it can be accomplished but not directly). Should a Chinese SWF use, in its alt-assets portfolio segment, a manager or strategy that shorts, that rather puts them in the position of an advocate for shorting… Similarly, should an SWF employ a third-party manager for portfolio overlay, that manager is almost certain to short to correct currency exposure, possibly contrary to central bank strategy. These rocks and shoals have not been contemplated in the regulatory advice to any SWF I’ve seen and are likely to cause friction down the road.
May 18th, 2008 at 4:37 pm
(Looks like the blog engine doesn’t like unterminated italics around the “read the rest” mark, front page is all italics)
May 18th, 2008 at 7:06 pm
it looks ok on my machine –
the software automatically puts a break after the third paragraph, which happened to be in the middle of an itlalicized quote. but the overall formatting still looks fine to me. if others are having trouble, let me know.
May 18th, 2008 at 7:53 pm
can you make full posts available in RSS pls? thanks!
cheers
May 18th, 2008 at 8:59 pm
Glory — I’ll look into it. I am not an expert at RSS feeds/ a big user so I have no idea how difficult this would be.
2fish — you are right that many countries, especially countries in Asia, often viewed private US banks and hedge funds as agents of the US writ large, not just as private actors. The US of course argued that the US government didn’t influence the actions of private bank and hedge funds, and thus there was no coordinated plot.
That said, there is a difference between private and public money. The US govenrment uses its public money abroad almost exclusively to promote political goals, not to try to make money. lending to the government of mexico to help it avoid default was meant to support US foreign and international economic policy, not to make money. Export credits support another policy goal. Development lending yet another. What the US doesn’t do, generally speaking, at the government level, is make big equity investments abroad. It also generally doesn’t bet against another countries currency or government — it may refuse to support a country in times of trouble, but it doesn’t take a simultaneous short position. The US is either long or flat.
the UK has in the past taken large “political” equity stakes. The UK government owned a big chunk of the Suez Canal until 56 I think. That didn’t work out to well — Egypt considered this a colonial legacy.
As a result, I do think that the expansion of sovereign equity investments — and the more active management of sovereign funds — does raise a new set of issues. There is always a continuum of sorts, as you note. But the scale of sovereign investment abroad suggests something really has changed.
May 19th, 2008 at 6:53 am
That said, there is a difference between private and public money. The US govenrment uses its public money abroad almost exclusively to promote political goals, not to try to make money
The line between private and public $ didn’t seem too obvious when Paulson found himself the subject of an investigation into whether he turned a blind eye to thealphabet soup business as part of a favour to former employers. The official reaction to the Venezuelan situation -how much of that was “inspired” by the energy businesslobbyists? Standard Petroleum didn’t exactly distance itself from the military forces it employed to “protect” its business interests in China in the early 1900s. Look, theoretically business and political interests should be kept apart but more often than not, they aren’t.
So SWFs are aiming for alpha? Unfortunately the economies of scale might just work against them- alpha tends to work well only when speed and disvcretion is applied alongside amazing insight; hedge funds have found that as more and more capital mloves in the same direction, returns (and therefore alpha) get squeezed. Good luck to moving those billions.
May 19th, 2008 at 8:05 am
bsetser: That said, there is a difference between private and public money. The US govenrment uses its public money abroad almost exclusively to promote political goals, not to try to make money.
1) The US *federal* government doesn’t use its public money abroad to make money, but US *state* governments most certainly do. From a US point of view the difference between the Federal and State governments might be extremely important (as is the Chinese distinction between the Central and local governments), but from the outside, it appears much less so.
2) The US government doesn’t do X. So?
May 19th, 2008 at 8:13 am
Yeo: Look, theoretically business and political interests should be kept apart but more often than not, they aren’t.
That’s actually one of the questions that I’m asking here. Whether and how business and political interests should be kept apart is something that needs to be debated.
As a practical matter, I don’t think business and political interests *can* be cleanly separated, since I happen to think that markets require a lot of government regulation and support to function. The question is how business and politics should interact, and I think we need to figure this out before trying to come up with SWF rules.
Also. the US situation in which an SWF is controlled by a subnational unit which is not subject to national control is a pretty common one, and it’s going to pose a major problem for issuing standards on SWF’s. Suppose the IMF issues standards for SWF’s, and the Treasury Department thinks that they are wonderful. What happens if the State of California or Orange County doesn’t like them?
This is going to be a very tricky problem in that if you have Treasury represent California at an IMF best practices meeting, then this radically changes the internal structure of the US government. If you have California directly interacting with the IMF in drawing up best practices, this is also going to radically alter the internal structure of the US government.
May 19th, 2008 at 12:56 pm
The 3×500 mill swap option will supposedly not be activated unless to defend against a future run on the ISK.
2008 is the time frame, but renewable (I presume for a year at a time). The eventual swap would be due a month after it was used, but extendable. That is pretty open ended.
It will be very interesting to see if, and how soon this will be utilized. This agreement might actually work as a bit of a deterance against a short raid on the ISK. Maybe that’s too optimistic a hope…
I still think Iceland would be better of pegging to the Euro, while preparing to join the EU. This going solo is too shaky a ride for us.
I would think you’re right to assume the managers of the Norwegian Sovereign Wealth Fund have had some kind of political message delivered about not trying to tip the scales against the Icelandic currency. I also think it is completely unrealistic to imagine any SWF not being used to political means, one way or the other. After all, money is power. Politicians don’t mind a bit of power…
How much power will oil exporting nations have to wield in the next few years?
May 19th, 2008 at 2:12 pm
Brad:”The US government uses its public money abroad almost exclusively to promote political goals, not to try to make money.. .”
Not public money, but yes to create conditions to make private money; usually political goals include as a main component the improvement of business enviroment; that means: promote present and future profits of US private investors and Corporations (frecuently government’s friends and supporters)at home and abroad. Also, a large fraction of US Defense Budget is devoted to this political goal; a lot more more money than several SWF, and with much more collateral damages: tears and blood. Brad: this is your democratic model?
May 19th, 2008 at 8:47 pm
pallj — my next post touches on the scale of the “financial power” the oil exporters in the Gulf have accumulated. I agree that the intent here is to make it clear that it isn’t worth betting against Iceland’s banks and triggering a run on said banks b/c the banks have — through the central bank — access to liquidity.
2fish — you are right to note that sometimes the line between private money and public power is a bit blurred in the us. US government support for Us “private oil cos” abroad is an obvious example, and one that has long made me a bit uncomfortable.
that said, the US has long relied on private companies to do things that state companies might do elsewhere — private defense contractors are one example. I think the us even privatized uranium mining/ enrichment … so there is a big difference between us institutional structures and the institutional structures of many rising powers.
that point also applies to the state pension funds. they do seek returns. but they also are quite transparent — ted truman’s paper highlights just how transparent they are. and they generally have an independent outside board that selects the head of the fund and the head of the fund selects the fund managers. the state governor doesn’t pick and choose which “foreign” company will get investment from the pension fund. politics sometimes does enter in, but the institutions still look to me very different from the institutions that have been set up to manage spare fx reserves/ the oil windfall.
why should the us care, you might ask. every country has the right to set up its own institutions. true enough. but here i think the crucial point is that these institutions have been set up:
a) to manage external investments, and every country has the right to regulate money coming in to its own country … sovereignty works in both ways
b) to manage surpluses that stem from policies that the us has opposed …
May 20th, 2008 at 9:07 am
yea, with carlyle buying booz allen’s gov’t biz — “With its deep ties to the defense establishment — the director of national intelligence is a former executive — Booz Allen has become embedded in a wide range of military operations such as planning wargames.” — say, one wonders what conflicts might arise, or aren’t disclosed; the panopticon should work both ways.
May 20th, 2008 at 10:06 am
bsetser: so there is a big difference between us institutional structures and the institutional structures of many rising powers.
Yes, and so??? Is there a belief here that US institutional structures are naturally better and that the world should automatically copy American institutions? If not, what exactly is the problem?
bsetser: that point also applies to the state pension funds. they do seek returns. but they also are quite transparent — ted truman’s paper highlights just how transparent they are. and they generally have an independent outside board that selects the head of the fund and the head of the fund selects the fund managers.
True, and personally I think that in managing CIC, that China should copy American institutions, but *why* I think that may be interesting. If it turned out that having Hu Jintao pick and choose what companies to invest in would maximize Chinese national interest, then I’d be in favor of having Hu Jintao pick and choose what companies to invest in. The trouble with a system without checks and balances is that you get massive amounts of self-dealing and if you put too much decision making power in one person, then inevitably Hu Jintao will make decisions that are in Hu Jintao’s interest rather than China’s national interest. Also Hu Jintao is quite busy. Thinking about what companies to invest in means that he doesn’t have time to think about earthquake disaster recovery.
To prevent this, you split up responsibilities. If Hu Jintao wants to write a big check to Angola to secure supplies of oil, then he discusses this with the State Council, orders CIC to write a check to the Chinese government, and then the Chinese government puts that money into the Angola development fund. That way lots of people see where the money is going, and we see that the money actually is going to Angola and not to Hu’s cousin. Also, you end up with lots of people who have time to think about Angola.
bsetser: a) to manage external investments, and every country has the right to regulate money coming in to its own country … sovereignty works in both ways
I don’t know of too many Chinese who object to that idea. I do know of a lot of Americans who would since this completely destroys the Reagan-Thatcher model of how the world should work. Also, I think that in practice, you’ll find its really hard to keep people from talking money when it is offered to them. There are a number of states that are travelling to China in order to attract Chinese investment in the US. One reason I think that all of this attention on SWF is misplaced is that I personally think that the vast majority of Chinese investment into the US will eventually take place outside of the SWF’s.
bsetser: to manage surpluses that stem from policies that the us has opposed
Again there is this problem of describing what it means for the “US” to oppose something. It certainly hasn’t opposed PRC/Gulf states currency policy enough or reserve accumulation to do any real about it, since it opposes steps that deal with the accumulation more than it opposes the accumulation itself.