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Higher Interest Rates And Carry Trade Threaten Iceland's Economy

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http://www.timesonline.co.uk/newspaper/0,,...2113958,00.html

British firms face chill as Iceland crumbles

Icelandic raiders have bought large stakes in UK firms. With their economy now in trouble, will they be forced to bale out? Richard Fletcher reports

Buoyed by a booming economy at home, Icelandic raiders have bought dozens of British companies in recent years from food producers and retailers to stockbrokers and airlines (see below). Icelandic-owned firms now employ 65,000 people in Britain.

But now Iceland's economy is in trouble. Interest rates are soaring, rising to 11.5% last week, and the stock market and the currency are sliding amid warnings that the country is facing a debt crisis...

Questions are being asked about Iceland's economy and a number of analysts are wondering whether the fallout will spread to Britain.

So should we be worried? Could we see the Icelandic raiders retreat, forced to liquidate investments in Britain as a debt crisis gathers at home?...

In a simple but nevertheless risky trading strategy, known as a currency carry trade, investors have borrowed at low interest rates in America and Europe and invested in higher-yielding investments in Iceland.

But spooked by February's stock-market slump and a sharp fall in the value of Iceland's currency, investors have been pulling out the 'hot money' as fast as they can.

As the 'hot money' has rushed for the exit, questions have been increasingly asked about the strength of the wider economy and in particular the financial strength of Iceland's banks.

In a bearish note last month Richard Thomas, an analyst at investment bank Merrill Lynch, warned clients that a soft landing for the overheated Icelandic economy was not a certainty.

'The collapse in confidence was only the beginning of the Icelandic banks problems', he said. 'Icelandic banks are particularly vulnerable to shifts in market confidence. We estimate that the banks have a total of $17.8 billion (£10.4 billion) of debt maturing through to 2007,' said Thomas, who questions whether the banks will be able to refinance the borrowings. 'We see significant refinancing risk for the banks next year, unless there is a volte-face in market sentiment in the next six months or so,' he added.

Sigurdur Einarsson, chairman of Kaupthing, Iceland's largest bank, claimed that Merrill Lynch had simply got it wrong. 'It is nonsense. Overblown. It is a misconception. There is no crisis,' :lol::lol: he said.

Merrill Lynch believes Kaupthing needs to refinance $8.6 billion equivalent of debt in 2006-07.

Eirnarsson also argues that Merrill Lynch and others have overestimated the bank's exposure to the domestic economy. Having invested in foreign businesses, using foreign capital, the banks have diversified with overseas investments. In fact, Einarsson argues that it is wrong to describe Kaupthing as an Icelandic bank. 'We are a European bank,' he said.

But Thomas is not convinced, and reckons that it is actually very difficult to assess the true risk.

“While the banks have diversified their revenue sources by expanding abroad, the risks faced in the domestic market are far from negligible, and they have been compounded by a complex system of cross shareholdings and nominee accounts that make the true risks faced by these banks difficult to qualify.

“The banks appear to often co-invest alongside shareholders and customers in private-equity-style deals that we see as risky given their modest capital bases,” he wrote.

In a heavily leveraged environment, especially one where there has been a long period of economic expansion, banks start to become more lax in terms of their lending criteria. They continue to lend into the expanding market and take increasing risks. Connected parties aggravate these risks.

“However, as cheap capital becomes less available, the most egregious of these practices should start to unwind. It is the possibility that such an unwinding could be disorderly that worries us,” he added.

Morten Kongshaug, an analyst at stockbroker Danske Equities, believes that a hard landing will force the Icelandic raiders to dump their overseas holdings. As well as buying companies, Icelandic investors have taken substantial stakes in a number of quoted businesses...

Edited by Baz63

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banks start to become more lax in terms of their lending criteria

Hmmm, where else have we seen lending terms relaxed?

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Gordon is soon going to be like a swimmer wearing lead diver's boots--thrashing wildly as he tries to keep the "Miracle Economy" from drowning in a sea of economic reality.

BTW, anyone reading the latest on the Blair-Brown wars? My bet is Tony will keep Gordon right where he is and watch devilishly as the credit driven miracle unwinds.

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Gordon is soon going to be like a swimmer wearing lead diver's boots--thrashing wildly as he tries to keep the "Miracle Economy" from drowning in a sea of economic reality.

BTW, anyone reading the latest on the Blair-Brown wars? My bet is Tony will keep Gordon right where he is and watch devilishly as the credit driven miracle unwinds.

I think you are right and it will be very satisfying to watch.

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Interesting thread. As a slight aside, I found this:

http://www.savingiceland.org/

which is protesting against multinational corporations such as Alcoa (aluminium smelting) basing heavy industry on the island.

In Iceland, work has already begun on a colossal $1bn dam which, when it opens in 2007, will cover a highland wilderness - and all to drive one US smelter. Environmentalists are furious, but the government appears determined to push through the project, whatever the cost. Susan DeMuth investigates.

With the potential to exploit amongst the cheapest energy reserves in the world, it makes sense to base heavy industry in countries with cheap, virtually limitless geothermal or hydroelectric power, where they will be immune to volatility in oil/gas supplies and prices. The more that Iceland is in hock to the US, presumably the greater the influence the US might have over exploitation of Icelandic energy resources.

TLM

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Guest Bart of Darkness
Gordon is soon going to be like a swimmer wearing lead diver's boots--thrashing wildly as he tries to keep the "Miracle Economy" from drowning in a sea of economic reality.

That's a lovely mental image. :)

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Did Iceland also suffer a housing boom and, if so, how is this affecting house prices there?

They did suffer a housing boom and then some.

They experienced 40% HPI in August last year, which has now slumped to 25%. You'll find a graph here:

http://eng.fjarmalaraduneyti.is/media/wwr2006/WWR_230206.pdf

Their second largest bank is predicting an imminent recession and house price crash.

Which made me wonder are we following close in Iceland's wake? Clearly not. Look at these stats-we're nowhere near Iceland's position which is dire to say the least.

Icelands interest rates are 11.5%. The central bank raised their interest rates by 75 points :o:o:o a few days ago. Their current account deficit is 16 % of GDP , and inflation is at 4%. Their overseas liabilities amount to 86% of GDP and they have invested heavily in the carry trade. More interest rate rises are in the pipeline.

Iceland appears to be in a far more advanced state of decay than UK. It will be interesting to see how Iceland fares in the face of further domestic and global interest rate increases, particularly in Japan, given their heavy reliance on the carry trade.

But does this mean our interest rates can increase to 11% and our current account deficit expand to 16% of GDP without a property crash? As has happened in Iceland? Or has Iceland survived a HPC (edit: for the moment) because of factors peculiar to their economy?

http://quote.bloomberg.com/apps/news?pid=1...nURk&refer=home

The Krona has slumped 12% against the dollar on concern over accelerating inflation, ballooning bank debt and a record current account deficit. Soaring house prices have also fueled consumer-price growth, which has surpassed the central bank's target for two years

Iceland had a current account deficit of 16.5 percent of gross domestic product in 2005, the central bank said on March 7. Its negative international investment position, or assets held outside the island minus overseas liabilities -- a measure of a nation's indebtedness -- was 829 billion kronur ($11.6 billion), or 86 percent of GDP.

The krona also dropped after Merrill Lynch & Co. on March 7 said Iceland's banks had ``too much'' short-term debt. Danske Bank A/S, the second-biggest Nordic lender, said in a March 21 report that Iceland's economy is heading for recession.

Declines in the krona will continue to fuel inflation, as imports grow more expensive, Lars Christensen at Danske Bank A/S and Thora Helgadottir at Kaupthing Bank hf said on March 28.

Inflation has exceeded the Sedlabanki's 2.5 percent target since April 2004 and averaged 4 percent last year, according to the data bank of Statistics Iceland. Correcting for house price gains, inflation was 0.9 percent last year, the office said.

Edited by Baz63

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A great quote from a fantastic article on the subject

The other problem is in Iceland. This is the carry trade nightmare. Icelandic banks borrowed heavily on European markets and invested in high yielding Iceland bonds that were over 10%. In February the Iceland Krone collapsed and interest rates are rising in Europe. The result the carry trades are blowing up. The Iceland banks have debt the equivalent of 150% of Iceland GDP maturing in the next two years. A banking crisis and collapse appears to looming sharply on the horizon. And with it could go the Iceland economy where a country debt default is highly probable given their debt is 300% of GDP. The Icelandic Krone is expected to lose even more in the coming months and in turn that could trigger a bigger global problem. At this stage Iceland is in deeper trouble than Thailand was at the same stage in 1997.

Link

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Good article today on Iceland's problems, credit cycles etc from David McWilliams.

Worth reading in full ...........

This week, Iceland is in crisis. It is on the brink of a currency collapse, money is flowing out, its banks are finding it difficult to keep credit lines open, and an Asian-style crisis appears imminent. But what happened? How could a country full of hardy people known for prudence find itself in such a mess?

The answer is: debt. In recent years, Icelanders started borrowing in huge amounts to finance massive acquisitions abroad. Personal debt rose tenfold and total debt as a percentage of income rose rapidly to 86 per cent.............................

Iceland is experiencing the tail end of a classic textbook boom/bust credit cycle.

This cycle is best summed up in Charles Kindleberger’s seminal work Manias, Booms and Panics, which was first published in 1947 but is still invaluable reading for anyone interested in credit booms and assets cycles. Kindleberger - a renowned economist - studied many booms in prices from tulips to stocks and houses, and he maintained that all credit cycles follow seven similar stages..........................

http://www.thepost.ie/post/pages/p/story.a...3108-qqqx=1.asp

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Are Iceland's problems a dress-rehearsal for what is going to happen in the US and UK sometime in the not-too-distant future ?

I THINK SO.

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A great quote from a fantastic article on the subject

Link

Nice find and a good read.

The more I read about this the more I think Iceland could be the catalyst which causes widespread damage globally in the markets.

How?

Crazy indebtedness combined with rising interest rates underpinned by a lunatic reliance on the carry trade.

Can you believe the 3 largest Icelandic banks have drummed up foreign debt on tht back of the carry trade equal to 130% of their GDP. Unbelievable.

There has been a ripple effect from the krone crashing against the dollar and what with £1.7 bn invested in UK recently and 65,000 jobs here dependent on a healthy Iceland we will no doubt feel the effects as will our markets. Despite confident blusterings from leading Icelandic bankers things have detioriated at alarming speed in Iceland over the past 2 months.

Iceland will illustrate in gory detail the impact the collapse of the carry trade will have on a country's economy. How soon after Iceland will we follow?

http://www.telegraph.co.uk/money/main.jhtm.../14/ixcity.html

Investors flee Iceland banks as economy heads towards forecast 'hard landing'

By Ambrose Evans-Pritchard (Filed: 14/03/2006)

Iceland's banks were pummelled yesterday as the Nordic economy lurched into its third week of crisis, flashing an ominous early-warning signal for markets worldwide.

The krona tumbled another 3pc against the US dollar and is now down almost 18pc this year, a victim of "hot money" flight by investors scrambling for the exit doors at the same time. Reykjavik's blue-chip stock index was down 3.3pc.

The cost of insuring against a bond default by Iceland's three big banks - Kaupthing, Landesbanki, and Islandibanki - shot up another 20 basis points yesterday as investors became increasingly alarmed over their use of foreign debt to fund an equity spree. "This is a warning sign the euphoria we've se en in global markets is dissipating rapidly," said Julian Callow, an economist at Barclays Capital.

Funds had piled into Iceland to milk 10.75pc rates but panicked after warnings of a "hard landing" by the credit agency Fitch. The krona's crash set off global dominos, hitting New Zealand, South Africa, Hungary, Poland and Turkey. The rumbling thunder of monetary tightening by all the world's big central banks provided the background music.

The banking crisis followed when Fitch and Merrill Lynch warned that the banks could have trouble rolling over their foreign debts. Merrill Lynch said the big three faced refinancing on $17.8bn of foreign debt by the end of 2007, equal to 130pc of Iceland's GDP.

"With a debt distribution that is front-loaded, Icelandic banks are particularly vulnerable to shifts in market confidence," it said.

Analysts said the banks had leveraged the nation to the hilt, borrowing vast sums on the global capital markets for a Viking conquest of corporate Europe. "The whole county has become a hedge fund," said one economist.

Icelandic banks and investment groups such as Baugur and FL have snapped up chunks of Britain, with investments reaching £1.8bn by last year. They own supermarket-chain Somerfield, Booker cash and carry, Hamleys toy shop, Teather & Greenwood stockbrokers, Whittards tea and coffee, and a stake in Easyjet.

Their banking empire in Europe includes Denmark's FIH and Norway's Bnbank.

Paul Rawkins, a sovereign debt analyst at Fitch, said the country's net external debt had reached a colossal 450pc of GDP. "The risks of a hard-landing have increased, raising concerns about how well the broader financial system would cope," he said.

Edited by Baz63

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Nice find and a good read.

The more I read about this the more I think Iceland could be the catalyst which causes widespread damage globally in the markets.

I think Iceland is a symptom rather than a catalyst. Watch for New Zealand to follow this month, over 1/5th of Uridashi bonds originating from NZ are due to mature in April, which should dwarf new issuance and place heavy downward pressure on an already weak currency, whilst the central bank looks on like a rabbit in the headlights and imported inflation starts to shoot through the roof.

Edited by RobertPaulson

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Could Iceland be the first victim of the carry trade meltdown? Are we witnessing the death knell of a country's economy in real time? HPC gurus predicted this would unravel some months ago.

This article explains how it works using Iceland as a working example. Helpful to non-experts like myself:

http://www.thepost.ie/post/pages/p/wholest...qn=1-qqqx=1.asp

This week, Iceland is in crisis. It is on the brink of a currency collapse, money is flowing out, its banks are finding it difficult to keep credit lines open, and an Asian-style crisis appears imminent. But what happened? How could a country full of hardy people known for prudence find itself in such a mess?

The answer is: debt. In recent years, Icelanders started borrowing in huge amounts to finance massive acquisitions abroad. Personal debt rose tenfold and total debt as a percentage of income rose rapidly to 86 per cent.

For a few years, things were moving along nicely. The stock and housing markets roared ahead. As long as global interest rates remained low, Iceland could borrow significant amounts and spend at will. The central bank of Iceland kept interest rates above 6 per cent and this was deemed sufficiently attractive for yield-hungry investors to keep their money in Reykjavik.

However, the sting in the tail is that all this ‘hot’ money can leave as quickly as it arrives and sometimes, the trigger for a change in investor sentiment appears very remote indeed. As we saw in Dubai a few weeks ago, an increase in Japanese interest rates has had a detrimental impact on the Gulf state’s stock market, without anything untoward happening in Iceland itself. So when the Bank of Japan indicated that it would increase rates, investors sold their positions in Iceland. But why? Is there any remote connection between Tokyo and Reykjavik?

No, there is not, but investors borrowed in low-yield yen to put on deposit in high-yield Icelandic krona. As long as Japanese interest rates remain low, this made sense and the Icelandic system got an injection of liquidity. When Japanese rates began to nudge upward, the investors cancelled the bet and took their money out of Iceland with the effect of causing a liquidity crunch. In responses to this liquidity crunch, the Icelandic central bank this week, pushed rates up to 10 per cent which simply scares investors and means that more and more money leaves. So we get a self-reinforcing negative monetary cycle, only months after a self-reinforcing positive cycle.

Iceland is experiencing the tail end of a classic textbook boom/bust credit cycle.

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Guest consa

Hot money leaving a cold climate could signal the big freeze

It may just be a chilly island close to the Arctic Circle with a population barely above 300,000 and fish its main export - but it could end up cutting the value of your home and your share portfolio.

Events in and around the Icelandic economy, culminating last Thursday in a further interest rate rise from its central bank, may be the first sign of problems in global financial markets with unpleasant consequences for all of us.

http://business.guardian.co.uk/story/0,,1745379,00.html

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Hot money leaving a cold climate could signal the big freeze

It may just be a chilly island close to the Arctic Circle with a population barely above 300,000 and fish its main export - but it could end up cutting the value of your home and your share portfolio.

Events in and around the Icelandic economy, culminating last Thursday in a further interest rate rise from its central bank, may be the first sign of problems in global financial markets with unpleasant consequences for all of us.

http://business.guardian.co.uk/story/0,,1745379,00.html

This article illustrates nicely how the mere threat of rising interest rates in Japan, combined with Japan's abandoning quantitive easing, causes carry trade money to be withdrawn which in turn puts pressure on currencies. Iceland today, the UK tomorrow? If Iceland is the first domino to fall then other countries will follow, accelerating increases in interest rates. Could this be the trigger so many HPCers have been waiting for:

The rises have been less to do with the domestic economy than with preventing a run on the Icelandic krona. The krona has fallen 10% in recent weeks, threatening to further push up inflation because of rising import prices. The reason all of this matters is that Iceland, like many small or "emerging" economies, has attracted inflows of speculative money borrowed in Japan or the eurozone at very low interest rates and invested in Iceland where rates have been much higher. These are known as "carry" trades.

With world financial markets having been generally calm in recent years, and bond yields low, many investors have become complacent about risk. The Bank of England has repeatedly warned over the past year or two that the low interest rates around the world were driving an unhealthy "search for yield" among investors not conscious enough of risk.

As we wrote last month, bond yields have begun to rise in response to higher interest rates in the US and eurozone, as well as an announcement from Japan's central bank that it is to end its policy of flooding markets with liquidity and eventually raise interest rates from zero. Investors seem to be waking up to the fact that the era of super-cheap money of the past five years is drawing to a close. As a result, carry trades are less attractive, and some investors are starting to fret about their riskier investments, unwinding some, such as those in Iceland. Hence the fall in the krona. The problem for the Icelandic central bank is that its attempts to prevent a currency crash risk tipping the economy into recession.

That would be tough for Icelanders but could also spell wider problems. If investors keep unwinding carry trades, bond yields globally could rise much further, which could push down the prices of assets such as houses or shares. "The strange thing is that Iceland could eventually trigger a sharp slowdown in Britain's housing market," says Mr Jessop.

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I think Iceland is a symptom rather than a catalyst. Watch for New Zealand to follow this month, over 1/5th of Uridashi bonds originating from NZ are due to mature in April, which should dwarf new issuance and place heavy downward pressure on an already weak currency, whilst the central bank looks on like a rabbit in the headlights and imported inflation starts to shoot through the roof.

looks like the muppet bounce at the end of last week is over, NZD is crashing again

Edited by RobertPaulson

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How much is known about the extent of the Yen carry trade, and what these investors have been "trying on"? And - more to the point - where?

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  • 336 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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