Tuesday, October 21, 2008 5 comments ++[ CLICK TO COMMENT ]++

Iceland...An example of the unfolding shift to the left

I consider myself left-leaning so I don't mind it but many investors may not like it. I'm talking about the likely shift across the world towards left-wing econopolitical ideals. Iceland is a sign of things to come as I suspect that you will see monumental shift in their politics for the next 20 years.

More than any of its Nordic neighbors, Iceland under Prime Minister Geir Haarde imbibed the economic policies of Margaret Thatcher and Ronald Reagan -- state-asset sales, light regulation and corporate growth abroad through debt.

Now that the hangover has arrived, many of Haarde's countrymen want his Independence Party-led coalition to pay the price for turning one of the world's wealthiest countries per capita into a beggar state staving off depression.

Goverments don't control economies but they do influence it. The capitalist strategy has completely backfired in Iceland and it's hard to see them continuing down that path. It's sad to see one of the wealthiest countries completely disintegrate. It happens quite often in Asia and Latin America but the governments are highly corrupt or totalitarian in those countries. In contrast, when it comes to Iceland, it's hard to blame some dictator or tyrant.

Iceland was ranked fifth- wealthiest in the world per capita in the UN 2007/2008 Human Development Index. Now, it's facing shortages of imports including food and clothing. Controls on foreign currency payments have been enforced to favor imports of fuel, medicine and food.

The value of Iceland's currency has evaporated and an economy that outgrew the U.S. and euro region every year since 2004 at the least faces a prolonged recession, if not a depression. The economy may shrink more than 10 percent with inflation reaching 75 percent in months, says Danske Bank A/S Chief Analyst Lars Christensen.

The country's main stock index has lost 90 percent of its value, most of it in the past week or so, more than double the decline in neighboring Nordic countries like Norway and Sweden.

Iceland is still worth considering as an investment opportunity for those with access and high risk tolerance. The stock index collapse looks bad but that's because a big chunk of the banks in the index ended up being valued at zero. It's somewhat similar to the 2001 version of Argentina (recall how there were riots in the streets of Argentina; it refused to pay government debt to foreigners; its presidents--multiple within a short period of time if I recall--were sacked; and its currency collapsed.)

The IMF is set to intervene in Iceland but it's not clear what they can do, other than provide money. Unlike many other cases of IMF intervention, Iceland basically follows IMF strategies already.

My opinion is that a similar shift in politics will likely occur in USA. This is the end of the Great De-regulation that has been popular over the last 25 years. It's quite possible for Democrats to sweep the US elections.

As someone who is in favour of free markets, this will be a setback. But at the same time, we have seen what happens in markets with very little regulation (or where individuals and businesses side-stepped the regulations.) The extreme free-market supporters will say that excessive regulation was what led to the mess. Or they will blame central bank actions. But it's difficult to see how that's the cause when most of the mess seems to lie with private actors, often circumventing government regulations (eg. banks and their SIVs; banks using monoline bond insurers to arbitrage capital requirement differences; investment banks leveraged to the max; hedge funds living only off borrowed money (otherwise they won't make enough to sustain their business); etc.)

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5 Response to Iceland...An example of the unfolding shift to the left

October 21, 2008 at 1:25 PM

what about the fact that everybody was working on the assumption that Fannie and Freddie were essentially backed by the government (which, as it turned out, was correct).

They seem like a pretty big examples of too much government intervention in the past 40 years, especially since Fannie and Freddie are at the root of this problem. If there were never Fannie and Freddie to buy all of these mortgages, or artificially low interest rates created by the fed, there would never have been a housing bubble; or at least one as we currently know it.

But then again, I am a Republitarian. :-)

October 21, 2008 at 4:31 PM

I have to disagree with that Jeff. Contrary to what many say, Fannie and Freddie are the least of the problems. If anything they are the most stabilizing force right now.

Fannie and Freddie did not deal with the toxic subprime mortgages where most of the losses are. The vast majority of losses lie with private investors and banks. Most of what passes through the GSEs have not posted losses anywhere near the subprime stuff.

Some argue that the GSEs would have been bankrupt and they cite mark-to-market accounting but I'm not a believer in that so I don't entertain that view. Fannie and Freddie may become a problem but, if so, that would be years from now.

Furthermore, Fannie and Freddie have been in existence for many decades (Fannie for 50+ years I believe) so I can't see how you can blame them for the current problems. If they were really the cause how come the housing bubble didn't occur in 1995 or 1985 or 1975 or 1965 or pick-a-date-in-the-last-50-years?

The bubbles are mostly in private markets. You can see this by observing that most of the losses are with private investors and banks. Even the Iceland case illustrates how it was all private free market participants. Remember that it is not the national bank or government in Iceland that has collapsed. Rather it is the private banks.

The fact that government had little to do with any of this (except the argument that central banks kept rates too low) is why I am critical of the free market policies right now. It's really hard to argue against greater regulation.

October 21, 2008 at 8:56 PM

Compared to any political comparison, Iceland was already "left". With free healthcare, free universities and strong social system.

It is actually more likely that the movement will be to "right". Were the government will not be able to pay for the strong social system after the crisis.

Even thought the banks are now in hands of the government it is rather unlikely to be for very long.

October 22, 2008 at 12:13 PM

The sad thing is that it is not the free healthcare/education/etc that brought down the country. But rather it was the private banks.

October 22, 2008 at 3:08 PM


I will do my best to respond to your well thought out argument.

In regard to the GSEs, they were taken over due to the fact that they were no longer economically viable, if the government didn't take them over due to that, then it is acting as a hedge fund, and buying up cheap assets in an immoral manner. While a great problem has been caused by sub prime loans, the recent deregulation and loosening of underwriting requirements from what the market regarded as government backed lenders, increased the supply of home buyers (coupled with low interest rates) and made prices go through the roof.

As a result of there being nothing to lose for lenders from the ensuing rising prices, sub prime mortgages came out. In the worse case scenario of a default, a house would be auctioned off for more than the defaulting owner owed; everyone would win. Since markets overshoot in both directions, when they start to correct, leverage will kill you-just look at LTCM. Simply put, the sub prime lenders were relying on the government to keep housing prices artificially high by making the supply of buyers rise, printing money like there is not tomorrow, and creating a great deal of restrictions on the building of new houses.

The crazy thing is that government agencies still have yet to learn their lesson! One of my friends and his wife just received a $0 down FHA loan on a home which couldn't justify it's sale price based on cash flows that it can produce. That is total insanity on part of the government.

Speaking of LTCM, I will also bring up the argument that the "too big to fail doctrine" has created moral hazard, and due to the government intervention that occurs from time to time, it leads people to take on tons of unnecessary risk.

What shocks me the most about this, is that we have been listening to this bubble talk for years now, but no one seemed to care. It is truly a shock to me that things have unfolded as they have.

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