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Thread: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

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    Default (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    (snip)"Opinion: Will we go down the Icelandic route?
    Last week was one of the most cataclysmic in global economic history. Share markets collapsed as much as in October 1987, and the banking collapse was more dangerous. It was riveting to watch the huge Royal Bank of Scotland share price melt. Iceland crashed, leaving its external depositors in the lurch.

    Australian banks were in the frame. I spent some time each day monitoring their share prices, and advising friends that only the Public Trust guaranteed deposits in New Zealand. It seemed possible that Australia and New Zealand could follow Iceland.

    Iceland had some external support. The Scandinavians helped, and Russia offered a loan (perhaps in return for Iceland’s magnificent military bases). Who would help NZ, or their Australian cousins?


    Why should we worry about Iceland?

    New Zealand and Iceland have the similarities of small populations, an independent currency, huge current account deficits, inflation and high interest rates set to attract foreign capital. While both have friends, they are not part of a big currency bloc. They are vulnerable to being the playthings of speculators.

    The New Zealand dollar has fallen from nearly 80c to the US dollar in June to about 60c now (a 33% loss). The Icelandic Krona is in free-fall, and dependent upon an IMF rescue. In short, Iceland raises a key question for New Zealand: namely, can small countries with similar problems avoid a banking crisis, currency crisis and debt default?

    What happened to Iceland?

    When Iceland nationalised or rescued its three biggest banks, the British Government condemned its failure to guarantee British savers deposits in Icelandic banks in Great Britain. Gordon Brown said the move was “effectively illegal and completely unacceptable; he froze the assets using anti-terrorist legislation. More than 80 British local government councils, police, fire services and charities have frozen deposits.

    Inflation targeting

    Iceland is the first sovereign casualty of the credit crunch. But its failure was predicted by many, including this one. Partly it failed because its central bank has policies (similar to RBNZ) which target inflation. This policy has widespread support in economic theory but was disastrous in the current extreme circumstances.

    In inflation targeting, the Bank raises interest rates if inflation is above its target level and lowers them if inflation is low. Iceland did not have low rates: inflation ran high, sometimes reaching 15%. Its high Interest rates, like NZ’s, encouraged the borrowing of foreign currency.

    This created a path well known in NZ: a large inflow of foreign currency resulted, which increased the exchange rate and created a bubble arising from the interaction of domestic interest rates and forex inflows. A huge current account deficit ensued because exports are over-priced and imports very cheap.

    Another factor was the magnitude of the banking system: its assets were about ten times the size of GDP. They were well capitalized but in the last resort could not depend upon the support of a powerful state. An Icelandic government might guarantee a bank: but who would trust that guarantee when it comes from a 300,000 person state? One lesson of the crisis is the crucial ratio between the state and the size of its banks.

    Iceland might have survived if it had been part of the Euro bloc. Ireland also had a ferocious run but survived by offering a deposit guarantee. There was no currency issue because Ireland is in Euro.

    Spare a thought for the innocent Icelandic people. They assumed housing loans in foreign currency. There was a nice rise in house prices. What now? Payments on loans have increased by up to 50%! Inflation? About 30%! Employment? Mass layoffs. My point is that Iceland is a front runner: who knows whether New Zealand might also be very adversely affected by the current crisis?

    New Zealand

    Iceland and most New Zealand banks have transgressed some rules of good sense. Sometimes you can borrow short, and lend long. This works when the interest rate curve is normal, with short-term interest lower than long-term. But in crises the curve can invert, and short–term rates are higher than long-term. Then short-term borrowers have a tiger by the tail, and the tiger can turn and bite. It bit Iceland.

    A key point is that although Icelandic banks borrowed extensively abroad, they lent most of it abroad, and were perhaps careless about hedging. Kiwi banks are not subject to that risk, but they have liabilities of about $130 billion and 60% of that is due in six months or less.

    The situation is not entirely dire, as some funding is due from parent banks (mostly Australian). Moreover, NZ banks also hedge their exchange rate risk which is important when the exchange rate changes. NZ banks swap most of their foreign exposure. Nevertheless, a lot of funding is problematic in the short-term, and the RBNZ has warned the banks of their vulnerability in times of a credit crisis.

    I would add that Iceland’s gross assets plus liabilities is colossal, especially in comparison to Australasia. It should also be noted that New Zealand is more exposed than Australia. Australia’s net foreign liabilities are 61% of GDP, while NZ’s liabilities are 89% of GDP which is 45% higher. New Zealand also needs to fund a mammoth current account deficit of 8.4% of GDP.

    Afterthoughts

    Iceland is road kill; the first sovereign victim in the credit crisis. Iceland failed largely because it was alone. If it had been part of the Euro area, as Ireland is, it may not have collapsed. The lesson of the present crisis is that New Zealand is also isolated. Australia is similarly exposed. Iceland’s failure will put pressure on Australia, Denmark, Sweden, Singapore and Switzerland to lessen exposure to their banks and currencies."(snip)


    The potential plight of New Zealand and Australia are of course further compounded by the recent 'collapse' of commodities / raw materials prices ... which are these countries main sources of export income.

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    Why did the commodities prices collapse? There is more money than there are commodities (mined or dug out of the ground) in the world currently. Money can be printed while commodities cannot be made of out thin air!

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    well, even though commodities do have intrinsic value ... i.e. a 1 oz bar of gold will always be a 1 oz bar of gold ... in point of fact the market price of commodities goes up and down with short term changes in supply versus demand. From that standpoint, recently there have apparently been two major forces at work.

    The first is a reduction in demand based on a reduction in consumer spending / business levels. New cars, new appliances, new houses etc. all demand large amounts of steel, copper, aluminum, plastic etc. Manufacturing of steel, copper, aluminum etc as well as shipping steel, copper, aluminum etc. demands large amounts of oil. Same principles apply for virtually every business, as every business consumes raw materials of some sort and consumes energy of some sort as well. Thus if the same amount of oil is being pumped, the same amount of copper is being mined, the same amount of aluminum is being smelted etc. but at the same but the volume of oil, copper and aluminum being purchased for consumption is falling off, the price of those commodities will fall. This is the reason that OPEC is now scrambling to significantly reduce the rate at which oil is being pumped !!!

    The somewhat new wrinkle in the commodities markets, of course, is that thanks to futures contracts most commodities now trade in 'paper' form as well as trading the 'real thing'. As the subprime mortgage meltdown caused money to exit 'paper houses' i.e. mortgage bonds, much of that speculative money flowed into 'paper commodities' i.e. commodity futures contracts. Arguably this artificially caused commodity prices to rise by artificially increasing demand for future delivery of commodities (that the speculators never intended to actually take delivery of or actually consume to manufacture something !). However, as futures contracts matured, and delivery of the 'real thing' became imminent, the speculative commodity futures contract owners who had no real 'use' for those commodities were forced to sell the 'real thing' onto the spot market. This is arguably the reason that the price of many consumable commodities like oil, copper, aluminum etc. has recently dropped to something like 50% of previous levels in US dollar terms.


    In specific regard to this thread, i.e. Aus and NZ being 'commodity based' economies, just as speculative money flowed into and out of commodities futures contracts that same money essentially flowed into and out of the Aus and NZ currencies. This in turn had a LARGE impact on the international exchange rate of the Aus and NZ currencies, an impact on the official interest rates applying to the Aus and NZ currencies, an impact on the domestic price inflation rate applying to Aus and NZ economies etc. Thus from the standpoint of an American, it appears that the US dollar denominated prices of oil, copper, aluminum etc. have fallen a whole bunch recently ... which makes everything 'cheaper' since we are buying in US dollars. But for Aussies and Kiwi's, their currencies have fallen right along with commodity prices. Thus to them the price of oil, copper, aluminum etc. appear to have stayed the same ... but the price of everything imported (like food, many manufactured goods etc.) appears to have INCREASED. And that increase is MAJOR, given that the Aus and NZ dollars have devalued by 33% or so in the past three months in terms of international exchange rate.

    And for global investors in Aus and NZ, the falling exchange rates of these currencies makes for a 'double whammy' ... as the foreign investors not only take a loss on the declining share price of their Aus and NZ commodity based investments, but they also take a second loss upon reconverting the Aus or NZ dollar proceeds from selling off their Aus and NZ investments back into their 'home' currencies. Thus a dropping of the Aus 200 stock index by the same 33% over the past few months combined with a 33% currency exchange loss has translated into a 50%+ loss to foreign investors ... no wonder they are now 'racing for the exits'. And this in turn will arguably leave Aus and NZ banks extremely short of capital, as well as leaving Aus and NZ gov'ts extremely short of tax revenues !

    ~
    Last edited by Melonie; 10-24-2008 at 01:25 AM.

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    Didn't look anything like the end of the world during trading in AU today, but hmm...
    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
    - Dr John Zoidberg

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    well the downhill slide continues for sure ... falling another 6-7% yesterday alone !!!

    (snip)"Oct. 24 (Bloomberg) -- The Australian and New Zealand dollars fell this week to the lowest levels against the yen in at least six years as investors sold higher-yielding assets.

    The currencies headed for their third weekly drop this month as Asian stocks slid on signs the world economy is on the brink of a recession. Investors bought back yen they borrowed in so-called carry trades used to purchase assets offering higher returns in Australia and New Zealand. The two nations' dollars also fell versus the U.S. currency as the price of commodities the countries export plunged on concern demand will falter.

    ``What you have is the global economy going down, commodity prices coming off and the old theme of global de-leveraging,'' said Thomas Harr, a senior currency strategist at Standard Chartered Plc in Singapore. ``All of these issues are negative for the Aussie and the kiwi and positive for the yen.''

    Australia's dollar dropped 13.7 percent this week to 60.42 yen as of 6:03 p.m. in Sydney from 70 yen on Oct. 17 in New York. It reached 60.17 today, the lowest since October 2001.

    New Zealand's currency declined 11.8 percent for the week to 54.89 yen and touched 54.56, the weakest since September 2002.

    The Australian dollar fell 7.3 percent to 63.84 U.S. cents from 68.88 cents in New York on Oct. 17. New Zealand's dollar dropped to 57.52 cents, losing 5.7 percent for the week. It touched 57.41, the lowest since September 2003. "(snip)

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    and this Australian commentary just appeared on a professional investor's BBS ...

    (snip)"More fund managers are expected to suspend redemptions on their mortgage funds, after a rush of payouts saw more than 30 mortgage funds put a freeze on the withdrawal of capital by investors.

    Customers have been flocking to institutions guaranteed by the Federal Government, causing some Australian funds management companies to freeze payments to investors.

    Yesterday investment companies Babcock and Brown, AXA Asia Pacific and Perpetual announced they would be suspending withdrawals from their commercial and property funds. AXA Asia Pacific says policy holders will have to wait six months before they can access their money.

    Richard Gilbert from the Investment and Financial Services Association says the Government needs to resolve the problem in the investment industry as soon as possible.

    "The industry is ... between $15 and $18 billion depending on how you assess it," he said.

    "Thirteen of the top 20 funds are now closed, and so we're probably talking, two thirds of 15, about $10 billion, $12 billion frozen, as we speak."(snip)

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    I agree...things are dropping like rocks!

    I just can't get into the "buy theory" today...

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    those 30 mortgage funds put a freeze because they arent govt guarenteed
    and they have had a run on their funds

    the aussie dollar will bounce back
    but atm monement i dont mind a weak aussie dollar beacuse im making a heap outta your usa market
    and i wonder who keeps deleting my posts

    nice to see you have a open mind melonie
    other people just cant air a different view and i thought the usa
    prided itself on free speech!!!!!!!

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    those 30 mortgage funds put a freeze because they arent govt guarenteed
    and they have had a run on their funds

    the aussie dollar will bounce back
    but atm monement i dont mind a weak aussie dollar beacuse im making a heap outta your usa market
    and i wonder who keeps deleting my posts

    nice to see you have a open mind melonie
    other people just cant air a different view and i thought the usa
    prided itself on free speech!!!!!!!

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    BNB are dodgy... ignore them except for laughs. Yeah, the drop in the dollar has been a bit sudden - I guess maybe I'm not so bothered because it was down around these levels only a few years ago so we're sorta used to it The ASX was up, then slid a titch downwards on Friday, so it's not like there was a load of panic selling or anything.
    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
    - Dr John Zoidberg

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    here's the reason that the fall of the Aussie dollar hasn't been steeper ...



    (snip)"For a second straight trading day the Reserve Bank of Australia intervened in the currency market as the Australian Dollar traded near five-year lows against it’s American counterpart. By purchasing the Australian Dollar, the central bank artificially props up the South Pacific currency in an effort to stave off further declines. Last week saw the currency plummet 9.7% against the greenback and 16% against the Japanese Yen."(snip)

    Unfortunately for any country except China / Japan / Russia, their foreign currency reserves (needed to intervene in world currency markets to prop up the exchange rate of the home currency) are woefully small in relation to the size of the world currency market they are trying to 'tip'. As a result, such central bank interventions offer only temporary relief.

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    Default Re: (early) weekend commentary - AUS and NZ following in Iceland's footsteps ?

    Yep. Ack
    Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor
    - Dr John Zoidberg

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