Jekyll and Hyde

There were a couple of bits of good news from Kreppaland this week. Firstly, the assets of Kaupþing banki h.f. are reckoned to be enough to pay off German depositors in Kaupthing Edge. The Kaupthing Edge accounts in Germany were operated under the disastrous "branch" model chosen by Landsbanki for its Icesave accounts, rather than the more conservative "subsidiary" model that Kaupþing chose for most of its overseas retail markets. The news from Kaupþing's Icelandic administrators is equivalent to €1.2 billion that the Icelandic state will not now have to take on in short term loans: Prime Minister Jóhanna Sigurðardóttir was justifiably pleased at last week's annual meeting of the Central Bank.

A second piece of good news came from the United Kingdom. The administrators of Landsbanki's Scottish subsidiary Heritable Bank plc reckon that uninsured depositors (mostly UK local councils) will get 70–80% of their money back. As a spokesman for Kent County Council put it, they'd have lost more money had they invested their reserves on the London Stock Exchange.

The news about Heritable Bank didn't cause many ripples in Reykjavík, for reasons I'll come to in a moment. However Iceland's finance minister and tireless promoter of relations with Norway, Steingrímur J. Sigfússon, was ready with a comment: "It is very positive that there are valuables at hand but it does matter how they are disbursed of the interest of the nation."

The problem for Steingrímur Jóhann is that these "valuables" are not available to be disbursed "of the interest of the nation". Heritable Bank was a subsidiary of Landsbanki h.f., or to put it another way, Landsbanki was Heritable's shareholder. Shareholders are always the last to get paid in a liquidation and, if depositors are only getting 70–80%, it seems very unlikely there will be anything left afterwards. As a Scottish company, Heritable Bank was a full member of the UK Financial Services Compensation Scheme, which picked up the £500 million deposit insurance bill but which will also be reimbursed at "70–80%". The only benefit to Iceland is a bit of good press, and a reminder that the banks had (and have) assets as well as debts, but even that is welcome these days with all sorts of ludicrous claims being exchanged in multiple fora.

Now Steingrímur Jóhann is a geologist, not a lawyer, but one would hope that he understands the principle of limited liability corporations, especially given his current job. Icelandic Wikipedia doesn't have an article on them, but I found this one in Nynorsk if it helps him at all… After all, it's hardly the first time he's put his foot in it in less than three months as finance minister, a job that one would think is pretty important (not to say hellishly difficult) in today's Iceland.

On the other hand, like the character from the Robert Louis Stevenson novella, Steingrímur Jóhann has another side to his (political) personality. As well as being finance minister, he is also minister of fisheries and agriculture, a subject dear to puffins!

Steingrímur Jóhann's party, the Vinstrihreyfingin–grænt framboð (Left–Green Movement) were long ridiculed by "those who decide[d]" for Iceland: until, that is, the kreppa came and people started to realise that the old decisions were not as sensible as had been claimed. Steingrímur Jóhann was born on a sheep farm in Northeast Iceland, and already had experience as agriculture minister (1988–91), but was still taking on one of the more conservative sectors of any society from the position of leader of the "loony left". And, despite all the anxiety which surrounded his appointment, he has done remarkably well at the helm.

His predecessor in the fisheries ministry left a poisoned chalice in the form of a controversial set of fishing quotas, especially for the section devoted to commercial whaling. Steingrímur Jóhann sensibly decided not to take on the powerful fishing lobbies in a head-to-head, saying that there were probably more important things for the nation to be arguing about, but neither did he simply dodge the argument. In one of his last acts before tomorrow's election, he has commissioned a study of the contribution of whaling to the Icelandic economy, which many believe to be zero if not negative. He has calmly cooperated with the European Commission in their review of the EU Common Fisheries Policy – possibly a far more effective way to insure the future of 8% of the Icelandic workforce than any hypothetical hardball negotiation.

The last opinion polls suggest a clear victory for the parties of the current coalition government, and hence a clear break with the hegemony of Sjálfstæðisflokkurinn (Independence Party). But as Heilög Jóhanna prepares her new government, she will still have to take account of grubby little demands like "another job for one of ours!" or "the best job for me!" I can only hope that she manages to place as many ministers as possible with portfolios that they will do well. That means removing finance from Steingrímur Jóhann, but keeping him as fisheries and agriculture minister. The next few days will really show the commitment of Iceland's political class to move ahead together for the good of the country – or not as the case may be.

How much is a króna worth?

A couple of days ago, I commented on Sjálfstæðisflokkurinn's crackpot idea to unilaterally adopt the euro as Iceland's currency. Nobody has pointed out the flaw in my argument, so I will come clean and admit it myself! Iceland can't adopt the euro on its own, at least not yet and not at the current exchange rate.

Today's Central Bank of Iceland selling rate is 168.09 krónur per euro, down 12% since 1 February. On the other hand, if you look at Yahoo! Finance, they quote a rate of 290.66 krónur per euro… The European Central Bank hasn't quoted a ISK exchange rate since 3 December, when it was 290 krónur to the euro. How much is a króna really worth?

Entire textbooks have been written about exchange rate theory: fortunately, we only need to consider a very simple definition here. You'll just have to trust me that we would reach the same results through more complicated theory, but we can just consider that a currency is worth what people are willing to pay for it. This leads to two important conclusions, neither of which you are likely to hear from the mouths of Icelandic politicians.

Firstly, in reality, the króna is worth less than 168 to the euro. It must be, because 168 to the euro is the rate it "trades" at within Iceland, where there are strict controls on selling krónur. If the currency controls didn't exist, more people would want to sell krónur – that's only logical, otherwise there'd be no need for the controls! If more people are selling krónur, it's exchange rate will go down. Hence the CBI exchange rate is artificially high.

Secondly, the króna must be worth more than 290 to the euro. To see why, we need to look at where this exchange rate comes from. Imagine you are a foreign investor who bought a million krónur's worth of Icelandic government bonds when times were good (you would have paid about €11,000 for them). As things stand at the moment, you can't get any of your money out of Iceland. because of the currency controls. You have two choices: either you can be patient and wait for the currency controls to be lifted, or you can sell the bonds onto someone who's more patient than you are. If you sell the bonds, you have to agree a price for them, which is equivalent to setting an exchange rate for the Icelandic króna. The 290 krónur to the euro rate means that people outside of Iceland are selling a million krónur's of glacier bonds for about €3500 (once you've factored out interest payments, etc). Now the people who are buying these glacier bonds don't know when they're going to be able to get their money out of Iceland, so they apply a risk premium: they want to make a profit from their patience, so they buy krónur at an artificially low exchange rate.

In other words, we don't know how much a króna is worth and we won't know until the glacier bond problem is sorted out. We can say that the króna is not worthless. Jokes like "What's the capital of Iceland?"—"About twenty euros and a couple of dried cod." are exactly that: just jokes. The offshore exchange rate, as quoted by the ECB, reached a high of 200 krónur to the euro last November: that's about as good a guess as you're going to get for the real exchange rate, but it's only a guess.

Last week, Finance Minister Steingrímur J. Sigfússon predicted that "it is possible that there will be news about the arrangements of the glacier bonds at the annual meeting of the Central Bank of Iceland" last Friday. I've heard more reassuring politicians… Governor Svein Harald Øygard did indeed speak of the problem: apparently "the Central Bank also reviews selected measures that may allow the most impatient investors locked in by the capital controls to convert their holdings of ISK, in a way that does maintain the currency reserves of the Bank."

Hints of these "selected measures" came out over the weekend. Apparently Norðurál is looking at financing the new aluminium smelter at Helguvík with "glacier bonds". In effect, they propose to exchange ISK-denominated securities for Norðurál bonds denominated in US dollars. An interesting proposal, but the devil is in the details. What will be the exchange rate proposed to holders of glacier bonds? Will it even be made public? Or will this just be another deal between friends of the type which has made Icelandic business infamous over the last few months? In any case, the Helguvík smelter will cost 80–90 billion krónur, less than a fifth of the total value of the glacier bonds: at best, the Norðurál solution will only be a partial one.

A better bet would be to set up currency auctions to allow holders of glacier bonds to liquidate their króna capital. If, at the moment, the Central Bank of Iceland can only afford to pay back, say, €500 million euros to glacier bond holders, it should organise an auction. Investors could offer their bonds to the Central Bank at a given exchange rate and, once the pot of euros is used up, the CBI stops buying. The sellers (ie, bond holders) determine the exchange rate at which they wish to bid, and those who bid the most krónur for each euro get their bonds bought off them. Auctions could be organised every few months until the problem is resolved. That way, the Central Bank gets the benefit of the current offshore speculation on the króna and overseas investors get to put a cash price on their impatience. Don't expect this idea to become reality though – it would require too many people to face up to difficult realities as to the true value of Iceland's currency.