Has Iceland Gone Loony?

Barrie McKenna of the Globe and Mail reports, Iceland eyes loonie, Canada ready to talk (h/t, Mikey):

For 150 years, no country has expressed interest in adopting the Canadian dollar -- the poor cousin to the coveted greenback.

But now tiny Iceland, still reeling from the aftershocks of the devastating collapse of its banks in 2008, is looking longingly to the loonie as the salvation from wild economic gyrations and suffocating capital controls.

And for the first time, the Canadian government says it’s open to discussing idea.

In brief remarks to be delivered Saturday in Reykjavik, Canadian ambassador Alan Bones will tell Icelanders that if they truly want the Canadian dollar, Canada is ready to talk.

But he will warn Icelanders that unilaterally adopting the loonie comes with significant risk, including complete loss of control over their monetary policy because the Bank of Canada makes decisions only for Canadians and the Canadian economy. He’ll caution, for example, that giving up the krona in favour of the Canadian dollar (CAD/USD-I1.01-0.004-0.36%) will leave the country with few levers, short of layoffs, to counter financial shocks and fluctuations in the loonie.

A group of prominent Icelandic business leaders approached Mr. Bones last year about the idea. And his speech Saturday, to a meeting of the opposition Progressive Party, marks Canada’s first public response.

The Bank of Canada, which referred all calls to the Finance department remains tight-lipped.

“We don’t speculate on another country’s currency or domestic issues,” Finance department spokesman Jack Aubry said.

There’s a compelling economic case why Iceland would want to adopt the Canadian dollar. It offers the tantalizing prospect of a stable, liquid currency that roughly tracks global commodity prices, nicely matching Iceland’s own economy, which is dependent on fish and aluminum exports.

There’s also a more sentimental reason.

“The average person looks at it this way: Canada is a younger version of the U.S. Canada has more natural resources than the U.S., it’s less developed, has more land, lots of water,” explained Heidar Gudjonsson, an economist and chairman of the Research Center for Social and Economic Studies, Iceland’s largest think tank.

“And Canada thinks about the Arctic.”

In a recent Gallup poll, seven out of 10 Icelanders said they would happily dump their volatile and fragile krona for another currency. And their favoured alternative is the Canadian dollar, easily outscoring the U.S. dollar, the euro and the Norwegian krona.

Iceland is also in a bind. The country imposed strict currency controls after its spectacular banking collapse in 2008. Foreign-exchange transactions are capped 350,000 kronas (about $3,000). A major downside of those controls is that foreign investors can’t repatriate their profits, making Iceland an unattractive place to do business.

Those capital controls are slated to come off next year. And many experts fear a return to the wild swings of the past -- in inflation, lending rates and the currency itself. Iceland is the smallest country in the world still clinging to its own currency and monetary policy. The krona soared nearly 90 per cent between 2001 and 2007, only to crash 92 per cent after the financial crisis in 2008.

The official government plan is to go to the euro. Iceland has applied to join the European Union and eventually the euro zone. But that’s not looking like a very attractive option these days. And formal entry could take a decade, experts said.

The other options are to peg the krona to another currency, such as the yen, greenback or euro.

And finally, there’s the route of unilaterally adopting another country’s money.

Icelandic officials have apparently reached out to the Bank of Canada and the Finance department about the idea.

It’s hard to imagine Canada would object. Iceland wouldn’t have a say in Canadian monetary policy and the dollars coursing through its small economy ($12-billion in GDP versus Canada’s $1.8-trillion) would be a blip in the Bank of Canada’s management of the money supply.

Unilaterally taking on another country’s currency is not unheard of. El Salvador took on the U.S. dollar in 2001. Ecuador did the same in 2000. And Kosovo adopted the euro in 2002.

There are some good reasons Canada might want to see Iceland embrace the loonie.

“If you join a new currency area it means you are completely open to businesses from that area,” Mr. Gudjonsson pointed out.

Adoption of the Canadian dollar could open opportunities for Canadian shipping companies, fish packers, banks, insurers and eventually oil distributors and service companies as the country taps undeveloped resources.

“Trade between the countries would obviously multiply,” Mr. Gudjonsson argued.

But the greatest benefit for Canada could be enhanced geopolitical influence in a region that’s poised to grow in economic clout.

The Arctic is the last frontier for the mining and oil and gas industries, sectors where Canada is already a global player. It holds an estimated 22 per cent of the world’s remaining conventional oil and gas, and vast untapped mineral potential.

The transition wouldn’t be easy. The Icelandic government, through its central bank, would authorize commercial banks to exchange kronas for loonies. At today’s exchange rate, it would take roughly 100 kronas to buy a dollar. Iceland would need very strong reserves to conduct the operation, which might require an extended period when both currencies would be in circulation as kronas are soaked up.

My advice to Iceland is wait till the Canada bubble bursts and then adopt our over-inflated loonie. In the meantime, Iceland should follow Israel and begin investing its foreign exchange reserves into U.S. equities:

The Bank of Israel will begin today a pilot program to invest a portion of its foreign currency reserves in U.S. equities.

The investment, which in the initial phase will amount to 2 percent of the $77 billion reserves, or about $1.5 billion, will be made through UBS AG and BlackRock Inc. (BLK), Bank of Israel spokesman Yossi Saadon said in a telephone interview today. At a later stage, the investment is expected to increase to 10 percent of the reserves.

A small number of central banks have started investing part of their reserves in equities. About 9 percent of the foreign- exchange reserves of Switzerland’s central bank were invested in shares at the end of the third quarter, the Swiss bank said on its website.

The investment will be made in equity index trackers and will include between 1,500 to 2,000 shares, among them stocks like Apple Inc. (AAPL), Saadon said.

The central bank decided to add equities to its investment portfolio in order to diversify, reduce risk and give better performance, Barry Topf, senior adviser to Governor Stanley Fischer, said in a Dec. 1 interview.

As you can see, it's not only hedge funds that are going gaga over Apple. Central banks are also actively participating in the biggest reflationary policy in the history of mankind (some call it the Mother of all Ponzis). Don't get out of bonds just yet, this could all end in a bust!

By then, Iceland will have adopted the loonie and I will make my way over there to live in peace and harmony, enjoying amazing spas, great fish and all of Iceland's volcanic beauties. Reykjavik Rocks! :)