Better known for its turbulent geology and hot springs, it has more recently become known as a purveyor of equally hot money into various areas and especially the UK economy. As an example, the investment business Baugur has included an eclectic range of relatively small holdings in a variety of assets and reads more like a list of the typical British high street or shopping mall.
Over the past decade there has been a steady trickle of Icelandic money coming in and initially buying quite small holdings in retail businesses. Often these have caused some surprise as the holdings appeared to be too small to be strategic and often at a premium price in a sector which was looking as though it was going to be coming under some significant pressure (their Woolworth investment comes to mind). As the weakening retail story has unfolded, many of these holdings have been added to as the prices have fallen – either good pound-cost averaging or a smart way of quietly gaining control. Either way quite an expensive way of growing their businesses!
But the question has always been – where have these Icelandic raiders got their money from? Now certainly in the past the nationalisation and subsequent privatisation of the Icelandic banks created a wave of extra cash, but this still cannot account for the huge surge of investment. There have been darker rumours of alternative routes of money coming out of Russia finding a suitable investment home via Iceland (a bit like the old Cyprus money pipeline from Moscow in the 1980/90’s).
However, there also been another key, although somewhat unlikely, source for Icelandic investment; the Japanese investor. You must feel rather sorry for the unfortunate Japanese investor, who for the past 18 years has seen most of his investment decisions dissolve in front of his eyes. From seeing the Nikkei 225 Index crash in the early 1990’s from over 39,000 to less than 8,000, property values collapsing by some 65% and nearly half the banking and insurance industry having to be bailed out – the unfortunate private Japanese investor (normally nicknamed Mrs Watanabe) has not had much success.
Then with the alacrity of a light bulb going on, a new investment structure developed whereby the Japanese could take their low cost Yen (with base interest rates at 0.01%!) and lend them out to countries where they could obtain double digit returns by way of investment and a strengthening foreign currency against those Yen.
And where could you get these double digit returns? As the advert used to say, “Mum’s gone to Iceland” – but in this case not the shop! Thus was born what became known as the “Carry Trade”, which put simply was merely borrowing cheaply in one country and getting a better return elsewhere.
Thus, the Japanese lent out to Icelandic borrowers for higher returns and everything would have been fine so long as the Icelandic Krona didn’t fall back and the Yen suddenly appreciate. The Krona has lost 20% against the Euro this year and the Yen has been powering away over the same time. Oh dear.
So Iceland has become a big bet, and a big bet whose funds were, amongst others, being put on UK assets with everything from clothes shops to investment banks. The global credit issues have been putting their domestic banks under some significant pressure and refinancing issues may well cause some concern. It would seem that seem that even Kazakhstan banks now have a lower risk premium than the Icelanders.
Rates have touched 15%, the currency is still weak and the government is doing what it can to stave off a potential economic crisis following the effects of a grossly overheated economy.
As for the effects elsewhere? Any unwinding in the borrowing may prove quite painful if assets invested in have lost some of their value. This means that lending based against these weakened assets may trigger defaults. Some of the banks have been doing their best to draw in investor monies and in the UK you can see this with some astonishingly attractive rates. Too good to be true? Well, good reason to be prudent here I think.
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The MPC meeting will be centre stage next week and will be very difficult to read. The key question will be – does Mervyn King give into pressures to cut rates to ease pressure on the economy, or does he hold fast the line against the eroding evils of inflation? I suspect his attitude will be wanting to fight inflation; the political pressure beaming from Downing Street may be to the contrary.
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And finally…there is something about the Japanese and their enthusiasm for everything to do with felines. However, owing to the strict pet ownership restrictions in central Tokyo, many are deprived of actually having their own moggy. But such an issue would never stop the imaginative Japanese – to answer this demand what do you need? A cat café! Yes you can now visit a pussy parlour and for around £4 / ¥816 an hour you can rent a kitten for some serious stroking – and no doubt play with one of the 19 “staff” kittens that are available. Possibly a more acceptable form of lap dancing I suppose?
Have a good weekend,
Justin A. Urquhart Stewart
Director
Seven Investment Management Limited