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Very small countries
Here is James Surowiecki on the economic problems of Iceland. Google tells me that Iceland has about 316,252 people. Fairfax County is over three times more populous but it hardly receives any out-of-state attention. Of course Fairfax County has neither its own language nor its own culture (apart from a lunch tradition, that is) but for economic questions that should not matter much.
One question is whether we should be trading asset claims to the future creditworthiness of very small units. Let's say there were tradeable shares in the future prospects of assistant professors. A low share price wouldn't do much for your mid-contract review and maybe not for your mortgage prospects either. It seems that noise traders can wreak more havoc on small units, if only because volatility relative to retained earnings may be larger. Maybe the real problem is when the small units cannot self-insure; imagine the public uproar if the Icelandic government were caught selling itself short.
Posted by Tyler Cowen on April 15, 2008 at 03:10 PM in Political Science | Permalink
Comments
It's "wreak" havoc, not wreck!
Posted by: Rachel at Apr 15, 2008 3:15:23 PM
Thanks, corrected...
Posted by: Tyler Cowen at Apr 15, 2008 3:22:17 PM
I used to work with a bunch of Finns, who often lamented the way their currency got batted around by FX speculators.Maybe that's why they were the only Scandanavian country to go into the Euro.
Posted by: Bartman at Apr 15, 2008 3:24:01 PM
The New Yorker article compares the population of Iceland to that of Pittsburgh which seems like a better a comparison than 1/3 the size of Fairfax County. I don't want to do math.
Posted by: mpkomara at Apr 15, 2008 3:51:03 PM
You write:
One question is whether we should be trading asset claims to the future creditworthiness of very small units.
If you use minimum capitalization on venture exchanges as a comparable, Iceland would be over the hurdle.
Posted by: Brent Buckner at Apr 15, 2008 3:57:04 PM
It's hard to read that article and not think on the boom and bust in the closing chapters of Halldor Laxness' novel Independent People.
Posted by: John Mansfield at Apr 15, 2008 4:20:19 PM
There would be a lot more interest in the economics of Fairfax county if it had its own currency.
Posted by: matt wilbert at Apr 15, 2008 4:23:13 PM
Uh, wouldn't shares or perhaps bonds of a mid-cap publicly traded corporation be tradeable asset claims to the future creditworthiness of a relatively small unit? Should we not trade those?
Posted by: at Apr 15, 2008 5:47:12 PM
Why are they so concerned about a manipulation of their currency? Sure it will make imports expensive but their exporters will make a fortune. If they're really convinced there is manipulation, shouldn't they be able to bet against the manipulators and come out ahead in the long term?
Posted by: Cliff at Apr 15, 2008 8:59:57 PM
What is that Iceland exports?
Posted by: Sam at Apr 15, 2008 9:12:18 PM
Everything Surowiecki says rubs me the wrong way, he's the one guy where I just don't get Tyler's fascination with him. To me Surowiecki comes off like, "overly simplistic summary, speculation speculation speculation, markets don't work, end of story".
Posted by: Paul N at Apr 15, 2008 9:59:41 PM
While it is obviously harder for institutions to single handedly impact larger countries, Soros still managed to hold the Bank of England hostage. So you reduce the probability as you enlarge countries, but the consequences are wider reaching when you coerce a larger group of citizens to share the same systemic risk.
Posted by: Jay at Apr 15, 2008 10:32:50 PM
"What is that Iceland exports?"
Fish, aluminum, tourism, financial services.
"Why are they so concerned about a manipulation of their currency?"
The banks are in trouble because they are strapped for foreign currency, the manipulation wasn't foreseen.
Posted by: Icelander at Apr 15, 2008 11:15:55 PM
If they're really convinced there is manipulation, shouldn't they be able to bet against the manipulators and come out ahead in the long term?
If your central bank is raising rates to stem the flow of foreign capital that has the side effect of making it more difficult and more expensive to borrow money. How do you stay liquid long enough to "come out ahead in the long term" when credit conditions are tight?
I do wonder though, if conditions in Iceland continue to get worse, is the stigma from asking for IMF intervention too much to bear for a developed country? In theory, the IMF is a great way for small countries who cannot self-insure to pool risk with larger countries. The increasing irrelevance of the IMF may be bad news for countries like Iceland.
Posted by: Ricardo at Apr 15, 2008 11:43:19 PM
[Maybe the real problem is when the small units cannot self-insure; imagine the public uproar if the Icelandic government were caught selling itself short.]
I don't think you've thought this through, Tyler. I can indeed imagine the uproar.
"Sigurd, have you heard!!!! The government has sold our beloved Icelandic Krona to hold deposits in dollars and euro!!! They say it's insurance against currency movements, but they're not backing us up by buying krona!!! They're selling Iceland short!!! Can you imagine the base lack of patriotism!!!"
"They're called foreign exchange reserves, Lars, everyone has them"
"Oh".
Posted by: dsquared at Apr 16, 2008 3:26:21 AM
I am puzzled how you could say having your own language and culture don't matter much? It seems to me that these matter a great deal for economic performance. If culture is "detectable patterns in the stuff people do", a distinct culture seems essential in explaining performance in producing goods.
Posted by: ralph r. emmers at Apr 16, 2008 3:30:33 AM
I don't see the imagined problem of noise trader volatility here at all. Surely such an asset would have plenty enough volume to attract technical traders to correct any such bias, as much as any larger asset gets corrected.
Posted by: Robin Hanson at Apr 16, 2008 4:44:06 AM
When markets go illiquid, manipulating them for profit is easier. The smaller the unit, the less difficlty in manipulating the market. One would expect Iceland to have financial troubles now; even if some of their investors had not got badly over-leveraged.
That said the Icelandic real economy has been surprisinly healthy for decades. And in the medium-long term Iceland is one of the places that are most likely to benefit from global warming.
Posted by: David Heigham at Apr 16, 2008 6:56:42 AM
Small untis have low opportunities in autarky (less specialization), so actually their reputation is much more important to them than large units. Also punishments can be better enforced againts a small unit than a big one which also keeps them in line. That is why as a borrower in the US you can get a loan for a lower rate and longer term than, for example, Argentina's Government.
Posted by: Joen at Apr 16, 2008 12:08:14 PM
The difference between Iceland and Fairfax County is surely that Iceland has its own currency and FC does not?
In addition, Iceland is a distinct tax jurisdiction, which has big impacts on locational decisions (income tax, rather than property tax).
David Heigham
In the long run the threat to Iceland is probably volcanism. Believe it or not, there is now some research that suggests as your ice melts, you get more tectonically unstable. But even so, 20% of the population of Iceland died in the 18th century due to an eruption (to be fair, in that case, due to complete harvest failure following one-- trade sshouldshould prevent that from recurring).
On global warming, a huge future business for Iceland will be selling carbon credits: either stemming from emission free geothermal and hydro power (precisely the reason why Alcoa, Intel and Google are all building facilities there) or exporting that power across the 'gap' to the UK (feasible with an undersea DC power line).
All
What Tyler is referring to is the impossibility (difficulty?) of Iceland taking out a short against its own currency, as a hedge to its natural 'long' position.
Arguably the Icelandic Central Bank could have taken out Credit Default Swaps against defaults by its leading financial institutions. Again with risk of political uproar.
This is all a pretty exact replay of the attempt by the hedge funds in 1998 to break the Hong Kong-US dollar peg.
Posted by: Valuethinker at Apr 17, 2008 7:53:09 AM
David Heigham
Further comment on re GW and Iceland.
Aluminium has been called 'electricity in solid form'.
Since Iceland has opted to specialise in the manufacture of carbon-free aluminium (aforesaid Alcoa smelter, newly built) you can see how even a shadow price for carbon is beginning to make an impact, potentially. In addition, another export for Iceland will be web hosting services (power is 60% of the lifecycle cost of a web server farm these days).
Posted by: Valuethinker at Apr 17, 2008 8:04:58 AM
Third comment
A bit speculative-- informed macroeconomists please critique:
There is a lot of talk about Iceland entering the Euro.
I'd have to check the convergence criteria, but I suspect Iceland, like Lithuania (or Latvia?) (which was refused entry and has a very similar economic problem) doesn't meet the convergence criteria. The ECB would be reticent to take on a non-EU country with such a severe current account deficit problem.
It would also, potentially compound the problem. As Ireland has showing, having a 'made in France/Germany' interest rate isn't necessarily suited to a small, high growth economy with soaring asset prices. Either you have massively contractive fiscal policy (politically very unlikely) or the amplitude of your economic boom/bust cycles (which feed through property markets) is magnified.
All of your real exchange rate appreciation/depreciation has to take place through adjustments in domestic demand. As in the Irish housing price slump, now well underway.
The old problem of surrendering monetary independence via a fixed exchange rate: see Barry Eichengreen's analyses of the Gold Standard era.
Posted by: Valuethinker at Apr 17, 2008 8:12:32 AM
Given that small countries can repudiate their debt, indeed can assume by fiat all domestic debt and then repudiate, I don't understand how "creditworthiness" is even relevant. Yes, claims will be pursued in such a case, but violent enforcement is unlikely; French creditors are unlikely to gain succor from an invasion by their army and repossession of Icelandic assets.
To illustrate, Weimar Germany or, more recently, Argentina have perhaps approached "national bankruptcy" and yet have not been under threat of (financial) hostile takeover.
So Surowiecki, like any good journalist, seems to be spinning an impossible tale, so he can reach the dramatic image of a nation going bankrupt from subprimes.
Posted by: Peter St. Onge at Apr 17, 2008 12:25:09 PM
[What Tyler is referring to is the impossibility (difficulty?) of Iceland taking out a short against its own currency, as a hedge to its natural 'long' position]
Not "impossibility", not "difficulty", it's more a case of "utter conventionality and ease". If Iceland has krona-denominated debt and foreign exchange reserves, it's got a short krona position.
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