Tags: euro | Iceland | recovery | banks

Correction in Euro Possible in 6 Months

Wednesday, 14 Aug 2013 10:01 AM

By Ashish Advani

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Just when you thought it is safe to enter into the water, a deep rip tide undercurrent in the euro currency is beginning to emerge.

This crisis is brewing just where you would least expect to look. The minnow of Europe may end up wagging the euro tail yet once again.

I am talking about Iceland. We all remember the infamous collapse of the Iceland Krona back in 2008. It was the trigger to the dramatic free fall of the banking sector in Europe, as the financial crisis of America spread around the world.

When Iceland collapsed under the credit-fueled boom, the banks there either went bust or were nationalized. The situation got so bad that the British government (whose taxpayers had much to lose from Iceland bank defaults) used their anti-terrorism legislation to seize Icelandic bank assets in the United Kingdom.

In reaction to the crisis, Iceland imposed capital and currency controls. It pretended to apply emergency measures and punished the culprits such as the bankers by sending them to jail.

Capital controls imposed by the government in 2008 are still in effect, forcing its citizens and, more importantly, the nation's massive pension fund to invest mainly in Iceland. At the same time, Icelandic consumers still find it hard to buy foreign goods, forcing them to buy less-desirable local equivalents, which give an artificial boost to the domestic economy

So what looks like a fabulous recovery in Iceland is in fact a sham. It appears that the gross domestic product of Iceland has rebounded and unemployment is falling. The model of recovery has been touted by many politicians. Famous economists like Paul Krugman praise the government for rapidly rebuilding the economy without having to resort to austerity. The Telegraph newspaper in the United Kingdom published a headline "Iceland has taken its medicine and is off the critical list".

Well, not exactly.

A few bankers were investigated and charged with fraud. The CEO of one of Iceland's biggest failed banks was even convicted and sentenced. What do you think he was sentenced to for destroying the country's economy? 10 years? 25 years?

Actually nine months. Six of which became probation.

Meanwhile, the government ended up taking on massive amounts of debt in order to bail out the biggest bank of all — Iceland's CENTRAL BANK.

Today, the government spends 17.3 percent of its budget just paying interest on debt. As we expect interest rates to go up, this burden will become even more unbearable. Wages are low, even though unemployment is low. Housing prices are falling, as most of the homeowners in Iceland are underwater on their mortgages.

The new prime minister (ironically he is from the party that led Iceland to its doom) is promising mortgage debt relief through a special state debt relief fund. Problem is that they have no money to do so.

Iceland is not a recovery story, but rather a how PR can help you fool the world story. And the world is buying it hook, line and sinker.

The fragile recover being touted in Europe is bound to shudder and falter once news of the second collapse of Iceland hits the financial world.

A risky but suitable trade would be to buy a long-term put option on the euro. A January 2015 put option on the CurrencyShares Euro Trust (FXE) exchange-traded fund may be a valuable play on this fake Iceland recovery story.

© 2014 Moneynews. All rights reserved.

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