Is Iceland Really Going To Peg Currency To Canadian Dollar?

Includes: FXC, FXE, UUP
by: Simit Patel

How the global sovereign debt crisis gets resolved remains to be seen, though one country that seems to be blazing the trail is Iceland. While growth has slowed of late -- Q4 2011 GDP growth was 1.9% -- it continues to outpace growth throughout Europe and most of the world. The most important step Iceland has taken that has enabled such growth is debt cancellation; much of the population that was drowning in debt simply had their burden cancelled, with banks taking the hit on the unpaid loans. Also of note is that Iceland has begun criminal prosecutions against some of the politicians that, through fraud, helped facilitate the country's economic meltdown. Those in other parts of the world still struggling to overcome their debt crisis may wish to heed notice.

Of course the issue in getting out of this mess is re-establishing monetary policy. In this regard, propositions are circulating that Iceland will peg its currency to the Canadian dollar. For speculators, I feel there are a few noteworthy points here:

1. The current talk is more focused on pegging to the Canadian dollar (CurrencyShares Canadian Dollar Trust ETF (NYSEARCA:FXC)) rather than the US dollar (PowerShares DB USD Bull ETF (NYSEARCA:UUP)); I view this as yet another example of how the world is psychologically shifting away from the US dollar, a consequence of a policy running over a decade long of low interest rates, sharp expansion of the money supply, and budget and trade deficits. Iceland seems to be understanding the dangers of a weak currency -- namely that it deteriorates savings, reduces consumption and investment, and hinders employment -- and is adopting the increasingly popular view that pegging to the US dollar will bring about ongoing currency weakness.

2. If Iceland does actually adopt the Canadian dollar, I think the move would be very bullish for the Canadian dollar -- perhaps the kind of event that could trigger a sharp spike, the kind characteristic of what happens when central banks make big interventions. This won't be the kind of event that will be easily forecasted by a technical chart pattern. For those who are positioned in the Canadian dollar, though, it could be a nice sudden profit -- though not necessarily a quick one, as who knows when such the announcement of an official pegging will occur, if at all.

It should be noted that Iceland is also considering joining the eurozone. This strategy, a more conventional one in our current times, would likely involve adopting the euro (CurrencyShares Euro Trust ETF (FXE)). Integration of an Iceland that is healed of debt is something I find bullish for the euro in the short-term. Ultimately, though, the euro will still have the same governance problems it currently has without some type of massive reform of the entire concept of the European Union and the euro as the currency, and so any long positions taken should be done so with that in mind.

In sum, the story surrounding Iceland's monetary policy has implications for both the Canadian dollar and the euro. More importantly, though, it could signal how countries decide to solve their debt crisis, and how the world order may change as a result.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long the Canadian dollar vs the US dollar in the spot forex market.