Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Over the weekend, Iceland once again showed some pluck and rejected an onerous agreement to repay debts incurred by the failed private banks to the British and Dutch governments. The Icelandic government has been trying to lumber the population with these debts largely because the politicians aspire to join the Eurozone and they have been willing to sacrifice the welfare of their own population in pursuit of that misguided goal. According to Iceland Statistics there are (as at January 1, 2011) – 318,452 people living in Iceland with 23,596 between the age of 0-4 years; 21,194 in the 5-9 years cohort and 21,802 10-14 year olds. That is 66,592 children that the people of Iceland have decided not to burden with debt obligations.
May I also note that the Iceland Statistics On-line databases are among the easiest to navigate and their output options are excellent and fail-safe, unlike many other central statistical agencies (for example, in the UK).
Al Jazeera reported at the weekend (April 10, 2011) that – Icelanders reject debt repayment plan – which is the second-time the citizens have declared decision made by their neo-liberal, Euro-aspiring government is not in the best interests of the nation.
I have written previously about Iceland in these blogs – Iceland … another neo-liberal casualty – Would someone please put something in the water supply and There is no financial crisis so deep that cannot be dealt with by public spending – still!.
In particular, this blog – Iceland – another neo-liberal casuality – provides a fairly detailed background on the controversy.
By way of summary, a privately-owned on-line bank, owned by Iceland capitalists, penetrated the UK and the Netherlands. The UK relaxed normal prudential control standards to let them trade. The bank offered ridiculously high (and unsustainable) returns on deposits to gouge depositors from other banks, while the regulators in the respective nations turned their backs.
After growing rapidly (by suckering in hundreds of thousands of depositors) they went broke in the financial crisis. The bank was thus a private (multinational) firm which was put into receivership by the government and that process is regulated through standard bankruptcy provisions.
When Iceland’s government put the banks into receivership – it split their operations into two – writing off the amounts owed to foreign creditors while sustaining the domestic operations considered to be in the public interest.
The Iceland government had no legal or moral responsibility to do anything other than ensure its own citizens were protected which it did. It bore no legal or moral responsibility to the British and Dutch citizens who faced losing their saving.
The British and Dutch governments however did bear the responsibility to ensure the innocent depositors were protected. Accordingly, they intervened and paid out billions.
That should have been the end of story as far as I am concerned.
However, the Icelandic government’s wise decision to let the banks go broke did not extend to their handling of this debt issue. The bullying Dutch and British governments placed pressure on the Iceland government, which represents a few hundred thousand people only, to pay the money back.
My first question was why should you be made to pay money back when you were not a party to the transaction?
The bullying took the form of threats to Iceland’s entry in to the Euro should they not agree to socialising the private debt and paying the Dutch and British governments back.
The Iceland government who wrongly consider the EMU option to be a sound option for the nation panicked at the thought of not being admitted to the EMU and so agreed to the blackmail – which required them to hand over 3.9 billion euros to Britain and the Netherlands. That would force them to pay in a foreign currency. At the time, they didn’t have the reserves necessary.
The President then decided that enough is enough – how can the citizens pay this debt when they were already being subjected to a harsh standard of living correction themselves as a result of the folly of their own capitalist greed coming unstuck. He showed leadership and loyalty to his people by vetoing the bill.
The traitorous Iceland government tried to derail that first referendum. In March 2010, 98 per cent of Icelandic voters rejected the Government’s payback agreement.
Again, that should have been the end of it.
As an aside, the bullies also threatened to block the IMF rescue package which the Government had also (sold-out) agreed to. As it turned out after the first referendum was overwhelmingly defeated the IMF still paid up despite all the threats.
In the months after that rejection, the predictions of the doom merchants were not realised. The economy started growing, albeit modestly and export revenue picked up.
On November 26, 2010, Iceland’s President Olafur Ragnar Grimsson was interviewed by Bloomberg on the state of recovery in that nation. This Bloomberg article (November 26, 2010) – Iceland Is No Ireland as State Free of Bank Debt, Grimsson Says – summarises the interview.
The President was asked about the problem that Ireland was facing and said that:
The difference is that in Iceland we allowed the banks to fail … These were private banks and we didn’t pump money into them in order to keep them going; the state did not shoulder the responsibility of the failed private banks … Iceland is faring much better than anybody expected … How far can we ask ordinary people – farmers and fishermen and teachers and doctors and nurses – to shoulder the responsibility of failed private banks … That question, which has been at the core of the Icesave issue, will now be the burning issue in many European countries.
The first lesson in conducting fiscal policy – is to avoid waste. By refusing to socialise the losses of the private banks yet guarantee local depositors the Icelandic government was advancing public purpose.
The decision to bailout banks in the US, Britain, Ireland etc was not in the public interest.
Second, Iceland’s case brings into relief the broader contradictions of capitalism. We often here privatise the gains, socialise the losses – which is just shorthand for how corrupt the “self-regulating market” lobby is. At least the Austrian school was consistent – let it all go!
But fiscal policy should only target the level of aggregate demand and questions of equity. Bailing out the banks does not help in that regard and should not be considered a reasonable fiscal target. The government can always nationalise the banks to preserve deposits in the currency of issue and let the private risk and return mechanisms work their way out via the legal frameworks.
Private enterprise is just that and should remain that. Where the public is harmed by poor private decision making the government has a responsibility to ensure the harm is minimised. This charter extends from ensuring the depositors are protected from incompetent, corrupt and greedy bank managers to ensuring there are enough jobs in the economy for all those who want to work.
I don’t usually agree with former IMF chief economist Simon Johnson but I recalled this New York Times article (February 3, 2011) – The Ruinous Fiscal Impact of Big Banks – where some salient points were made.
He was talking about the threats that two of the big bankers made at the World Economic Forum in Davos. Johnson wrote that their threats amounted to “First, if you regulate us, we’ll move to other countries. And second, the public policy priority should not be banks but rather the spending cuts needed to get budget deficits under control in the United States, Britain and other industrialized countries”.
Johnson, instead noted, and it resonates when thinking about Iceland:
Public deficits and debt relative to gross domestic product have ballooned in the last three years for one simple reason – the big banks at the heart of our financial system blew themselves up …
No one forced the banks to take on so much risk. Top bankers lobbied long and hard for the rules that allowed them to behave recklessly. And these same people effectively captured the hearts, minds and, some would say, pocketbooks of the regulators – in the sense that a well-regarded regulator can and often does go work for a bank afterward.
The mega-recession, which is starting to look more like a mini-depression in terms of employment terms for the United States (which lost 6 percent of employment and is still down 5 percent from the pre-crisis peak), caused a big decline in tax revenues. Falling taxes under such circumstances are part of what is known technically as the “automatic stabilizers” of the economy, meaning they help offset the contractionary effect of the financial shock without the government having to take any discretionary action.
Whatever you think about the effectiveness of the additional fiscal stimulus packages provided to the economy in early 2008 (under President Bush) or starting in early 2009 (under President Obama), remember that the impact of these on the deficit was small relative to the decline in tax revenue.
The discretionary interventions were too small relative to the automatic stabilisers. But that is another point.
What was not fully reported in that Bloomberg article from the interview were the comments the Icelandic President made in relation to the exchange rate. He said:
Because of the Krona – the independent Icelandic currency we were able to devalue considerably. So the export sector, the fishing sector, the energy sector, tourism sector, the IT have been having quite a good time since the collapse of the banking system. That is why the Icelandic economy is coming out of this crisis earlier and stronger than anyone expected … The advantage of having a separate currency is that you can devalue and make the export sector more competitive.
Yes, another reason why Iceland is not wallowing in recession like Ireland and many of the EMU nations. I am not advocating export-led recovery. But in an economy where trade is a higher proportion of GDP than most, the exchange rate movements have allowed them to improve their international competitiveness without domestic deflation.
The reality is that export revenue is growing strongly in Iceland now and it is diversifying into manufacturing. Iceland Statistics reports that inflation is low and workers’ wages and conditions have grown during the crisis. Contrast that with Ireland and Greece which took similar cuts to real GDP growth per capita as the crisis unfolded in 2008.
After the first referendum categorically rejected the debt repayment strategy negotiated by Iceland’s government, they then redrafted the agreement in cahoots with the “creditors” and passed that agreement into law in February.
The Icelandic President then rejected the bill for a second time which forced another referendum – the one held last weekend.
That referendum has now been convincingly rejected despite a massive campaign by the Government and its conservative pro-Euro supporters to pressure the voters into a yes vote.
What is behind this is the desire by an elite to join the EU and then the EMU.
The Europe debate has been a fractious issue in Iceland for years. Remember it only became an independent sovereign nation in 1944 after splitting from Denmark. It is part of the European Economic Area (EEA) which gives it full access to the EU’s common market. Icelanders can live and work in the EU whenever they choose.
So why abandon currency sovereignty (and exchange rate flexibility)?
The pro-Euro lobby are now saying that the Krona is not trading in foreign exchange markets and banks cannot borrow abroad at present. They claim that the capital controls that the country imposed to shore up the crisis are thwarting investment.
The sad thing is that the Social Democrats in Iceland are the most pro-EU although on the “progressive side” the Left-Green movement is strongly opposed.
The Government, true to its pro-Euro colours claimed that “economic and political chaos could follow” – at least, political chaos is to be hoped for and the Government gets its marching orders.
The Prime Minister was quoted as saying in relation to the lost second referendum that:
The worst option was chosen. The vote has split the nation in two.
My view is that the rejection by voters was the best option for Iceland. They should just default on all non-Krona debt which might initially be broached by renegotiating the debts in its own currency.
The voters appear to have the capacity to understand what Simon Johnson was outlining above. The debts were the product of irresponsible bankers operating in markets that they had themselves lobbied to become freer. Their risk, their return.
The parties that entered into risky arrangements with the bankers did so voluntarily. Where laws might have been broken the state should ensure that justice is achieved which doesn’t extend to paying back debts that any fraudulent behaviour might have incurred.
Mainstream economists have attacked the vote outcome claiming it will stop the country getting access to “international financial markets” and prevent the lifting of the capital controls, imposed in 2008 by the Iceland government as a means of defending the currency and preventing inflation.
Capital controls do not sit well with mainstream economists. But in this blog – Are capital controls the answer? – I examined some new IMF research papers on the issue.
The IMF acknowledged that their previous position against capital controls, based on free trade backed by total liberalisation of cross-border financial flows was unsustainable.
They now argue that controls on capital inflows can be effective if well designed and safeguard an economy from the costs of speculative attacks.
The controls in Iceland (as in Malaysia in the late 1990s) have certainly helped them stabilise the economy and put it back on a growth footing. The Government is now slowly relaxing the controls as the recovery unfolds.
The conservatives are once again ramping up the argument that foreign investment will dry up, that the government will not be able to fund itself and that the ratings agencies will downgrade public debt and force higher costs onto the government.
I laugh when I read some of the journalistic pieces – in one breath saying that the Icelandic government will not be able to fund itself and the next saying Moody’s will impose higher funding costs onto the government.
Neither is true if the Icelandic government is wise. It can fund all its domestic programs in krona without recourse to foreign funds. Indeed, it should completely avoid borrowing in foreign currencies.
If the bond markets do not want to invest in Iceland public debt that is their problem – the Government is fully sovereign and can maintain whatever spending program it deems wise in the circumstances.
You might ask why repaying the debt to Britain and the Netherlands is such a problem for a sovereign government which issues its own currency. The first point is that if the debts were restructured into Krona then the solvency issue does not arise and matters of principle and the impact on the exchange rate become the issue.
But the debts are denominated in Euros (as per the now-illegal agreement). So why is that a problem? The government has to get the Euros in order to pay them back which from a macroeconomic perspective means they have to forgoe some import benefits (in real goods and services) for a given export level.
That is the burden that the voters have decided not to visit on their children.
Two years later, Iceland is growing again (from third quarter 2011) – unlike Ireland and (probably) the UK. Further the three restructured (new) banks are profitable and inflation is low. Meanwhile, the bond markets appear happy to buy government debt.
That is enough for today!