Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
The world’s press is once again whipping up the “Greece to exit” frenzy and wheeling out all manner of mainstream economists who are issuing the most strident warnings that Greece needs the Euro and will walk the plank if it exits. Most of this is conservative hype. The reality is that while the exit would be immediately costly – the situation is currently so dire and the outlook so negative – that these “costs” have to be weighed against the almost immediate return to growth should the nation exit and default. Apparently, the Greek political elites (the President and the two main party leaders) are proposing that the recent election, which overwhelmingly rejected the Troika-led austerity, be ignored and, instead, a government of technocrats – all of whom will play ball with the Troika, be installed to rule the nation. The machinations of the neo-liberals never cease to amaze me. Greece should take a lesson out of the Iceland book. But then they had a President who seemingly cared about national interest.
Recently, Statistics Iceland provided this updated Spring 2012 Economic Forecast:
Economic growth reached 3.1% in 2011 and was due to increasing private consumption as well as investment. The forecast for 2012–2017 assumes that gradual economic recovery will continue with 2.6% growth in 2012. Positive growth is expected throughout the forecast period, though changes to the planned large scale industrial investments may affect the forecast. Economic growth will be driven by investment and consumption.
This could be Greece’s future. It is a graph taken from the Spring 2012 Economic Forecast.
Compare that to this characterisation of the Greek tragedy. I thought this was a pretty stark piece of work from Greek cartoonist Dimitris Hantzopoulos. The title of the graphic – ΤΗΣ ΗΜΕΡΑΣ means The Day.
If your geography is lagging, here is a hint:
The weekend before last, the Greeks voted to end austerity – a categorical call at the recent election. But there is confusion among the electorate because the majority also want to keep the Euro. This is an education gap – they cannot feasibly keep the Euro under current (or perceived future) conditions and avoid the painful austerity.
Further, even if they get beyond this crisis in some sort of battered shape – much poorer and with yawning social divisions – it is only a matter of time before the next business cycle swing hits them and the aftermath or vestiges of the current malaise will quickly multiply with the new strife as aggregate demand collapses again.
The EMU as it is current structured – without a credible supra-national fiscal authority with the clear mission to defend regions that are suffering from asymmetric demand shocks (positive or negative) – cannot handle a sizeable business cycle swing. A monetary system that is incapable of meeting the challenges of such swings in aggregate demand is not a reasonable basis for organising complex economies – if the prosperity of all citizens is the goal.
So if Greece wants to end austerity and use its productive base to restore growth then it has to abandon the Euro.
It seems that the political machinery of the elites in Greece (and outside) is however manoeuvring to spit in the face of the electorate and to impose some sort of technical panel to govern the country.
The recent election has ended in an impasse – such is the polarisation of the vote as the support for the main right and left middle-class parties collapsed. The Greek people might not understand the intricacies of the monetary system tyranny that is being imposed on them but they were clear on one thing – they wanted an end to the Troika-led austerity.
There can be no doubt about that. The guess is that a new election will consolidate that view even further and the two main parties will see further loss of support. There would be hope of some sort of coalition opposed to austerity which did not include Golden Dawn. But correct me if I am wrong – I am hardly an expert on Greek politics.
The Euro elites, of-course, are currently issuing all sorts of warnings and the Greek elites from President down to the leaders of the two main parties (so abysmally defeated at the recent election) are now conspiring to implant a government of technocrats and politicians. The Greek people clearly resented the installation of Lucas Papademos (under pressure from the Troika) when the elected Prime Minister indicated he would take the last bailout to a popular vote.
They should take a lesson out of the Iceland book.
Iceland soon learned that when your government is selling you out its only recourse is to get the titular head (president) to intervene. That is what happened in Iceland when the President intervened in 2010 – in line with the mood of the population – and refused to sign legislation passed by an out-of-touch government intent on big-noting itself on the world stage by pushing for EMU admission in spite of the obvious harm that would do to the nation.
The President of Iceland vetoed an act of parliament which would have seen the nation “repay” £3.4bn to Britain and the Netherlands. This repayment was in relation to the amount that the British and Dutch governments paid out in 2008 to their citizens who had deposits in a private Icelandic bank which collapsed during the height of the global financial crisis.
At present, the press hysteria is reaching new heights with all sorts of dire warnings for the Greek people if they dared leave the Eurozone and abandon Germany to Spain and Italy (and Ireland) and soon other nations.
At the time the Icelandic President intervened the press also rose to hysteric heights. The jingoistic British press made all sorts of threats against their tiny northern neighbour.
The Icelanders however were vehement and resentful that the British government had used the UK anti-terrorist act to freeze all Icelandic assets in the UK in late 2008. It was that move that was the final nail in the Icelandic banks’ solvency.
The Icelandic population considered the deal their parliament has agreed to was not in their interests and not their responsibility and they realised that the motivation of Iceland’s politicial leaders was, in fact, to walk the EMU stage, which the overwhelming proportion of the population remain opposed to.
The same could now be said about the Greek population. They have voted resoundingly to reject the imposition of austerity on them.
The Dutch and British governments bailed their own citizens out after they allowed Icesave to operate under the Passport system. They then tried to cadge the money back from the Icelandic government – there were claims that under European law there is a sovereign guarantee of deposits (that is unclear – there is no requirement of a state guarantee).
Further, they claim Iceland is being discriminatory (against European law) in that it bailed its own citizens out but refused to bail out the foreigners (also unclear). The Dutch and the Brits will not go to an independent court to let these matters be decided impartially. The reason – they would probably lose their bullying capacity to pressure Iceland to pay up.
All the same sorts of statements are being made about the Greeks – legal threats, economic threats – all vapid if the Greek government takes back control of its currency and lets it depreciate.
The problem the citizens of Iceland faced was that the Icelandic Parliament, seemingly wanting to appease those who would block its proposed entry into the EMU (Britain has been making threats), finally agreed to repay the loans. You can read more about what the people think via the In Defence home page.
It is clear that the citizens did not approve of this deal and the vast majority do not want to go over to the Euro (that is, enter the EMU). This people protest which has gathered strength in 2009 and provided the President’s with his motivation to protect the national interest. It was only the second time in the 66-year history of Iceland as a republic that the titular head has exercised this power.
Recall the national TV address the President’s made when he announced his decision to the nation. His official declaration said that after the parliament passed the law to repay the loan he:
… has received a petition, signed by about a quarter of the electorate, calling for the Act to be subjected to a referendum. This is a far larger proportion of the electorate than the criterion that has been referred to in declarations and proposals from the political parties.
Public opinion polls indicate that the overwhelming majority of the nation is of the same opinion. In addition, declarations made in the Althingi and appeals that the President has received from individual Members of Parliament indicate that the majority of the Members are in
favour of holding such a referendum …
It is the cornerstone of the constitutional structure of the Republic of Iceland that the people are the supreme judge of the validity of the law …
Now the people have the power and the responsibility in their hands.
Contrast that to what has been happening in Greece.
When the incumbent Prime Minister George Papandreou indicated he would put the earlier bailout plan to a referendum the Troika had him removed post haste. The Germans are even suggesting that Greece should retain its unelected Prime Minister indefinitely (that is, avoid the upcoming elections) in the same way that the Italians are suspending a democratic vote until 2013 at least.
It is true that Iceland had its own currency and Greece chose to use a foreign currency. The fact that Iceland has its own currency has given it tremendous leverage over the international financial markets. Greece has no such leverage. Iceland could default on foreign currency-denominated debts and let its currency depreciate.
The Greeks have to change their entire monetary system, which adds complexities – all of which are tractable.
For Iceland, the crisis imposed massive real costs on the nation but the benefits became obvious relative quickly. A more rapid return to growth was guaranteed. Greece is now in its fifth year of recession (Depression) with no end in sight.
On February 17, 2012 the rating agency Fitch upgraded Iceland’s rating and said:
The restoration of Iceland’s Long-term foreign currency rating to investment grade reflects the progress that has been made in restoring macroeconomic stability, pushing ahead with structural reform and rebuilding sovereign creditworthiness since the 2008 banking and currency crisis … Iceland has successfully exited its IMF programme and gained renewed access to international capital markets. A promising economic recovery is underway …
While I treat these ratings agency assessments with a grain of salt, they do reflect the way the bond markets think. The point is that Iceland has a place in the world that the EMU nations would envy right now.
While the Icelandic government certainly didn’t go on a fiscal spree and allowed net exports to reap the advantages of the massive depreciation, the government also didn’t scorch the economy with austerity. They have allowed growth to build its tax revenue rather than exacting harsh tolls on its citizens.
As the Spring 2012 forecast shows – private consumption and investment is now driving growth – as confidence returns – unemployment is falling, real wages are rising and aggregate demand is stable.
All of that was predictable. Modern Monetary Theory (MMT) shows that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency. Which means it always has the capacity (given real resources) to improve domestic growth and employment irrespective of what is happening in the private economy and the external sector.
Moreover,a floating currency allows fiscal and monetary policy to concentrate on domestic policy without the need to engage in “official intervention” (central bank transactions in the foreign exchange market) to stabilise a given parity.
It means that external imbalances do not have to be resolved via dramatic domestic deflation (attacks on working conditions).
Here is some graphical evidence which helps support this narrative.
Real GDP growth comparison – Greece and Iceland
The following graph is constructed using the latest quarterly National Accounts data from Iceland and Greece (from their respective national statistical agencies). It compares real GDP growth (seasonally adjusted and in annual terms) from the March-quarter 2005 to the December-quarter 2011 in both nations.
There is only one conclusion – the nation that has so far resisted the European neo-liberal elites and demonstrated leadership from the top is on the way to recovery from a larger shock than Greece faced. That nation – which has increasingly bowed to the unreal demands of the same elites even to the point of installing an unelected technocrat-central-banker to the Presidency – is sinking.
I am not suggesting Iceland is all brights lights. Far from it. But it is in control of its currency and has allowed the flexibility inherent in that control to play out to its advantage (exchange rate movements, central bank interest rate setting capacity, and fiscal support).
Nominal and Real Exchange Rates
The following graph uses data available from the Central Bank of Iceland and show the USD, Euro and Broad Trade Index exchange rates against the Krona (monthly average, mid-rate) from January 2000 to May 2012.
You can read about the Broad Trade Index – HERE – but suffice to say it represents a weighted exchange parity based on the trading proportions of its partners. The Central Bank of Iceland regularly update the currencies in the “basket”, which is used to calculate the Index as trading patterns change.
In 2011, Iceland’s major trading partners were EU27 (66 per cent of total trade), Norway (6.5 per cent), United States (6.2 per cent), Brazil (4.1 per cent), and China (3.1 per cent) (Source).
The depreciation in the Icelandic currency against the major world currencies during the crisis has been dramatic. The same sort of adjustments would quickly happen in Greece should it exit the Eurozone and restore its own currency sovereignty.
But note that the depreciation is finite! Those who claim that nations which run counter to the sentiments of the financial markets will experience a currency collapse and never recover fail to understand the dynamics of an exchange rate crisis. Sure enough, major depreciations occur.
But historically, the parities stabilise and begin to improve once the structural adjustments that the depreciation brings (changing terms of trade, changing industry composition etc) start to occur.
Consider the following graph which shows the real exchange rate (that is, the nominal rate adjusted for relative price inflation). Movements in the nominal exchange rate and the relative price level (Pw/P) need to be combined to tell us about movements in relative competitiveness. The real exchange rate captures the overall impact of these variables and is used to measure our competitiveness in international trade.
The nominal parity can also be adjusted for unit labour costs. I show both in the following graph.
Please read my blog – Saturday quiz – January 28, 2012 – answers and discussion (Answer to Question 2) – for more discussion on the derivation of the real exchange rate.
The rapid drop in the real exchange rate gave Iceland a massive boost in international competitiveness. It is the same boost that Greece would get if it leaves the Eurozone. As long as it can isolate the real income effects of the exchange rate plunge – it will be finite and growth will return almost immediately.
Notice that the two ways of computing the real exchange rate – the CPI (broad inflation) and ULC (labour cost) measures – move together. This tells you that the labour costs were indeed contained as the price of imports rose in the face of the rapid nominal exchange rate depreciation. This allowed the increase in competitiveness to “stick” (using the jargon of my profession).
The EMU nations are trapped and cannot exploit the flexibility of a sovereign currency. The only adjustment to the external balances is then domestic deflation which imposes a recession bias. Adding fiscal austerity at the same time is the reason Greece’s National Accounts are in such an appalling shape.
For a government to pursue public purpose they have to have control of their own currency and that means it must float.
What about inflation? Many commentators claim that flexible exchange rates are dangerous because they will result in accelerating inflation. The claim is only partially true and forgets to take into account the internal (substitution away from imports) and external (improvement in export competitiveness) adjustments that occur when the terms of trade change – especially when they are as drastic as depicted in the graphs above.
The following graph is from the Central Bank of Iceland and shows you what happened to the annual inflation rate in Iceland between 2000 and 2012.
It is clear that there was a spike in inflation (the annual rate went from 3.4 per cent in August 2007 to the peak of 18.6 per cent in January 2009 as the Krona depreciated. Since the economy resumed growth, the inflation rate has averaged around 4 per cent per annum.
There is no evidence to support the view that the large depreciation has created an unstable high inflation environment. Most of the import cost impacts have been well-managed and are through the system now.
Depreciation is likely to have long-term implications for the price level if domestic (non-traded) wages and prices chase each other up in a profit-margin-real wage resistance spiral.
If the nation is prepared to take the real income loss that is involved in the depreciation – which is generally finite – then the parity adjustment works in its favour (increasing competitiveness).
Statistics Iceland also publish a Real Wage Index which is shown in the following graph (from January 2005 to March 2012). It peaked at 120.2 in January 2008 and then reached a trough in May 2010 at 103.9 (down 13.6 per cent on the peak). It has now recovered some of the loss and in March 2012 was standing at 112.1 (down 6.7 per cent on the peak).
This is a predictable pattern. The exchange rate depreciation erodes the real wage as import price rise.
The nominal wage index continued to grow in Iceland throughout the crisis although the rate of growth slowed appreciably in 2008 and 2009. This point goes to an important aspect of the dispute between Keynes and the Classical writers who urged wage cuts during the Great Depression. It also bears on what is happening in other economies as the austerity mavens push large nominal wage cuts onto workers as part of the so-called structural adjustment.
Keynes noted that workers would resist real wage cuts if they were delivered via cuts in money wages but would tolerate them if they were induced by general inflation. The rationale was that the former would disturb relativities while the latter impacted on the wage structure more or less uniformly.
But there is another reason why preserving nominal wages growth is important.
Most of our contractual commitments are denominated in nominal units ($ or whatever currency is applicable). So when real wages are being cut by rising inflation (in this case by a depreciating exchange rate) but nominal wages are preserved, workers can then make adjustments to the composition of their spending without, in the first instance, undermining their capacity to meet their weekly contractual liabilities (for example, their mortgage payments).
Attacking nominal wage levels, more readily undermines the capacity of workers to meet these nominal contractual obligations and opens the possibility for further instability (credit collapse etc).
Compare the real wages trajectory in Iceland with this story from Athens News (April 27, 2012)Real wages tumble by 25% as tax burden soars in 2011. We read that in Greece:
The Paris-based think tank said real wages before tax fell in 18 of its 34 members during 2011, with by far the sharpest annual cuts taking place in Greece, where gross salary earnings fell by 25.3 percent …
In absolute figures, the OECD annual Taxing Wages report said that average gross income declined from 20,457 euros in 2010 to 15,729 euros in 2011, which is equivalent to real reduction of 25.3 percent, taking into account a 3 percent rate of inflation.
The Greek President should show the same sort of leadership that Iceland’s titular head demonstrated when he blocked the machinations of the scheming politicians there who were intent on playing along with the European elite cabal.
The fact that Iceland also maintained their own currency allowed them to restore growth and confidence relatively quickly, notwithstanding the massive recession they encountered.
Greece is stuck in austerity with no way out. It can only grow in a robust manner and sustain that growth if it leaves the Eurozone. It should declare a bank holiday next Monday (making the declaration sometime over the weekend), default on all Euro-denominated debt, and renegotiate from the strength of its own currency.
It might also start printing tourist maps in German to cater for the swarm of northerners who would take advantage of the terms of trade shift.
Politics in the Pub
For those that live locally (I am in Newcastle at present), I am giving a talk at the Monthly Politics in the Pub gathering tonight on the Eurozone crisis.
The evening starts at 18:30 at the Station Hotel, Hamilton (just near the railway gates).
That is enough for today!