Iceland’s method of coping with the financial crisis had a brutal charm about it. In essence, the country hoisted its middle finger to the owners of bank bonds, and a few other people it owed money to, and walked away.
It worked. For evidence, note that Iceland made a triumphant return to the international bond markets late last week, and that its tiny economy is growing at a fair clip, both remarkable achievements when you consider its punishing economic and banking collapse in late 2008.
And therein lies a lesson. Make that two. The first is that bond holders of clapped out banks can, and should, take losses for the greater good of the recovery. The second is that keeping your own currency is a terrific idea when you’re going through economic hell -- it gave Iceland the fiscal freedom that Greece, Ireland and Portugal entirely lack.
Iceland’s sale of 5-year bonds raised $1-billion (U.S.) at 5 per cent, not cheap but a bargain compared to the outrageous yields of comparable Irish and Greek bonds (though neither is able to borrow and is relying on emergency European Union and International Monetary Fund loans stay afloat).
Given the way Iceland treated bondholders, it seems a miracle that the government was able to push the new bonds out the door. Three of Iceland’s banks collapsed in October, 2008, shortly after the Lehman Bros. implosion tore the global financial system apart. Iceland refused to bail out the bank bond holders -- they took “haircuts,” to use the argot of the debt markets.
Iceland determined that it was under no legal or moral obligation to underwrite the reckless behaviour of its commercial banks, whose assets soared to 10 times gross domestic product, making them grenades ready to explode. Ireland took the opposite view and guaranteed its banks, much to the rage of the taxpayers. As a result, Ireland’s debt-to-GDP has climbed four-fold since the financial crisis.
Iceland also refused to compensate Britain and the Netherlands for reimbursing the more than 300,000 depositors of Icesave, one of Iceland’s dud banks. The depositors should have received the money from the Icelandic government’s depositor protection scheme, but the country did not have a kronor to spare (proceeds from the liquidation of Landsbanki are expected to meet much of the liability, which explains why Britain and the Netherlands, though angry, have not gone berserk).
Iceland made it clear what it was going to do, or not do. With the help of the IMF, it submitted the economy to tough but fair reform programs in the form of tax increases, capital spending cuts and the like. The steady, clear plan obviously encouraged bond investors. They bought Icelandic bonds in spite of the country’s many lingering problems, such as high unemployment and capital controls that have trapped deposits held by foreigners.
Compare this Greece, where the European Union, the IMF and the European Central Bank are in open warfare about the best way to equip Athens with the next rescue package. Germany wants Greek bondholders to contribute to the painful effort; the ECB condemns the idea, insisting that any tweaking of the bonds’ maturities or yields would amount to a default with potentially catastrophic consequences. No wonder Greek bond yields are north of 20 per cent.
Iceland’s other clever move was to keep its own currency. The kronor depreciated about 50 per cent against the euro during the crisis. As a result, exports took off, contributing greatly to the improvement in the trade balance. GDP growth should be 2.2 per cent this year, and 2.9 per cent in 2012, and the budget deficit is narrowing considerably.
Argentina discovered fiscal freedom too when it dropped its currency peg to the dollar in 2001. Had it kept the peg, its economic turnaround would have been unthinkable.
Here’s the big question: Given Iceland’s progress, why oh why does it want to join the EU? It applied for membership in 2009 and expects to become a member in 2013 or 2014. Of course, EU membership does not mean adopting the euro, but most EU countries eventually scrap their own currencies. Given the horror show in the three bailed out euro zone countries, you have to wonder whether Iceland would be making a big mistake giving up its fiscal independence.