econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 29 May 2016

Diamond Geysers: Rule-Breaking Iceland Completes Its Miracle Economic Escape

from The Conversation

-- this post authored by Alan Shipman, The Open University

Disgruntled Icelanders recently forced their prime minister to quit, and are threatening to hand power to self-styled pirates at an early election. But whereas other European voters are culling traditional parties out of weakness, Reykjavik's are rebelling out of strength. In contrast to eurozone countries (core as well as periphery) that remain deeply constrained by excessive external debt, Iceland has just paid down its foreign obligations by a cool US$61 billion, returning them to the safe 2006 level.

The country that suffered proportionally the world's biggest financial collapse in 2008 is now set to boom again as it diversifies from fish, tourism and aluminium into renewable energy and information technology. Its GDP, already among the highest in the world per capita, is back above the pre-crisis level and set to rise (on central bank forecasts) by 4% in 2016 and 2017 - twice the eurozone and UK rates.

Although its overgrown banks were one of the causes of the global financial crisis, Iceland responded to their meltdown in the opposite way from the rest of Europe - and against the received wisdom of most economists. It allowed its currency to fall in value - an option unavailable to eurozone members, which had to ratchet down wages and prices through "internal devaluation". It nationalised the big banks that had run up unsustainable debt, rescuing only the fraction that served the domestic economy. It imposed capital controls so that the banks' creditors and other foreign investors couldn't withdraw their money. Locals, including pension funds, couldn't invest abroad.

Protesters in Reykjavik in 2010. EPA/S Olafs

Let's get fiscal

The central bank also tightened monetary policy. Its policy rate peaked at 18% in 2009, and was still at 5.75% this month. In the UK, eurozone and the US, central banks pushed their rates to near-zero and applied quantitative easing. Defying the austerity that prevailed across Europe, Iceland then allowed fiscal policy to take the economic and social strain. In particular, public money was used to relieve households of the debt that would otherwise stop any spending recovery.

Economist Paul Krugman, perhaps shielded from the orthodoxy by a Nobel prize, has repeatedly drawn attention to the way these policies allowed rule-breaking Iceland to recover far earlier than less afflicted eurozone peers - even Ireland, the poster child for conventional "adjustment policies".

Until now, critics had one powerful riposte to this improbable ray of Nordic sunshine. They said it was a false dawn. They argued that the whole recovery was only achieved on the back of draconian capital controls, in place since November 2008. Removing them would be painful, but failing to lift them promptly would have equally dire consequences. Foreign investors would despair of getting their trapped cash back - making it impossible for Icelanders to borrow again even for worthwhile investment far away from banking. The critics said that domestic investors' savings would, with nowhere else to go, turn the already strong tourism and stock market investment booms into overheated bubbles whose bursting unleashes more trouble.

In the red. Fishing boats ready for launch. Johnny Peacock/Flickr, CC BY-NC-ND

Emerging from capital controls is notoriously tricky, especially when they've been in place for eight years and when it's a small, open economy with a narrow productive base of mainly cod-fishers and whale-watchers. And so the pessimists have tended to hint that when the controls lift, the whole fairy-tale escape story will unravel. In this nightmare exit scenario, Iceland's currency (the kronur) will plunge as foreign funds flee, never to return. Interest rates will rise even higher to rescue the exchange rate, choking-off investment, without stopping the runaway inflation sparked by imports getting more expensive. The weaker kronur will leave the country struggling to service its remaining foreign debt, despite its recent reduction.

Kronur capitalism

In practice, Iceland has regained economic strength inside its gilded cage - to the extent that it can now step outside, melt it down and resell the gold. The current account surpluses permitted by the devaluation, and the nationalised bank assets that regained value after the economy's return to growth, have enabled the repayment of so much foreign debt that the rest will be manageable, even if the currency sinks when controls go. It's a stark contrast to the eurozone and especially Greece, which had to ask its creditors for debt relief that will not begin until 2018.

The chances of a kronur crash have diminished because the current account is back in surplus (foreign transactions bring in more money than they take out), and because foreign investors are again being attracted to Iceland. They like its high interest rates, growth prospects and investment opportunities. Icelandic households and businesses can live with higher borrowing costs because they've paid down their debts, while incomes have been rising fast.

Icelandic geothermal borehole. Lydur Skulason/Flickr, CC BY

Although a remote island with a population of 300,000 and unique natural resources could be dismissed as a special case, Iceland's remarkable renaissance make its remedies a serious challenge to the orthodoxy. Krugman is not the only one to find useful lessons in this Nordic saga. The IMF, which used to insist on free capital movement as precondition for assistance and recovery, has published research which assigns capital controls a valuable role in maintaining stability in a world of volatile international money flows.

Privateers, not privatisers

The sting in this unlikely tale turns out to be political, not financial. The recovery was laid out by the Social Democrats and Green Party in Iceland in a 2009-13 coalition, and taken towards completion by a coalition of the Independence Party and Progressives. However, Icelandic voters appear to have rounded on all the political groups that used to serve as government and opposition. The Pirates - launched in Iceland in 2012 as a campaign for more democracy and freedom of information - have led recent opinion polls with a commanding 40%, and are well placed to lead any government formed after early elections this autumn.

Neo-liberal orthodoxy could still return - in the form of David Oddsson, who (as finance minister, prime minister and central bank governor) was an architect of the financial liberalisation that preceded the 2008 crash, and who has joined an unusually crowded field. But if normal politics is restored, it's only because highly abnormal economics made good the elites' past mistakes.

The ConversationAlan Shipman, Lecturer in Economics, The Open University

This article was originally published on The Conversation. Read the original article.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.



You can also comment using Facebook directly using he comment block below.





Econintersect Contributors


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
Big Mess in Italy
Are You Feeling the Economic Surge?
News Blog
Early Headlines: Asia Stocks Up, Oil Down, GOP Healthcare, Trump Not Reagan Redux, EU Ending?, UK Lost Decade, Putin Taking Over Mid-East, Yuan 'Flash' Crash And More
December 5, 2016 Weather and Climate Report - December Update - Zonal Prevails
Irish Births And Baptisms Visualised
What Happens In The Smartphone Afterlife
Water Intoxication: Are We Drowning In Advice To Drink More Fluids?
The Worldwide Virtual Reality Market Is Set To Be Huge
Average Gasoline Prices for Week Ending 05 December 2016 Rose Over 5 Cents
What We Read Today 05 December 2016
Why We Have Different Blood Types
November 2016 Conference Board Employment Index Improved.
November 2016 ISM and Markit Services Index Mixed
Are All Collateralized Loan Obligations Equal?
A Third Of Homes Sold For The List Price Or More In August 2016
Investing Blog
Momentum Issues A Warning
The Great Bond Crash Of 2016: 05 December Update
Opinion Blog
The Shale-War Is Over
Fake Science
Precious Metals Blog
Silver Prices Rebounded Today: Where They Are Headed
Live Markets
05Dec2016 Market Close: US Markets Close Higher, WTI Crude Settles At $51.09, US Dollar Drops Below 100 Temporally
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government



Crowdfunding ....






























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved