Iceland Shows Other Europeans How to Survive Bankruptcy

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    Sep 13, 2012 3:03 PM GMT
    http://reason.com/archives/2012/09/07/iceland-provides-a-blueprint-for-survivi

    Small Atlantic nation enjoys growth and employment gains after failing to rescue its banks. Mainland Europe remains stuck with stagnation, decline, and ruinous "rescue" packages.

    Taxpayers in Europe (and the United States) who have been terrorized since 2008 by government officials warning about economic armageddon, catastrophe, and pestilence should look to tiny Iceland for a taste of how little there is to fear when the experts can't save the people. [...]

    Iceland’s GDP per capita (in current U.S. dollars) was a little over $65,500 in 2007; in 2009 it was almost $38,000. It would be cruel to overlook the effect a sudden loss in wealth like this had on the average Icelander’s economic well-being. Having investments you thought were safe vanish is unfortunate at best and tragic at worst. However, the economic future of young Icelanders will almost certainly be substantially better than that of their peers in Greece.

    Icelanders will do better than Greeks precisely because financial institutions collapsed in Iceland, ironically in part because of mechanisms in place requiring bailouts from the Icelandic Central Bank. Economic collapse allowed for proper refinancing. Greece has suffered from too much attention, and because of all of that attention, the actual size of the Greek economy has been forgotten.

    Greece's GDP is roughly the size of Maryland’s, about $300 billion. The eurozone as a whole has a GDP of almost $12 trillion. Figures like these only highlight the strictly political motiviations behind the attempted rescue of Greece by the rest of the eurozone. Certainly, a Greek exit from the eurozone would be a major event. However, Iceland’s example shows that letting financial institutions fail allows for strong and comparatively quick recoveries following a period of economic hardship.

    Unsurprisingly, government attempts to fix the European financial crisis have made the situation worse and humiliated the most affected countries the most severely. Had Greece been left to default on its debt and leave the eurozone early, the effects, economic and political, would have been much less dire in comparison to the effect of a Greek exit now. What is forgotten about the example of Iceland is that although the initial international reaction to Iceland’s collapse was anger, the country's reputation recovered. The animosity brewing between the Greeks and other Europeans (especially Germans) will not diminish within a matter of months. Too often the cultural changes that are happening in Europe are overshadowed by the economic fiasco.

    The comparison between Greece and Iceland is not perfect. If Greek GDP, at $300 billion, puts it on par with the Old Line State, Iceland's, at just $15 billion, puts the island nation below even Vermont, the U.S. state with the lowest GDP. But so what? The economic stagnation caused by Too Big To Fail, of which the Euro "crisis" is only the most monstrous example, resulted from policymakers believing that the same math you know to be true at the local level does not apply at the macro level. The central bankers are wrong about that, and the example of Iceland provides Greece and the rest of mainland Europe with a valuable example.

    Unfortunately, it looks like it will be a lesson learned in hindsight. How severe the effects of fiscal and monetary activism will be on the eurozone will depend in part on how quickly continental policymakers can abandon their political agenda and focus on the economics.
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    Sep 13, 2012 5:13 PM GMT
    'Tiny Iceland' got away with defaulting on its debts because, well, it is tiny. It is no example for a real nation to follow.
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    Sep 13, 2012 5:42 PM GMT
    Ex_Mil8 said'Tiny Iceland' got away with defaulting on its debts because, well, it is tiny. It is no example for a real nation to follow.


    Why can't other countries follow in the steps described above? They aren't limited in size or amounts.
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    Sep 13, 2012 6:22 PM GMT
    If Greece defaults and leaves the euro, it will be forced to impose exchange controls and rationing. If it is to import the drugs necessary to run the health service, the oil necessary to run the transport system and the electricity needed to keep the lights on at a price that the government can afford, then foreign currency will have to be rationed. It's happened in Iceland, where everyone who wants to buy foreign currency has to submit an application to a bank, and in Argentina, where the power to buy foreign currency is used as a tool of patronage by the administration. It would inevitably happen in Greece.

    And if it happens to Greece, then it could happen to Spain or Italy too. Thankfully, we are still far away from the prospect of either of those countries leaving the euro, but in Spain, the source of the problem is the banking system, not the government – much as it was in Iceland. If no bailout or European-level banking system can be agreed, the temptation to stop foreign creditors from withdrawing money electronically by imposing capital controls would be quite strong. Since most of the world's €500 notes are in Spain, it would probably have to be accompanied by border controls to stop the money leaving physically too.

    Quite quickly, the free movement of capital around Europe would be dismantled. Since for goods to move one way, capital must move the other, that would probably lead to a drying up of trade too, as debtor countries engage in import substitutions. And since trade is the main way in which we can all get collectively richer (by specialising in what we're good at), GDP would end up frozen too. Given Europe's demographics, the result would be permanent depression, accompanied by worsening diplomatic relations between countries and chaos within them. Much of the good that free trade within Europe has done over the last 30 years would quickly be undone. The continent would be substantially and permanently poorer.
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    Sep 13, 2012 6:52 PM GMT
    Ex_Mil8 saidIf Greece defaults and leaves the euro, it will be forced to impose exchange controls and rationing. If it is to import the drugs necessary to run the health service, the oil necessary to run the transport system and the electricity needed to keep the lights on at a price that the government can afford, then foreign currency will have to be rationed. It's happened in Iceland, where everyone who wants to buy foreign currency has to submit an application to a bank, and in Argentina, where the power to buy foreign currency is used as a tool of patronage by the administration. It would inevitably happen in Greece.

    And if it happens to Greece, then it could happen to Spain or Italy too. Thankfully, we are still far away from the prospect of either of those countries leaving the euro, but in Spain, the source of the problem is the banking system, not the government – much as it was in Iceland. If no bailout or European-level banking system can be agreed, the temptation to stop foreign creditors from withdrawing money electronically by imposing capital controls would be quite strong. Since most of the world's €500 notes are in Spain, it would probably have to be accompanied by border controls to stop the money leaving physically too.

    Quite quickly, the free movement of capital around Europe would be dismantled. Since for goods to move one way, capital must move the other, that would probably lead to a drying up of trade too, as debtor countries engage in import substitutions. And since trade is the main way in which we can all get collectively richer (by specialising in what we're good at), GDP would end up frozen too. Given Europe's demographics, the result would be permanent depression, accompanied by worsening diplomatic relations between countries and chaos within them. Much of the good that free trade within Europe has done over the last 30 years would quickly be undone. The continent would be substantially and permanently poorer.


    The f/x controls were a temporary measure - and you're right, it is quite likely something similar in Greece and Spain would happen but the problem now is that the currency is causing much of the imbalances as it doesn't allow the price of goods and services to fall and the markets to correct themselves.

    And you're right that for goods to move one way, capital must move to the other - so prices for goods would instead have to fall - which they could because of the drop in the value of currency.