We can learn from Iceland's crash – and their recovery

(Photo source: The Guardian)

I have posted below my contribution to the New Statesman Current Accounts economic blog, in which I discuss the lessons we can learn from Iceland’s crash and recovery:

“Let’s confess, it felt good to see a Prime Minister criminally charged for the financial mismanagement of his country, as happened to Iceland’s Geir Haarde. But it also seems fair that he was convicted only of negligence.

After all, he and his government had full policy cover from mainstream economists like Richard Portes (ex-President of the Royal Economic Society) in the bubbly lead-up to the banking collapse in October 2008. Professors Portes and Baldursson co-authored a November 2007 report for the Icelandic Chamber of Commerce, in which they concluded that:

. . . the Icelandic economy and financial sector are highly resilient. . . With regard to both the macroeconomic situation and the characteristics and performance of the banks, we consider that the current market premium on Icelandic banks is excessive relative to their risk exposure and in comparison with their Nordic peers. . . Overall, the internationalisation of the Icelandic financial sector is a remarkable success story that the markets should better acknowledge.

The authors made similar points in a letter to the Financial Times in July 2008 – just 3 months before the crash!

No wonder then that Mr Haarde argues that

None of us realised at the time that there was something fishy (sic) within the banking system as now appears to have been the case.

Moreover, he added, “nobody predicted that there would be a financial collapse in Iceland.”

Well, that last point is not quite true. Many did, like Professor Robert Wade. In my book The Coming First World Debt Crisis (2006) I drew attention to a report by Danske Bank which flashed strong warning lights:

Iceland seems not only to be overheating, but also looks very dependent on the willingness-to-lend of global financial markets. This raises the question of whether the economy is facing not just a recession but also a severe financial crisis.

Yet if Iceland got it all wrong in the lead-up to the October 2008 banking collapse, the country (which still has its own currency) has since done much that is interesting and positive, ignoring or going against the counsel of orthodox economists:

  • Iceland nationalised the domestic parts of its banks, and allowed the non-domestic parts to go bankrupt
  • Iceland looked after its own citizens first, and refused to be bullied by the UK and the Netherlands demanding preferential treatment for non-existent ‘loans’ at usurious rates of interest
  • Iceland’s President responded to popular dissatisfaction with proposed deals with the UK and the Netherlands, by allowing a democratic vote – which confirmed overwhelming opposition
  • Iceland imposed capital controls to stop hot money flows into or out of the country.
  • It gave special protection to home-owners threatened by banks foreclosing.

Despite (because of) all the above, GDP grew by 2.7 per cent in 2011, and unemployment – though high at 6.9 per cent – is far below the current EU average of 10.2 per cent. The IMF’s latest country report (March 2012) states

Iceland’s post-crisis recovery has taken hold. After two years of recession, growth turned positive in 2011, led by domestic demand. The labor market improved, although the unemployment rate remains high… A moderate economic expansion is projected going forward.

So compared with the Eurozone, Iceland is not doing so badly. And compared to Ireland, which has followed very different policies, it’s steaming ahead. Ireland’s GDP rose by 0.7 per cent in 2011, and unemployment is now double Iceland’s at 14.7 per cent. Given that many of Europe’s governments are now run by unaccountable technocrats, the same ones that developed the kind of policies that brought Iceland down, one must congratulate the people of this small country for insisting on the democratic accountability of its political class.”

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4 comments to We can learn from Iceland’s crash – and their recovery

  • Dear Ann Pettifor

    If the banks are asking for money they must show that they have a material loss, since the money they lent was created out of thin air this would be impossible to show they lost anything. To take the example of Northern Rock who had 2bill in deposits but somehow had lent out 105billion, there seems to be a distinction between real capital and bank credit. The banks claim they have lost trillions, but did they have those trillions to begin with?

  • Keith Tapp

    Dear Ann,
    What kind of capital controls have Iceland used to stop ‘hot’ money flows?

  • As a voice in the wilderness in 2007/8 I argued for the banks to be ‘saved’ for their retail (domestic) business while their investment arms be placed in moratorium until such time as their supposed investments could be forensically analysed, audited and valued.

    Of course at this time G Brown was too busy disguising funk under the robes of being a world saving messiah while being manipulated by the strings of the financial alchemists to an extent, I believe, they simply could not believe their luck. Not only were they being re-financed by their debts being socialised and free of any real control or liability, but also their abilities to create absurd ratios under fractional reserves and the creation of fiat debt were being consolidated. In effect the tape worm that had emaciated society had now been given the power to dictate societies diet.

    To my mind there’s not one chance of a viable prognosis emerging from this chaos that will be ultimately beneficial to society as a whole unless and until we re-invigorate the democratic process (not just with regard to the financial system – that is only an effect) but from the constitutional bottom to the corrupted self serving hierarchical top.

    That’s where Iceland has got it right.

  • Donna

    Great post, even great responses; very informative for a university student. Thank you.

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