Last week we all received the tragic news of the collapse of Iceland's economy, and the subsequent collapse of its government. I've read more than one writer's words describe the events as a “canary in the mine shaft,” a reference to larger, more dire events that have yet to manifest in other governments, in other parts of the world. I couldn't agree more, or summarize it better. Those are choice words. Iceland is an excellent and early example of what governments should avoid during credit bubble trouble, bailout requests and general economic reversals. In short, they should stay out of the private sector, and leave the peoples' economy alone.
What I think clarifies some of the goings-on in Iceland best is a short time line of exactly what has transpired over the last couple of decades that might lead the newly unhinged Icelanders into such horrible financial circumstances.
A time line:
2001: Icelandic banks expand rapidly after deregulation of domestic financial markets.
2007: Iceland's GDP grows to over €8.5 billion, or $10.8 billion.
1990's – 2008: Government spending on public programs surpasses 42 percent of GDP ($4.53 billion).
April, 2008: The private banking sector has amassed more than 80 percent of Iceland's privately held external debt.
September 15th, 2008: Lehman Brothers seeks Chapter 11 bankruptcy protection.
September, 2008: the Icelandic Króna loses more than 35 percent of its value against the Euro.
--- Inflation surpasses 14 percent.
--- Interest rates are raised to 15.5 percent to curtail inflation.
--- Icelandic authorities request $2 billion loan from the IMF.
--- Icelandic authorities request $4 billion loan from four Nordic neighbors.
September 29th, Iceland's government nationalizes Glitnir Bank, taking a 75% stake in the troubled company.
--- Glitnir Bank shares collapse.
--- The Króna begins dropping in value.
October, the top three private banks in Iceland are found to be holding privately held liabilities exceeding twelve times Iceland’s GDP.
October 6th, Iceland's government pegs the Króna to the Euro.
October 7th, the Central Bank of Iceland announces a currency peg for the Króna, while knowing is does not have adequate reserves for international currency trading markets.
--- The Króna goes into currency value free fall.
--- Landsbanki Bank is nationalized.
--- Iceland's government agrees to give Kaupthing Bank a €500 million loan, equal to half of Iceland's GDP. Between public spending programs, and the new loan, the total amount the government owes is now 92 percent of the country's GDP. If the liabilities of the two newly nationalized banks are included as a debt total, the government now owes 715% of its GDP.
Oct. 8th, the solvency of Kaupthing Bank is questioned on British television. British authorities seize Kaupthing Bank's foreign assets by force and transfer them to Dutch bank ING.
--- Iceland goes into a currency panic, which is blamed on British Prime Minister Gordon Brown, and the seizure of Kaupthing Bank's assets.
--- The Central Bank abandons its attempt to peg the Króna to the Euro. It's the shortest currency peg in history - one full business day.
October 9th, Kaupthing Bank is nationalized. This is Iceland's largest bank. The government debt total is now 1,315% of its GDP.
--- Trading in the Icelandic Króna collapses.
October 10th, the Central Bank of Iceland introduces restrictions on the purchase of foreign currency within Iceland.
October 15th, temporary currency auctions are held to facilitate international trade.
Mid October, Iceland's foreign exchange reserves fall by US$289 million.
November, 2008, the real exchange rate reaches a thirty year low.
December 3rd, the last currency auction is held.
January 26th, 2009, Iceland's government collapses.
This whole scenario played out like a slow-motion nightmare. One mistake after another was manufactured by policymakers in their attempts to contain what could not be contained.
In this drama, only the mistakes were plenty
First, the Icelandic government consumed a whopping 42 percent of the GDP of the economy, and spent the proceeds publicly, mostly on infrastructure. While such spending certainly will make nice roads, bridges and public buildings (if it's spent efficiently), it ultimately leaves very little wiggle room for a governing body, should a threatening new economic situation arise. After giving over more than forty percent of everything they earn, the people of Iceland are sure to feel more than just a little pinched should their taxes suddenly increase, or should their currency become hideously devalued – or both. To wit, there was no accounting room left for a rainy day.
Second, Iceland's Central Bank, in a very bone-headed maneuver, tagged its currency, the Króna, to an external currency, the Euro, while in the midst of a currency crisis. At first blush, this seems reasonable. The Euro is already established, traded and stable. But research and development should be left for prosperous times. Contrary to the axiom, in economics, desperate times do not call for desperate measures. Desperate times call for renewed fiscal conservatism; they call for us to fall back on the things we know will work every-single-time. To make matters worse, the government entered the international currency market knowing it did not have adequate reserves in its central bank. Here we can see an overt act of desperation and overreaching. Clearly the government had no answers.
Third, in the worst move of all, Iceland's government nationalized its biggest three privately held banks, despite the fact that the banks were known to hold over twelve times Iceland's GDP. Now this is simply stupid. When, you, as an individual, see the money you hold being devalued at a rapid clip; see your economy in upheaval; and see that you already owe far more than you can pay or calculate, the last thing you want or need is another massive debt. There is no difference whatsoever for governments. Combine all of these events, and the government of Iceland no longer looks like it contains leadership of any kind. It looks more like Moe, Larry and Curly. But the argument against these actions goes far deeper than just fiscal conservatism. There is a moral to this story, and it's an extraordinarily important one.
Welcome to Iceland... Slave
Governments transfer private debts onto the shoulders of the public all the time. We're doing the same here in the U.S. Our banks, mutual fund companies, automakers, large mortgage companies, etc. - they are all soaking up taxpayer dollars at an alarming rate, and the public is outraged. And rightfully so.
Though most people, I assume, don't fully intellectualize why that sort of scenario is so offensive, there is very good reason to be angered. You, the taxpayer, have become the beast of burden to the failures of others. They are irresponsible, disorganized and fail? They win. You are responsible, conservative and succeed? You lose. This means the government has decided that you, as a responsible person, have no say in how your productive effort is used. Your rights to your effort are less important than the perceived well being of another. When a human has no say in how his productive effort is used, s/he can only be described as a slave. And slavery, of any kind, is evil. But the evilness doesn't end there.
The slavery scenario created by government is done under the guise that they are saving jobs, preventing disaster, and doing all of their confiscating “for the good of the people.” Nothing could be further from the truth (If you disagree, reread the time line above). They are simply cloaking government growth, parasitism and whipping boys, while speaking about how much good they are doing by intervening in the economy. They confiscate, and then publicly try to justify their confiscation. What's sad is that there are so many naive people in the world who still believe them.
The greater good doesn't exist – through force
The ironic thing about what Iceland, or any other government does in such dire circumstances, is that when they procure monies from the people, three unavoidable things happen. First, the obvious happens. Money is taken away from the most productive members of society. Second, those monies are given over to those who have failed in an effort to prevent their failure. Third, a bureaucracy is created around the confiscation and distribution of those monies. But lastly, and most importantly, had there been no intervention, none of those circumstances would be present. There would be no sacrificial animal, who would otherwise still be successful. There would be no parasite to receive, and become dependent upon, redistributed monies. And, there would be no need to increase the breadth and depth of government to oversee the taking and spending activities. Spoken quickly, there would be no need to produce economic slaves. So under the auspices of making the lives of the voting public better, they have succeeded in making them worse. They have grown the burden that individuals, who had nothing to do with the business dealings of Iceland's banks, must pay to government. They have created dependency. And they have dumbed down their entire society to a lower common economic denominator. And, as any former communist can tell you, that common denominator is unbelievably low.
So what Iceland has done is create its own problems. Its government made its own bed, and now it must sleep in it. Before the banks were wrongly nationalized, the enormous debts that were held by Glitnir, Landsbanki and Kaupthing banks were entirely private. The taxpayers of Iceland owed nothing to the banks for their rapid growth and fiscal irresponsibility. The recourse that the banks' customers had before nationalization included confiscation, which Britain did, and lawsuits. But that all changes totally when the banks become publicly funded. What would otherwise be a normal, albeit painful, free market correction, that is limited to one industry, instead becomes a nationwide malaise felt by the entire population. The argument for intervention centers around how people “need” banks and the credit they provide, and the jobs that will be lost in the industry when those businesses are allowed to fail. And that's true. But...
Should one bank in Iceland have failed, there would then be two, suddenly more solvent banks, to pick up the pieces left behind by the one that has gone under. Should two fail, there would then be one, more solvent bank to provide products and services to the country. And should all three fail, banks from foreign countries would step in to provide the needed credit. The “bank of last resort” argument doesn't make sense, since Iceland has one – The Central Bank of Iceland. So long as all of the private debts are kept out of public hands, a central bank can print money, manipulate interest rates, or pursue a small arsenal of other activities to make sure the entire country doesn't feel the pain of the banking sector. In a market that is free to respond to the needs of its customers, rebounds happen quickly. Where there is money to be made, there will be people to fill the needs. But that's not so in a hyper-regulated market. Those take much longer to recover, because of arbitrary market restraints.
So the omniscience of Iceland's government became an extraordinarily egocentric animal. It believed it knew better than the unregulated market. And the “fatal conceit” that Nobel Prize winning economist Frederick Von Hayek wrote about years ago has been proven once again. No one in government has enough information on hand to successfully manipulate an entire economy. The best thing to do is simply leave it alone. The less you regulate a population, the more opportunities they have to build their own prosperity.
Government, in this example, has proven to be the problem rather than the solution. Unfortunately for the people of the United States, the present administration appears to subscribe to the same mindset as the Icelandic leadership – that if we just manipulate enough, if we just redistribute enough, we can control the economy.
So take a good look around. If you see any canaries struggling to breathe, grab your dollars, exchange them for gold, and head for that distant point of light, before you get stuck in the mineshaft.
The Isle That Rattled the World
2008–2009 Icelandic financial crisis
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2009 index of economic freedom
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Global financial crisis overwhelms tiny Iceland
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