Icelandic mulishness wins the day

December 9, 2010

Iceland’s remarkable return to growth shows once again that in this crisis the best policy is often the one that will make international partners most angry.

Having been reviled and chastised when it refused to make good the outsize debts of its banks, Iceland this week capped a striking turnaround when it announced that its economy expanded by 1.2 percent in real terms in the most recent quarter, its first such rise in two years.

This is in stark contrast to Ireland, whose pliability and inability as a member of the euro zone to act unilaterally leaves it with a still crashing economy which must service ever more debt by making ever deeper cuts to public spending.

Iceland, which sailed into the crisis in 2008 as essentially a small fishing fleet with a massive hedge fund attached, looked its predicament square in the eye and followed a set of policies seemingly designed to tick off both its friends and enemies, doing its small but mighty best to beggar its neighbors by letting its currency crash, imposing capital controls and, crucially,  refusing to make whole the global creditors of its three failed international banks.

While an International Monetary Fund and multilateral package was eventually agreed, and a deal with Britain and the Netherlands over debts from Icesave Bank are currently being hammered out, Iceland’s leaders, at least the current ones, seem convinced that making bank creditors share its pain was the right course.

“The difference is that in Iceland we allowed the banks to fail. These were private banks and we didn’t pump money into them in order to keep them going; the state should not shoulder the responsibility,” Iceland’s president, Olafur Grimsson, said last month, tweaking the nose of EU officials who are insisting that Ireland make good all senior creditor calls on its own distended banking system.

“Bondholders should not rely on the government stepping in and bailing them out,” Iceland Central Bank governor Mar Gudmundsson said last week. “They should do their due diligence.”

“I think the Irish are accepting that they were probably too fast in guaranteeing the whole liabilities of banks. Now this is turning out to be a big burden because the assets of these banks turned out to be much worse than they thought.”

Indeed. Though Iceland has a 6.3 percent budget deficit this year, it is on track to soon record a surplus, while Ireland’s deficit this year is 32 percent if the cost of bank bailouts is included. Similarly, Iceland’s unemployment rate has fallen by almost a quarter to 7.3 percent, as against more than 14 percent in Ireland.

It is all strangely reminiscent of Malaysian leader Mahathir Mohamad, who attracted international condemnation when in 1998 he rejected IMF measures, instead pegging the ringgit to the dollar and imposing widespread capital controls. Your correspondent was among those who stroked his chin and said that Malaysia would rue the day it cut itself off from international capital, but of course this proved to be far off the mark.

Malaysia recovered robustly, foreign capital eventually flowed and more to the point, the country and its Asian neighbors learned the importance of being able to self-insure against the vagaries of global capital flows, leaving them by and large better prepared for the most recent crisis than the rest of the world.

While Mahathir was a strongman acting against international and internal advice, Iceland’s mulishness has been a model of democracy. In a March referendum 93 percent of voters rejected a deal with Britain and the Netherlands to repay 3.9 billion euros of Icesave losses. Even more striking, and a contrast with a singular lack of prosecutions elsewhere, was the decision of Iceland’s parliament to refer to the legal system¬† criminal charges surrounding the crash against former Prime Minister Geir Haarde.

To be sure, Iceland may have succeeded in rejecting the international consensus precisely because it is so small — many argue that a default by Irish banks would cause another global banking crisis costing far more than 30 or 50 percent of Irish GDP.

Quite possibly it would, but that does not mean that the policy of pretending that banks are not insolvent and loans not underwater is wise. The tepid, halting and largely jobless recovery argues that it is not, that debts need to be properly purged before both borrowers and lenders can play their respective roles.

Regardless, the great victory of Icelandic stubbornness is not just in its recovery but in winning a fairer division of the burden than in Ireland, Greece, or for that matter, the U.S.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email:


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Well described, and refreshingly honest about how “bad” behaviors sometimes win. Question on my mind is how to make clear what the risks are for all sides: to governments which implicitly or explicitly guarantee private entities (such as banks), to investors or depositors in financial institutions, and to businesses who rely on investment. The invisible hand only can work with full information for all participants in a market.

Posted by m11213 | Report as abusive

Much to be praised in the way Iceland has dealt with the situation, but remmeber, they agreed to make local savers whole, while not savers from other countries.

This is not an option in the EU, and for me it is wrong.

Posted by Dafydd | Report as abusive

Population of Iceland – 319,000. About the size of Lexington, KY in the United States.

Population of Ireland – 4.5 million

Just to put things into perspective…

Posted by jobon1 | Report as abusive

I often find the writing here to be less than balanced. I found the analysis of what economists thought of the tax deal to particularly one sided. But this is marvelous writing. I was very impressed especially in the way the numbers were used in a simple and useful manner instead of being used to impress.
I’ll have to look and see if the gentleman has a book or two out.

Posted by southwerk | Report as abusive

I doubt the Brits and the Dutch are done with Iceland. What they did is default on their debt, hardly a new thing in the world, but the limitations of what they can do in their home economy is eventually going to have them trying to talk to their neighbors again.

They will never be part of the EU, the U.S. banks won’t deal with them on anything like a favorable condition until they get that fixed, and it won’t be fixed on their terms. I suspect what you are hearing is an attempt to put a bold face on what is and will be a desperate situation.

Posted by ARJTurgot2 | Report as abusive

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