Debt Crisis – Learning From Iceland

Iceland experienced an identical crisis to Ireland – private banks borrowed too much money in deregulated markets to finance a domestic real estate boom. This is not the case in Greece. Iceland responded by privatising the debt whereas Ireland socialised it.  

In 2008, when the domestic real estate boom collapsed Iceland refused to guarantee the debt of non-resident bondholders. They introduced capital controls and devalued their currency.

Ireland adopted a classic orthodox approach. It opted to save the banks and introduce an austerity package that since 2008 has equated to 13 percent of GDP .This was widely supported by most Irish economists, journalists and political parties.

Two years later Iceland were back in the bond markets and experiencing economic growth. Ireland was in receipt of an ECB-IMF-EU Commission financial loan with strict conditions.

Ireland adopted the orthodox approach with the explicit intention and belief that it would enable full access to international bond markets at reasonable rates. The Irish strategy failed and the Icelandic one succeeded. This is a brutal fact that cannot be ignored (and nor will it by economic historians).

The difference between the two countries is of course – the Euro.

International finance markets find it much more difficult to cause a sovereign liquidity crisis in a country that controls its own currency than one that does not. Ireland and Spain are reliant on private finance markets whereas the UK and Iceland have their own central banks. They have much more domestic political discretion to coordinate monetary policy.

The UK has pursued a classic orthodox approach for political not economi reasons. The Tory government have clear policy choices if they opt to pursue them.

Spain and Italy, on the other hand, are preempting markets by flexing their austerity muscles before it is imposed from the Troika.  It is a political signal to the market that they are as tough as the Irish.

Ireland, Portugal, Spain, Italy and Greece are bound by the constraints of the Euro. Greece will default, this is inevitable. So will Ireland if the German government does not change policy direction. In fact, the German elections are probably more important for policy outcomes in Ireland than Irish elections.

So, although I do not fully support it, it is perfectly rational to call for exit from the Euro to solve Ireland’s problems. In fact, it is much more rational to call for an exit from the Euro than to advance the argument for more austerity (or at the rightwing extreme – call for what Jurgen Stark advocates).

Ireland is in the position of an emerging market economy that is issuing debt in a foreign denominated currency. The only journalist to face up to this reality and call a spade a spade is David McWilliams.

Irish policymakers and economists will be judged by the history books. Most will be painted as short-sighted and lacking the courage to change direction from a vicious path dependent route to self-defeating austerity and ‘structural adjustment programs’. This reality might appeal to the self-interest of politicians and force a change in direction.

Ireland is no longer a democracy. The bind of the Euro and the Troika means that we are living through a technocratic adjustment. This begs the question as to whether the reality of losing democratic sovereignty might lead to a nationalist-republican sentiment to rise up and challenge the orthodox consensus?

It has not so far. But, my guess is that this will radically change when the next election comes around. That is unless the centre-right German coalition are kicked out of office and a new government adopts a radical new strategy for Europe.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s