Diamond geysers: rule-breaking Iceland completes its miracle economic escape

Unhappy Icelanders recently have forced their leader to resign and are now threatening to give the reins over to the self-styled pirates in an election that is scheduled for early. While the majority of European voters are cutting down traditional parties because of their weaknesses, the Icelandic people are fighting because of their power. In contrast to eurozone nations (core and periphery), which are stifled by massive external debt, Iceland has just reduced its foreign debt by US$61 billion, bringing it back to the level of security in 2006.

The country that was hit with the most financial crisis during 2008 is now expected to rebound in the coming years as it diversifies its economy from tourism, fish, and aluminum to the fields of renewable energy as well as information technology. The country’s GDP, already among the top globally per person, has risen currently higher than the pre-crisis average and is expected to increase (on forecasts by the central bank) by four percent between the years 2016 and 2017, nearly twice as much as eurozone and UK rates.

Although its overgrown banking institutions were a major cause of the financial crisis in the world, Iceland responded to its collapse differently in contrast to the other countries of Europe and also against the conventional wisdom of many economists. It let its currency decrease in value – an option that was not available to members of the eurozone, who needed to reduce the cost of living and inflation by implementing “internal devaluation.” It renationalized banks that had accumulated insolvent debt, only rehabilitating the portion that was used to support the local economy. It introduced capital restrictions to ensure that banks’ creditors and foreign investors were unable to withdraw their funds. Locals, like pension funds, weren’t able to invest in foreign markets.

Protesters in Reykjavik in 2010. EPA/S Olafs

Let’s get fiscal.

The central bank has also tightened its monetary policy. The policy rate reached 18,05% in the year 2009. It was 5.75 percent this month. Within the UK, eurozone, and the US, central banks increased their rates to near zero and also implemented quantitative ease. In contrast to the austerity policies that were prevalent throughout Europe, Iceland then allowed fiscal policy to ease the burden of social and economic growth. In particular, public funds were utilized to alleviate households of debt, which would otherwise impede any recovery in spending.

The economist Paul Krugman, perhaps shielded from the mainstream by his Nobel prize, has repeatedly been adamant about the way these policies have allowed the rule-breaking Iceland to rebuild much earlier than its other eurozone members who are less affected, and even Ireland, which is the model for the conventional “adjustment policies.”

Up until now, critics had a strong rebuttal to this unlikely light Nordic sunshine. They claimed that it was an untrue dawn. They claimed that the entire improvement was achieved only due to the draconian capital controls, which have been in effect since November 2008. The removal of these controls would be difficult, and the inability to remove them quickly would result in equally devastating consequences. Foreign investors will be unable to imagine receiving the cash that was held, which would make it difficult for Icelanders to obtain loans to fund an investment that is worthwhile and away from banks. Some critics suggested that the savings of domestic investors will, without a place to go, transform the already robust tourist and investment growth into overheated bubbles, which rupture could cause more problems.

The red. Fishing boats are ready to launch. Johnny Peacock/Flickr, CC BY-NC-ND

The process of removing capital controls can be difficult, particularly those that have been in place for more than eight years, and it’s an undeveloped, open economy that has a small market of mostly whale watchers and cod fishermen. The optimists have tended to say that once the controls are lifted, then the entire fairytale tale of escape is likely to unravel. In this nightmare scenario, the Icelandic currency (the Kronur) will plummet as foreign money flees into the void, never to return. Rates of interest will climb higher to save the exchange rate, which will stifle investment but not stop the raging inflation caused by imports becoming more expensive. The weaker currency will make it difficult for the country to pay off its foreign debt despite the recent decrease.

Kronur capitalism

In the real world, Iceland has regained economic power inside its gold-plated cage to the point that it’s now able to go out, melt it down, and then resell the gold. These surplus current accounts are facilitated through devaluation and the nationalized assets of banks that gained value after the economic recovery and have allowed the repayment of a large number of external debts that remain manageable even if the currency plummets once controls come down. This is a stark contrast to the eurozone and particularly Greece, which was forced to seek out the creditors of its debt for relief, which is expected to not be in place until the year 2018.

The likelihood of a crash in the Kronur has been reduced due to Iceland’s actual account being in good shape (foreign transactions earn more cash than they take out) as well as because Iceland Iceland once again attracts foreign investors rates of interest draw them, as its growth prospects and its investment options. Icelandic families and businesses are able to afford higher borrowing costs due to the fact that they’ve paid off their debts while earnings have been increasing rapidly.

Icelandic Geothermal Borehole. Lydur Skulason/Flickr, CC BY

While a small island with a population of over 300,000 as well as distinct natural assets can be viewed as a unique case, The remarkable renaissance of Iceland makes its methods a major challenge to conventional wisdom; Krugman isn’t the only one who can find valuable lessons from this Nordic story. The IMF was the first to insist upon free capital movements as a prerequisite for aid and recovery and has released research that considers that capital controls play a crucial contribution to maintaining the stability of fluctuating international financial flows.

Pirates are not privatizers.

The real sting of this bizarre story is economic, not political. The process of recovery was outlined in Iceland’s Social Democrats and Green Party in Iceland during a coalition of 2009-13 that was then pushed towards the final stage by a team comprising The Independence Party and Progressives. The reality is that Icelandic people seem to have taken a stand on all political parties that served as both opposition and government. Iceland founded the Pirates at the end of 2012 to promote greater democracy and the freedom of information – they have dominated recent opinion polls with an impressive 40%, and they are well-positioned to be the leader of any new government that is formed after the early elections scheduled for this fall.

Neoliberal orthodoxy may return with the help of David Oddsson, who (as the finance minister as well as the prime minister and governor of the central bank) was the architect of the financial liberalization that led to the 2008 crash and has been admitted to an unusually competitive field. However, if normal politics are reinstated, it’s due to the highly unusual economics that had made good the past mistakes of elites.

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