Iceland in a boom – but a fiasco in Greece

The story of two countries which tackled the financial crisis in entirely different ways

by Dr rer publ Werner Wüthrich

Iceland, which just a few years ago was trapped in a terrible financial and economic crisis, is doing well today. (“Neue Zürcher Zeitung” from 19 May 2017) Spurred by the country’s economic growth, the Icelandic currency, the crown rose by 24 per cent against the euro in the last year. This year, the revaluation is still continuing. In April alone, the crown gained 7 per cent. Economic growth of more than 6 per cent is expected for this year, and the problems of the boom are starting to show up. Wages and prices are rising. Especially the tourist facilities are fully stretched. Tourists have to fall back on private apartments because hotels are fully booked. The fishing and hotel industries are worried that prices will rise too high. The Icelanders are considering increasingly their imports again in order to weaken their exchange rate.
Not even ten years ago, the situation was still quite different. Let me compare this to the situation in Greece. In 2008 – at the height of the financial crisis – Greece had debts amounting to about 180 per cent of GDP. Their debt has hardly fallen since then. The economy is currently stagnating after massive downturns in recent years. The current boom in tourism is helping some (partly because Greece’s main competitor Turkey has become a war country fraught with problems). Yet it is uncertain whether this can initiate a sustainable change. Unemployment is still well over 20 per cent, while youth unemployment rates are even higher by far. Four out of ten employees earn less than 1,000 euros gross. Public finances are running dry. In July is payday again. The Greek minister of finance has to raise 8.5 billion euros for interest and repayment of debt. Recently, the IMF and the Euro Group announced that they will make this money available. (“Neue Zürcher Zeitung” from 16 June 2017) Most of this money is intended to repay old debts, mostly owing to foreign banks, with interest. Debts accrued by private creditors has been replaced by public debts – as has often been the case – and for these the taxpayers will have to answer directly or indirectly. A small portion of the money is to be used to pay open government bills.
As to the negotiations with the donors, Premier Alexis Tsipras – who has in the meanwhile become as unpopular as his predecessors – will have to make concessions. From 2019 on, pensions will be further reduced by 1.8 billion euros annually. Tax increases are to augment the public purse by the same amount. The finance ministers of the Euro Group are ready to extend loans by up to fifteen years – an endless story.
Things are quite different in Iceland, the situation of which was not better in 2008 – in fact, it was even worse. The debt did not amount to 180 per cent of GDP, but to about ten times the GDP – around 1,000 per cent – a disaster of the utmost extent. Current Concerns has repeatedly reported about this. However, much has happened since that time. Let me briefly summarise some episodes from the crisis years and some measures taken (see also Current Concerns from 16 April 2015).

November 2008: Icelandic citizens demonstrating for their rights. (picture keystone)

The people leads the way in the question of foreign debt

The main problem was the foreign debt accumulated by the three big banks, for which, according to EU doctrine, the state was to assume liability. The government of the non-EU country of Iceland negotiated – especially with Great Britain and the Netherlands, from which most foreign funds (the so-called Icesave Funds) originated. Icesave was the internet bank of the Icelandic Landsbanki, which had over many years attracted foreign savers with high interest rates. The two governments demanded the repayment of the funds and accommodated Iceland with low interest rates and long repayment periods. On 30 December 2009, the Icelandic Parliament passed a law regulating the repayment modalities. But now the Icelandic people went out into the street, making a great noise with pots and pans and expressing their unwillingness to pay for a debacle which they were not responsible for. Foreign speculators were to bear the consequences for their actions themselves. After all, they had for many years received 10 per cent interest and more for their money. “Is it morally and legally justified to simply transfer the risk to the state and the taxpayer?” was written on banners and leaflets. The citizens’ initiative DeFence (Resistance) organised various kinds of protest campaigns. It collected over 60,000 signatures (from 350,000 inhabitants) and demanded a popular vote. The citizens laid siege to the President’s residence with red Bengali candles, which clearly indicated a “stop” to his ongoing policy. President Olaf Ragnar Grimsson heard the voice of the people and ordered a popular vote: “The core of our Icelandic state is that the people are the supreme judges of the validity of our laws. In this light, I have decided, in accordance with the Constitution, to pass the decision on the law in question to the people.” – In March 2010, 93 per cent of the voters said “no” to their state paying the bank debts.
Great Britain and the Netherlands were then for better or worse ready to renegotiate the repayment of bank debts. Iceland was granted further concessions and payment facilities in a new agreement. The repayment was extended until 2046, which would burden the next generation. The majority of the people’s representatives in Parliament accepted this agreement. The President of the State again scheduled a popular vote. In April 2011, there followed a further massive “nay” by the people. By that time, many an observer will have wondered “what now?”
The Icelanders solved their banking problem: All three big banks had to file for bankruptcy. Some of those persons who were mainly responsible for the mess went to jail. The Landesbanki with its internet bank Icesave was nationalised, the two other banks were split into a “New Bank” and an “Old Bank”. The New Bank (which was equipped with new capital) included all those business areas which were domestically relevant, such as payment transactions, ATMs and cash machines, a credit department, etc. The huge mountain of debt and all the international business with its many doubtful assets, which were liquidated in bankruptcy proceedings, all this was transferred to the Old Bank. In this way, the bank halls remained open, and the cash machines were always in operation. The banks were newly named. The former Kaupthing Bank is called Arion today; the former Glitinir is now called Islandsbanki. All three banks (which are now partly foreign-owned) are limited to traditional domestic banking transactions. The Icelandic currency was severely impacted by the financial earthquake and by the economic crisis, and so it became necessary to control capital transactions.
Results soon became apparent: Tourism and the fishing industry benefited from the weak currency. Everything Icelandic became cheap and Icelanders advertised visits to their sympathetic island with its natural beauty, especially in European countries. Less expensive commodities were imported, more were produced domestically instead. The cuts in social services were of a limited dimension. The 2009 fall of 7 per cent of economic output was followed by a plus of 3 per cent not more than three years later – and this was a figure above the EU average. The unemployment rate declined. The rating agency Fitch raised the country’s credit rating and explicitly justified this with the “success of unorthodox responses to the crisis”. (“Frankfurter Allgemeine Zeitung” from 21 February 2015) The 2013 EFTA Court decision also helped, as in this case it judged popularly and rejected the liability for foreign bank debts. Iceland has withdrawn its request for EU membership. Capital controls are history and the IMF credits have already been repaid.

Success on the basis of sovereignty and direct democracy

Why did the country recover so quickly? On the one hand, the voice of the people was crucial to the country’s rescue. Not only did the Icelanders decisively set the course in two national votes. In a variety of ways, the population also played an active part in what was happening – but always without violence. So, for example, by means of witty internet appearances they resisted attempts by Great Britain to denigrate the Icelanders as terrorists and to freeze all Icelandic bank deposits in Great Britain. On the other hand, the Icelanders rolled up their sleeves and knocked back into shape their ailing banking system and their struggling economy.
It was also crucial for its rescue that Iceland had its own currency: the massive collapse of the Icelandic crown did not lead to its downfall (as some financial prophets had prophesied), but was a crucial prerequisite for a quick recovery. The Icelandic way out of the banking crisis differs significantly from the European way of bank rescue, debt management and state financing, which the ECB operates today by means of the electronic “money printing press” (by purchasing state papers in large quantities).
Obviously, the situation is different in every country, and the Icelandic way cannot be transferred to other countries par for par. However, it shows how a government, together with its population, boldly sought new ways and found a way out of the worst crisis. It also shows that a small country with its own currency is mobile and can assert itself in the global financial and economic world.
It speaks for itself that, three years ago, the IMF asked the Icelandic finance minister Steingrimur Sigfusson (who, however, declined) to assist in the management of the debt crisis in Greece. (“Frankfurter Allgemeine Zeitung” from 21 February 2015)
It is striking how Iceland has been able to resolve its catastrophic financial situation in a few years, a feat which probably nobody had thought this small country able to achieve. In reaching this goal, the Icelandic people have played an important role by way of direct democracy. A small elite behind closed doors must not be allowed to solve financial problems. Otherwise, the result is like what we can observe today in Greece – a debacle. The question inevitably arises why such a way or a similar way should not be possible in other countries, and how to break out of the crippling and restricting corset of the euro system.
Inevitably Greek mythology comes to mind, the parable about the Gordian knot. Gordian knots were the artfully knotted ropes attached to the chariot of the Phrygian King Gordios, which joined the drawbar of the chariot with the horses’ yokes. According to the legend, an oracle prophesied that he who could break the Gordian knot would gain the dominion of Asia. Many wise and strong men tried to do so, and none succeeded, until Alexander the Great, on his way to Persia, simply cut through this knot with his sword and thus began his triumphal procession through Asia. A similar courageous act of a people is needed today to extract itself from its entanglement.     •