As the first country to experience the full force of the global debt crisis, Iceland opted to default and not enslave its taxpayers in perpetuity to bail out the banks. (You can read more about Iceland’s path to financial destruction in Michael’s Lewis’ Vanity Fair series from 2009 here.
The choice to knock off zeros on their debts has not been pain-free fix for Icelanders, their Icelandic krona plunged spiking the prices for items they import and Icelanders saw an 18% drop in their disposable income in 2009. Mind you, if other nations had chosen to admit the truth and let their bad banks go at the same time in 2009, many currencies would have taken a more simultaneous hit which would have made for less of a relative decline in any one currency. In this case Iceland was the first to admit truth, scratch off and start fresh. They are also further along in recovery now as a result.
Iceland’s pain was mostly front loaded, and their growth in 2012 (est. 3%) is looking brighter than most countries in the debt-plagued developed world. Not spending tax dollars on bail outs, they have been able to double down on investment in things that will strengthen them long-term like education and green technology. They are an example of how it is possible for a country to let the banks take their deserved losses, and still overcome deep economic dislocation without undoing the social fabric. Joseph Stiglitz discusses lessons learned in this video link.
No path out of the debt crisis is pain-free. We have to decide whether to cut out the cancer now or let it continue to sicken and impede our progress for years to come. Countries can choose to let the banks take their losses and reestablish capitalism as the model, or they can keep choosing to support banks and socialize losses that encumber us worker bees for decades. The choice is up to each country to make, and in a democracy, the workers are supposed to have the power to decide.
For a good summary on this see: Here’s what Europe can learn from Iceland.
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The Icelandic approach seems to be a preferable solution. Default, take the hit now, and get the worst of the pain out of the way in order to establish the foundation for future recovery. Let the banks and reckless speculators take the losses they deserve in accordance with capitalism and thereby avoid the moral hazard of bailing them out. Etc.
However, Iceland probably dared to do this because it has a small and ethnically homogenous population without extreme discrepancies in wealth. Consequently there is a lot of social cohesion there. Moreover, their false prosperity was brief; the country has never been an affluent place. Even though many people are experiencing hardship now, they have never had the expectations and entitlements of long term affluence.
There might be significantly less tolerance for a rapid and precipitous drop in the standard of living in most other places in the West. Consequently, many politicians would probably not dare to risk the wrath of the electorate.
Another significant reason why the Icelandic approach might be difficult to implement in other countries, particularly the US, is because there are powerful vested interests that might be opposed to such a solution. For some insight into such crony capitalist interests just refer back to Ms. Park’s blog from a few days ago entitled “How Power And Influence Allowed Big Banks To Re-write the Rules Of Our Economy”.
As a result we are probably destined to experience a somewhat drawn out economic malaise, marked initially by gradual austerity and concomitant grinding stagnation, and then possibly later by significant inflation; punctuated throughout by periodic crises and extremely volatile markets.
Gradual Austerity as in Kick-the-can uphill until it rolls down and kills all of us.
As part of a PR move, these video clips have been distributed from Iceland with endorsement from the Icelandic government. I think they are pretty good.
http://www.pecsinapilap.hu/cikk/Az_izlandi_pelda/90812
PS.
Please disregard the foreign text and click on the videos only.
This is the kernel of truth at the heart of this crisis that greater minds than I have completely failed to grasp. Fiscal stabilisation is looking more and more impossible; neither austerity nor reflation seem particularly fit. I expect to see cases of austerity-induced breakdown (austerity leads to falling revenues, which ultimately leads to bigger deficits in spite of cuts), and at the further down the line I expect to see some cases of hyperinflation, as various nations try to (unsuccessfully) inflate away their debt.
Finally, I expect more nations to choose strategic default.