Good news from Iceland Post author By Kevin O’Rourke Post date June 11, 2011 Here. Categories In Banking Crisis, Fiscal Policy 38 Comments on Good news from Iceland ← Gavin Kostick, Paul Krugman, and Jean Claude Trichet → Patrick Honohan on Vincent Browne 38 replies on “Good news from Iceland” Meanwhile Ireland is in the equivalent of purgatory. I note that the folder “banking crisis ” is still in daily use 3 years on. Debt to GDP has soared to 100% from under 30% in 2007. That burden could rise higher depending on the outcome of unresolved disputes with the UK and Netherlands over deposit guarantees for Internet bank Icesave and with private creditors challenging the decision to accord depositors priority in the resolution process. Foreign investors have deposits and short-term investments worth some 30% of GDP locked up in Iceland. The Wall Street Jurnal says Iceland’s return to bond markets reflects two key factors available to any sovereign in or out of the euro. The first is time: It has taken nearly three years since the October 2008 bank implosion to get this far. The second is credible, consistent policy-making that has encouraged investors to provide funding even if the recovery is fragile and problems remain. That is the real lesson for Greece, Ireland and Portugal. Look at this table and ask yourself why anyone would want to be in the Eurozone. http://www.tradingeconomics.com/world-economy/bonds.aspx Brian Hayes insisted the other day on the radio that ‘we are not Greece, we are not Portugal’. We used to have to listen to the chant that ‘we are not Iceland’ from one Brian Lenihan. Ironically, this is one of the few things Lenihan got right. The Icelanders are at least twice as bright and ten times as courageous as us. May they go forth and prosper. We deserve what’s coming to us. Michael H We have had time. We have not had consistent credible policy making. Spot the difference. Oh, and whats our debt to GDP heading for? Bottom line, and no disrespect to the man involved in the times that are in it, but he decision to socialise the private debt of the banks has sunk us. 99% of people said it would at the time, the only ones saying no were bond salesmen here, FF members and deluded green jersey wearing canny macSavvy’s Since we are discussing Ireland versus Ireland on banking policy, I note that Stephen Collins couldn’t manage to write a column saying nice things about Brian Lenihan without resorting to his well worn approach of taking a swipe at (unnamed) economists he doesn’t like: “Interestingly, economists like Brendan Walsh, Colm McCarthy and John O’Hagan, who had been around in the 1980s, showed a far keener appreciation than some of their younger professional colleagues of the kind of economic and political choices Lenihan faced.” Which younger colleagues? And what exactly did the trio named support that other younger colleagues didn’t? For example, I don’t recall a single contribution from the three named above in support of the previous government’s banking policy. http://www.irishtimes.com/newspaper/opinion/2011/0611/1224298736288.html Strange. I don’t think Collins can have been reading Colm’s pieces in the Sunday Independent. “….six day roadshow in Europe and the U.S” Perhaps we can learn something here especially since we have a lot more public servants, diplomats and politicians than our smaller neighbour. I also firmly believe if we offered 5 year bonds @”3.75% in Dollars or sterling we may surprise ourselves how much we could raise in 2012 and beyond especially if we offered “small” amounts at a time. We could even start with interesting titles such as “Recovery bonds”, “Diaspora bonds”, “solidarity bonds” etc. and accompany them with some kind of roadshow with modest targets so the “naysayers” would not be able to jeer so much at the initial small amount of sales. As a kick start the state could even make a limited offer of 20% tax relief at source to adults in the state (subject to a maximum equivalent of 10000 Euros in dollars or sterling). There may be some legal obstacles ( I am not an expert in the area) but that is why we have a public service and legislature. We could even target small and medium investors through “semi direct” sales. There are a lot of people who would be quite willing to buy 5000 dollars/pounds worth of bonds for their grandchildren or as part of their own portfolios. Even with inflation in the sterling or dollar area 3.75% would still perform equally as well as some pension funds in recent years which the contributor has very little control over. In my experience the whole world, including the diaspora, knows we have an overpaid public service (Medical Consultants and Academics are often mentioned ) and an unsustainable Public Service pension system However if the world could see that we were making inroads into public sector reform and utilising our civil servants to proactively promote the country (not just offering “junkets”) the results may be very positive in a short space of time. IMHO this is what some members of the ECB are afraid we will actually do which is why they are constantly threatening that the roof will cave in on us if we step out of line. The real fear, I suspect, is that an Irish departure will cause a disproportionate threat to what is effectively a ludicrous currency. Considering that our roof has actually already fallen in we may as well start fixing it ourselves rather than hanging around until we have to fix the entire “EZ roof” which we will never be able to do anyway. Ok – I know this is a bit off centre but why is this a measure of success? If this has thought us anything it’s that the concept of sovereign debt needs to be seriously re-examined. Should a sovereign raise debt at all? Now people will say a sovereign needs debt to finance capital spend but each capital project should be seen as a separate venture and made raise funds itself – independent of the sovereign. You see the sovereign, as a legal entity, has no protection. It is not a limited company. It is in effect a company in which all citizens are forced to be shareholders and face limitless liability when things go wrong and have very very little influence on the “board” – in most cases only getting to pass verdict on them every 4-5 years and not having the capacity to fire them. So, when all this is over (in a few years time) we might have to ask – is it right for a sovereign to engage in raising debt at all? Livonian So, what, you think its a good idea to ask people to invest in a double risk? Risk of currency plus default? Oookkkayyy.. This being a Kevin O’Rourke thread it’s as good a place as any to express my appreciation of Power and Plenty. I’m just on Chapter 4 but I don’t need to know how it finishes to feel able to say that it’s an excellent book. Maybe part of the reason why the last few years have brought so many nasty surprises is that we’ve lost sight of the fact that the path to prosperity is typically somewhat bloody. Our EU ‘partners’ are not acting out of character in demanding that we subordinate our interests to theirs. That’s how they got to be where they are in the economic league-table. @Eureka Interesting point.! I very recently spotted a brief article (which I did not read very closely) where a bond specialist reportedly claimed that democratic pressure in Ireland may result in Ireland deliberately staying out of the bond market until 2018. I cannot remember if he meant the entire bond market or just the international bond market. It would not surprise me that if Ireland could manage to deliberately stay away that long your question may well become a policy debate in the very near future. Although somehow I would always see some kind of bond market even if it eventually only involved small to medium domestic/citizen investors. In which case capital spend could easily conceivably become a series of separate ventures. @Livonian “We could even start with interesting titles such as “Recovery bonds”, “Diaspora bonds”, “solidarity bonds” etc. and accompany them with some kind of roadshow with modest targets so the “naysayers” would not be able to jeer so much at the initial small amount of sales.” Those are what the state should be using to pay salaries above say, 70,000 euros – making them legal tender for some goods and services. @ seafoid Its looking like time will not solve Irelands problem. As an eu member Ireland had no alternative to the bailout. On a more positive note while under stress the banking systems remains functioning. The main question for this FG government is, is there any alternative to the bailout, as I’m not sure that mere tinkering with the interest rate is a solution. @Grumpy Can you give some examples of where this happens? Would it not just be simpler to cut the wages (as for sure as eggs are eggs the value of these bonds would decline). Would you include salaries and pensions of bankers in these? Which goods and services and how would you see these sectors reacting? What if people simply refused to take this parallel currency (for thats what it is)? Again, would cutting the salaries, being honest about it, not be easier? So : what sectors…? Banking? Baking? Restaurants? @Philip II “Would it not just be simpler to cut the wages (as for sure as eggs are eggs the value of these bonds would decline).” Yes, but imagine the fuss. The parenthesis point is the whole idea of them… @Philip II Loads of countries have parallel currencies. The dollar for example is often used as the hard currency of a country – for external dealings, with ther local whatever, used to pay the state’s domestic obligations. It is interesting to note that during bank strikes people have used cheques as a form of parallel currency – knowing that for some time they were un-cashable, and knowing that there was always the chance that one of the cheques that was passed on to them as payment might bounce. Yes it would be simpler to reduce pay. You might note that the new Greek bailout is apparently going to have the re-alignment of public sector pay towards private sector pay. Croke Park has been a most effective way of stalling over this subject. If people will not take pay cuts, you need some other plan to reduce the requirement for external; borrowing. You need a way to cut domestic costs AND pay rates simultaneously. You need more than me and a couple of other guys pushing for this. You need people to try to makle it work. You need to figure out the parameters and details. I bet the current reaction to the idea is – plan A – ignore it studioously, failing that – put whatever effort is necessary into coming up with objections abnd arguments as to why it could never work. I have been around long enough to realise I don’t have the resources to counter that. I can encourage people to start being a bit more imaginative and less incrementalist in their thinking. That hasn’t worked too effectively so far. @Philip II BTW ” (as for sure as eggs are eggs the value of these bonds would decline) ” ….. so in what way would it be appropriate to con foreigners into buying them if Ireland’s own people wouldn’t accept them? Hogan Indeed. However, the honesty issue would perhaps be worth pursuing. Back earlier we were talking about credible policies. Honesty is, imho, a prerequisite for credibility. So: what sectors would YOU say these nonnan-vouchers or howlin-bonds could be used in? Where not? How would you prevent leakage to other sectors? How would you think those sectors could be compelled to take these? For instance, you envisage forcing Lidl or Supervalue to take these – how to enforce that? Would they not just say – NO? This seems to me to be one of the magic bullet ideas (like mcwilliams and his now thankfully dropped leave the euro) that seems nice but is in fact a complicated way to something that can be achieved much simpler. Dont think that public sector workers (because that is what we are talking about) will be fooled. Money illusion is just that – an illusion. Much simpler – rebate wages. But that wont happen. Grumpy : cross postings “Loads of countries have parallel currencies. The dollar for example is often used as the hard currency of a country – for external dealings, with ther local whatever, used to pay the state’s domestic obligations.” legally? Id love an example where there are two legal tenders. Not currencies of convenience, but legal as you suggest “It is interesting to note that during bank strikes people have used cheques as a form of parallel currency – knowing that for some time they were un-cashable, and knowing that there was always the chance that one of the cheques that was passed on to them as payment might bounce.” yes, I do recall that. I took some of em….But one took cheques only from a very very small set of people – whom you knew were “good for it”. Glad you mentioned costs : dont see the doctors or solicitors or lecky cutting prices. Or banks, or insurance companies. Why not advocate going the whole hog and simply pass a law to state that no service or good can be offered at a price greater than that which it was stated at in say 2003 and rebatat PS pay to teh same degree? Again simpler. Amazed that nobody has said it so far so here goes. What’s the difference between Ireland and Iceland? Iceland can borrow from bond markets and Ireland can’t An alternative answer. One letter and one year. Ireland is hoping to be able to borrow from bond markets next year. @ Eureka I for one would like the issue you have raised explored. How much of the money borrowed since 2008 has been spent on capital projects? The justification to borrow for capital projects is trotted out but invariably the money gets used to fund salaries and services which are consumed in the hear and now. In fact, much of it is used to keep the ATM’s running if we are to believe our ministers. As for Irelands theoretical re-entry into the bond markets? What would the proceeds of those bonds be used for? Would they be ring fenced from paying public sector salaries and pensions or would they be immediately diverted to those that have had some of the feathers and down removed during Irelands period of forced austerity. The fact that we are firmly locked out of these markets means now is a good time to have such a debate. In fact, maybe the markets might appreciate, that money borrowed will not be used for inappropriate purposes. livonian, You could have a point. Ireland does indeed have a large diaspora and many, including myself, are grateful that the country provided me with a good education, even though Ireland itself didn’t capture any of the benefit of that investment. The comment that investors are taking double risk (both currency and default) is not correct IMO. A bond, denominated in USD with a long enough maturity and a low coupon could be attractive to some. Also, Ireland is small, so it could tap derivatives markets in sizes that, while significant for Ireland, is not meaningful for those markets. For instance, a bond that pays in line with gold prices with a ten year or more maturity and a convertible into gold at today’s price, could be interesting to many. Ireland would have to buy call options on gold at the advertized strike price to make the contract credible, but that is possible. The added benefit would be that a bond of this nature would carry a very low interest rate, as it is essentially a leveraged gold investment. And uses for proceeds? Repay the IMF and EU facility. This alone would be huge. Ireland needs to break free from it’s prisoner status. Today it is trapped in the middle of that horrible PIG acronym. If Greece goes (and that is increasingly likely) then it is taken as read that Ireland and Portugal will be next. It is imperative that Ireland does not default IMO because the consequences of that will linger for a generation or more. We need to open a new path to financing while the country tackles the horrible task of bringing expenses into line with affordability. That means a root and branch reassessment of everything Ireland is and has been. For instance, public sector pay may be too high (I don’t know that it is BTW), citizens living abroad could be given a vote, politicians pay may have to be reduced, and new commercial codes that prevent the government from casually assuming private sector liabilities (banks, church, developer) have to be passed. Then a re assessment of all the liabilities that have been assumed to date has to be done, with a view to minimizing current debt exposure. @Karl The difference is Iceland refused to take responsibility for debt incurred by their banks and consequently have very little external debt in contrast to Ireland which took responsibility for all debts of the banks and ended up with a debt mountain which is constantly growing. So the real difference is solvent v. Insolvent. @ Livonian Who is going to buy these 3.75% bonds when you can buy 2 year Irish Sovereigns yielding 11.76% at close on Friday which at least come without currency risk. FWIW, throughout the late 1980’s and 1990’s Latin American bonds had very weird yield curves, the 2 year and five year yields would balloon out in any crisis, but 10, 20 and 30 year bonds (all USD denominated) were very stable. The idea was that, even if a default occurred in the shorter end, eventually the debt would be resolved. Well done to all those Sons and Dottirs. Back in the sovereign market; back in the game. @Robert Browne I don’t think it will be picked up on. Economists don’t seem to be interested in this kind of thing. Odd thing is that sovereign bonds were originally to fund war. The return was the loot from the vanquished party. It was fairly straight forward. In times of peace there is no reason for sovereign bond markets at all. And, what’s more, there is no clearcut real return. This industry is bringing the world to its knees. I’m not religious (in fact Im an atheist) but there was a reason Moses came down from the mountain with the stone tablets. We, like his people, have become besotted with the golden calf (or cow). We don’t seem to understand that even though these bondsters are rich they have no value. We need a new economic ten commandments. We should begin by asking a simple question: After all that has happened do we need a sovereign debt market at all? @ Philip II +1. as for sure as eggs are eggs the value of these bonds would decline @Philip II Where? Anywhere in South America minor – the dollar is legal tender currency. In eastern Europe and the Balkans before the fall, the deutschmark was pretty much legal tender. What payments? A proportion that the state makes – all of children’s allowance, for example, most of JA, part of state salaries and pensions. Nobody would take them? You might want to look at food stamps in the US. Or the California IOUs. @Karl Whelan Iceland: A budget deficit of 1.4%… it’s mostly about the deficit. When can you economist chaps come up with a plan? The government clearly can’t…. Ah, economists believe that cutting deficits is bad for growth. Makes them go all anti-austerian. Never mind. We’ll slog on doing the unreasonable in pursuit of the unattainable. Hogan 1 Are you 100% sure that the dollar is legal tender for goods say bolivia or argentina? Accepted, yes, but legal tender? 2 “pretty much” indeed it was. But again, we have a perfectly good legal tender 3 you still havent told me about how you will enforce it. Say someone rucks up to Lidl with a packet of “new improved not really food stamps”. Lidl will impose a discount on them : have to send to bohola to get them reimbursed, will take forever, no certainty they will be redeemed etc. So, again, why not cut. Your being deeply intellectually dishonest here. And why start with CA? Why not, lets say, 6% of judges salaries? 4 When we get to the stage of issuing food stamps, time to leave. 5 Why not try paying for sofware services or some internationally traded service in lenny-stamps or noony-scrip ? Also, whats to stop the issuer from flooding the market? 6 Well MK had a plan. I suspect most of the economic boffins here posting could make a plan. You could make a plan. In fact, the govt has a plan. All the plans differ really only on trajectory. And I think you might find some who still think we can hae expansionary fiscal contraction. Mind you, KW had some words on that, based on, y’know, evidence. @Philip II 1 Erm, if people accept it in payment for goods and services, does that not make it de-facto legal tender? 2 We have a legal tender that we have to borrow to hand out. We are fully funded (with borrowings) until the end of 2012 or the middle of 2013 (depending on whether you want to spend every last penny you have). 3 & 5 I’ll start with 40% of judges salaries, if you don’t mind. The idea is to use a domestic depreciable currency in the local economy. It is the local economy that is over-priced and the local government that hasn’t the money to pay for that over-pricing. 6 Ah, yes, expansionary fiscal contraction. Sort of like what they have in Iceland, except not. What there is, is a sharp contraction, a movement to balance and an expansion from a lower base. That is what is happening in Iceland. We have had elements of the first, little of the second and almost none of the third. As I say, the key element of Iceland returning to the bond markets is a sustainable fiscal deficit. If you can afford to pay interest and repay capital, people will lend to you. If you cannot, they won’t. 4 Yeah, so that’s your solution is it? Last one out turn off the debt clock? I’m sorry, but I’d like some solutions, not any more escape plans for select sections of society. I intend to stay. 1 : no. It doesnt. It makes it a currency 2: see above 1 3/5 : fairy snuff! However, greshams law comes to mind if we set out to deliberately create a “bad” money 6: We never repay capital. We roll over and move on the debt. And accumulate new. Sinking funds are so old fashioned (no idea why) 4: Feel free to stay. Welcome to a wetter poorer alabama. If I wanted to live in Alabama id move there. The Icelandic banking system was over 12 times the size of the economy and the vast majority of assets (loans) and liabilities (domestic deposits,foreign deposits and bonds) was external. The banking system collapsed and the govt basically secured domestic deposits against most of the domestic bank assets and walked away from the rest. Foreign deposit holders could not get their cash, many still have not got it, and the only reason most got it back was because the uk and dutch governments stood in and made good the Icelandic deposit protection scheme. I’m not sure why we keep comparing the response of the Icelandic authorities to the Irish ones. They had very little choice either way and basically walked away from the majority of the banking systems assets and liabilities. The same solution was not as obvious or practical to the Irish authorities. Most of the deposits were domestic, most of the assets were domestic and the foreign assets (uk mortages and commercial real estate loans) would subsequently turn out to be the least problematic. Hogan, If memory serves, the USD was legal tender in argentina until 2001/2, it is legal tender today in Ecuador and although it may not have legal status in Bolivia, it is a de facto currency in most in Latin America (although it’s acceptance is weakening as the USD weakens) I believe argentina’s state and municipal governments issued their own “legal” tender to pay wages in the last stages of that country’s collapse. These vouchers had all the marks of a currency with the pic of some historical figure and everything. The key was that, banks and businesses would accept if there was nothing else floating around. The market applied a discount on the notes. So it’s true they were not “legal” tender, but you could tender them. @Philip II 1 Er, okay, I’ll leave you to put up a textbook definition of the difference between a currency and a legal tender. Meanwhile, I’ll continue to work in the economy that recognises different currencies as legal tenders for debts and obligations and provides a mechanism for converting them from one to another to satisfy local legislative requirements. 6 I presume you are just being obtuse? The point is the Icelandic deficit is under control, therefore they have the ability to sustain interest payments and repay capital; whether they do it or not is up to them, but there is no point in viewing one part of their solution whilst ignoring the elephantine other. 4 Away with you then. You appear to have no solutions to offer. @Brklyn_renter Indeed, thank you. Turkey also had a dollar standard for many years with prices set in dollars and varying in local currency. Likewise Indonesia. hogan, Yep and although if you went to Turkey in the last few years, they would accept a € or a $ for a taxi fare…the rate may not be great, but it was better than the hotel rate…. Indeed, for most of the 18th and 19th centuries, any currency was acceptable in the US, spanish doubloons, sovereigns, francs, all swirled around the US economy and every bank in the early 19c had the ability to issue “currency”. Individuals set the value of that currency, it was never “set down from on high” Today, the market will ultimately set the value of an Irish government piece of “legal tender”, and although the insiders in any country will never express this fact openly, they do understand this at a visceral level. They are playing for time. Solutions will not be forthcoming in this phase, because the only credible solutions require a root and branch restructuring of the system….the power pyramid has to change…..”they” (the insiders) refuse to accept that, so they are kicking the can forward until they can find a weasel way to resolve the debt overhang without affecting their own status. Massive inflation is the preferred route, BTW. Print, print and print again, downplay inflation stats but make sure your own are protected. The badly educated poor believe it when they are told that inflation is somtething akin to an act of god, and accept their loss of purchasing power because they don’t understand it. @ Philip II Livonian “So what you think itsś a good idea to ask people to invest in double risk? Risk of currency plus default? oookkkayyy…” At first I did not consider your comment to my first post was worth acknowledging as (judging by your comment ) I believed that I have the possibility of entering that kind of debate around closing time in any public house in our beautiful country every day of the week. However after reading your responses to other contributors I can see that you are giving some serious thought to the topic of this thread and are no doubt forming opinions of your own which you may be assured I respect . So I will clarify the thinking behind my original opinion and proposal. If you look at my original post you will see that I refer to 2012 before any attempt to sell bonds should be considered. Prior to such attempts obviously an “amicable separation” from the the Euro Zone would have to take place. A departure from the Euro Zone currency does not necessitate a default only a decison by the sovereign member state. 1)”currency risk” does not IMHO come into it especially if Ireland decides to issue bonds in Dollars or Sterling even if we are using the Irish Puint.(Obviously investors would have to form their own opinions about the wisdom of buying dollar or Sterling bonds and the record of “default” by the soveriegn selling them. Ireland has no record of default) + 2)”default” is not a necessary precondition to departure from the Euro Zone. (In Irelands case unlike Greece “default” is effectively only an optional “tool” until the end of 2013 if we choose to stay in the EZ) If Ireland chooses to leave the Euro before 2012 “default” is no more an issue then when we converted from sterling to puint in 1979 and converted from puint to Euro in 1999. Therefore “currency risk” + “default” = no “double risk” (other than the kind investors make every day when dealing with developed stable western economies) Other contributor(s) have given their opinions about how two currencies can be used simultaneously within an economy. Iceland has demonstrated that despite using a national currency it can sell bonds in dollars. Another contributor has explained how Public servants earning above 70000 Euro can be paid in IOU`s`( with precendence in the US) which also has the added advantage of providing exchequer credit but ensures the money stays within the economy while the state tackles the Public Service pay, pensions and allowances . I hope this clarifies my opinion and proposals and if you forgive me I do not wish to enter a debate on the matter. Best…L Comments are closed.