Icelandic Miracle or Mirage? Round 2

EconMatters's picture

By EconMatters

Paul Krugman has long been an advocate of Keynesian economics, and a proponent of aggressive and expansionary fiscal policy drawing parallels between Japan's decade-long deflation and the current Great Recession.  Krugman also has also been writing quite extensively using Iceland as the poster child on the benefits of currency devaluation.     

Krugman's latest endeavor on the so-called 'Icelandic Miracle' was when he posted on his NYT blog last month with the following chart showing the seemingly much better GDP growth from Iceland compared to Ireland, Estonia, Lativa, and Lithuania, the countries either in Euro or has a currency pegged to the Euro.  He then rhetorically remarked:   

"Looking at this, would you have expected that Latvia would be lionized as the hero of the crisis?"  

Chart Source: NYT/Paul Krugman, June 14, 2012



That was quickly rebuffed by the CFR (Council on Foreign Relations) with Washington Post and The Economist also weighing in and stirred up a debate on twitter.  The following are the two key charts in the CFR rebuff--the main point is that Iceland looks a lot less impressive than Krugman claims if one shifts the chart starting period around:   



Chart Source: CFR, July 2, 2012

Chart Source: CFR, July 2, 2012


This actually is the second round of the 'Icelandic Miracle' debate between Krugman and CFR.  Round one took place in June 2010.  Two years ago, Krugman used a similar chart showing a much higher GDP growth of Iceland relative to IrelandLatvia, and Estonia since the 4th quarter of 2007 to support his declaration that Iceland is a "Post-Crisis Miracle." (We are not quite sure why Krugman dragged Lithuania in his 2012 post except the country has the Euro-pegged currency and fits Krugman's story.)  

CFR at the time quickly pointed out that 
"It is an illusion created by the starting date Krugman chose for his figure." [R
ead here for More detail on round one between Krugman and CFR]

In this second face-off, CFR laments:   

"...Once again, Krugman has relied on a Potemkin-Village graphic to illustrate his wider claim, which is that Icelanders derive unambiguous net benefits from their government obliging them to hold and transact in a national currency that their trading partners will not accept. (80% of Greeks consistently reject going back to such a state.)" 

Meanwhile, Washington Post completely endorsed Krugman, and in a somewhat self-contradictory post, The Economist, on one hand, seems to support Krugman's view that [emphasis ours]  

"....the Baltic economies remain substantially poorer than Iceland and most euro-zone members and should therefore be expected to have a much faster rate of underlying growth thanks to the potential for catch-up. That they've essentially kept pace with rich Iceland rather than catching up points to the advantage of adjustment via devaluation, as does Iceland's good performance relative to Ireland." 

On the other hand, The Economist also appears to say it was all but a number's game depending on the comparative elements involved with the following conclusion [emphasis ours

"..... it is telling that to spin a story of growth via internal devaluation one has to resort to citing emerging markets—notably, ones that have managed very little catch up over the past 5-6 years at a time when other key emerging markets were marking enormous gains."

We say the bottom line is that regardless which country or starting year you pick to compare and chart, fundamentally, Iceland is definitely NOT the "fiscal role model" that Krugman intends for people to believe.  

You might recall, Iceland suffered the biggest banking collapse in history by any country relative to its economic size in 2008 when its highly leverage banks lost access to the funding market.  The tiny Nordic nation was eventually bailed out by the IMF and other Nordic countries, partly because too many Europeans had deposits into Icesave.  


Afterwards, the value of the Icelandic króna currency plummeted (down 80% against the Euro since 2008), and does not even have a regular official exchange rate any more.  Inflation soared (41% in about four years), while people's savings and pensions got wiped out, and real wage and home value fell off a cliff.  The country has been held together mostly by IMF loans, "technical defaults" and capital control ever since.   [Check here for more of the economic horror story of Iceland.]   

Now, four years after the banking collapse, Iceland was able to wipe the slate clean, and has now revived its economy at 4.5% growth rate in Q1 of this year, while inflation was at an elevated level of 5.4% in June.  Iceland had to raise interest rate five times since last August to contain inflation, which could get even worse as króna could depreciate even more with the current Euro crisis, and the country is still years away from fully removing capital controls, according to the Finance Minister.     

Back in 2010, Krugman concluded in his post that [emphasis ours]

    "The moral of the story seems to be that if you’re going to have a crisis, it’s better to have a really, really bad one. Otherwise, you’ll end up taking the advice of people who assure you that even more suffering [i.e. austerity and the resulted deflation] will cure what ails you."

Sure, if a country could technically default on a significant portion of its debt, trash its currency, impose capital control, then there's no where else to go but up with a heck of a price to pay in terms of internal turmoil (Zimbawe is an extreme example, but yes.).  Furthermore, Iceland is of relatively little significance in the global grand scheme of things, but due to the dominance of the US dollar in the global currency system, the size of the economy and population, the "Iceland model" is not even an option for the United States, which Krugman seems to intimate.     


One last tibit for those preaching "the advantage of adjustment via devaluation," Iceland, in a bid to gain stability in its currency system, now is considering ditching the króna, and adopt either Euro or the Canadian Loonie instead.  Poll says 70% of the Icelanders want to get rid of the króna.  The Icelandic government believes an EU membership would be the best option since Europe is the largest market for Iceland.  

Unfortunately, Iceland most likely can't count on much support for its EU membership, as the country refused to pay back the €4 billion owed to UK and Netherland.  UK, for one, has already publicly refused to back a resolution on Iceland's EU membership.  

The more important question is if currency devaluation is such an economic miracle cure, why is Iceland looking to adopt Euro or Loonie?    

Further Reading The Pitfall of Rock Star Economists


© EconMatters All Rights Reserved  |  Facebook  |  Twitter |  Post Alert  |  Kindle

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
jabhagsb's picture

Stratetic default on all bankster fiat debt is the only true solution:

A modern day debt jubilee.

toncuz's picture

Conservative Republican policy deregulated the markets from 1920 to 1933...guess what happend? A Great depression and banking failure with taxpayer bailouts.

Conservative Republican policiy deregulated the markets under Reagan from 1981 to 1988...guess what happend?...Recession, a Savings Loan faliure with 400 billion in taxpayer bailouts.

Conservative Republican policy deregulated the markets from 2000 to 2009...guess what happened?...Great recession, banking failure with 800 billion in taxpayer bailouts.

Only conservative voters can not see a pattern here. I know...let's blame the progressives.

Coke and Hookers's picture

A bit of selective world view there dude. Are you trying to lie on purpose or are you actually that ignorant? Try looking up Clinton and Larry Summers and derivatives deregulation and use that as a starting point.

The financial elite have owned both parties for a century and used them to pass any laws and deregulation they wanted. These guys laugh at sheep like you who are still stuck in the fake two party 'reality'. In fact, by pushing this conservative-liberal bullshit in regards to deregulation, you are just being their tool and might even get a pat on the head from a bought politician one day at a rally. That should leave you with a warm and fuzzy feeling. Tool.

toncuz's picture

Talk about ignorance....Clinton was a CONSERVATIVE...If you read once in a while you would know the Congress has been MAJORITY conservative Republican and Dem the last 25 years. Fool

brettd's picture

McDonalds has 100,000 more employees than Iceland has inhabitants.

brettd's picture

The state of Vermont has nearly TWO TIMES the population of Iceland.

dcb's picture

the grph starting point is a classic krugman trick and he has done it over and over. As always I have lost almost all respect I have for the man.

lamont cranston's picture

I'd opt for the Loonie. Energy supply foremost, pure & simple. Plus linkage to the USD. I'd think the C$ would rise against the Euro for a considerable future period, and, for all we know, the Euro might be trashed in 6 months, whereas the Loonie ain't. 

Coke and Hookers's picture

There seems to be a lot of misconceptions out there about the Icelandic economy. Some people want it to be a model, others don't - for obvious reasons. I doubt the CFR wants to hear any good news from Iceland because it might give people ideas about leaving the globalist matrix. A few facts here:

- 12 month inflation is 5,4%;  12 month economic growth is 3,1%, May unemployment rate is 8,5%.

- Last year's trade/services surplus was somewhere between 15% and 20% of total exports. If this drops significantly in the unforseeable future, Iceland will default. Surplus can only be attributed to drop in imports. Exports have increased little.

- Iceland did not default on its payments. It only refused to pay foreign owned debt of its private banks. That is not defaulting.

- Government and municipalities are run with a deficit amounting to 10% of GDP (2011) - which means that GDP is overvalued by 10% of course.

- Since the 2008 crash, purchasing power has dropped something like 40%. Solid numbers do not seem to be available so that's a guesstimate.

- Growth is partly driven by people spending their savings but how much that contributes to growh numbers is not entirely clear.

 A few more interesting insights:

- Foreign debt (in foreign currencies) is almost impossible to figure out but is probably close to 100% of GDP.

- After the crash the fallen banks were bought by foreign vulture funds who now own a big part of Icelandic companies and real estate. All this is being slowly sold for kronur which can't leave the country because there's not enough foreign currency to pay it out. Currently foreign owned money which can't leave but wants to leave amounts to 65% of GDP. As more companies are sold this number will most likely exceed 100% of GDP. It may even go up to x2 GDP in the future.

- There's an immense glut of money in Iceland which is almost solely absorbed by the government. The source of that money is mostly pension funds which must invest but don't have anything to invest in except government bonds and companies sold by foreign vulture funds (that also end up in government bonds because it can't leave the country).

- There has been very little investment in new business in Iceland since 2008. The reason is that the government has systematically stopped virtually all investment by 'technical means', both domestic and foreign. The reason for that is that the government consists of two leftist parties; liberals and socialists. These parties made an agreement: The socialists (who are anti-industry and anti-EU) Allowed the libs to apply for EU membership while the libs allwed the socialists to stop all investment in newbiz. As a result of this and the shortage of foreign currency, money has nowhere to go and gets piled up in government accounts and bonds.

- The support for the government is currently 31%. The support for joining the EU is about the same while about 65% opposes.

- There is a rumor that the government intends to transform most foreign debt, particularly the kronur owned by foreigners trapped in the country into a huge eurobond if/when Iceland joins the EU/Euro. Interest payments alone on that bond would possibly be between 15% and 30% of total exports. But this is only a rumor. This, or some version of this, is what will happen if Iceland adopts the Euro resulting in a Greek situation where total control of everything rests with Brussel

I could go on and on. Maybe I should write an article.


The conclusion: Iceland is screwed but the difference between Iceland and the PIIGS (soon to be PFIGGS with France included) is that it has some control over when it's screwed and to what exten it's screwedt - unless their government sells the country out to the EU. The PIIGS have no control whatsoever over anything.





Paracelsus's picture

Ummm...You forgot to mention the distinction of the Icesave default.The UK depositors were chasing a high saving return for their accounts overseas doing internet banking.This sounds high risk to me being that putting ones' money in a foreign bank account with no deposit insurance scheme seems like flawed logic.This is a weird parallel to Glass-Stiegall,where the risky (investment) side should be PHYSICALLY separate from the depositors side (FDIC) to give the retirees and such the confidence in the institutions soundness and security.


Coke and Hookers's picture

Correct. The Icelandic banks may even have have suggested that the deposits were government guaranteed but that was not the case. During the diplomatic war between the UK/Netherlands and Iceland over Icesave, there was a really interesting fact behind all the action. The emergency legislation implemented by the former Icelandic government included a clause where the foreign individual deposit owners were put in front of everybody else in getting paid from the sales of the assets of the failed banks. This meant that the deposit owners would get paid in full but other creditors (euro banks mostly) wouldn't get squat. This really freaked the Brits out and they demanded that this clause be dropped and the Icelandic state instead paid the depositors. The Icesave agreement rejected by the Icelanders was therefore about protecting creditor banks - not about deposit holders getting paid back. The UK government was threatening Iceland on behalf of the UK/Euro financial system.

moneymutt's picture

Most excellent sum up, analysis....Krugman ignores debt and thinks everything can be fixed by currency devaluation...ignoring the oesky little detail of price of imports and debts denominated in foreign currency.

Neither Krugman nor CFr argues for full on default....

But I do agree despite the complications and muddier story you present, Iceland's path has been better than Greece or Ireland or Latvia will be, all will suffer while big banks thrive, it's just a matter of degree, and to that end Iceland is a better example for regular people than what most other countries are doing.

Coke and Hookers's picture

The key word here is 'control'. Greece and other countries using the euro have no control over events. Absolutely none. Iceland with its own currency can control stuff. They can default if they need to, they can trap foreign owned kronur inside their country, they could tax them into non-existence if they want to and they could nationalize the foreign owned banks and seize their assets. Iceland is still a sovereign country but Greece is not. That's the difference and that's the reason Iceland has a chance to survive this. Iceland's biggest threat now is being sold out by their own government.

cognus's picture

Coke - thank you so much for saving my life.  I was about to explode by the end of that toxic article....

Would you please consider running, now, for POTUS?

Seriously, this article illustrates why the entire working [or wannabee] world is sinking into despair.  Virtually every sentence is either a deception, a lie, or bait.  The Net is that its exemplary of either plants/trolls, or sycophantic boot-lickers.

If Iceland succeeds, which I'm thinking is a "yes", it will be short-lived.  The oligarchs do not want such a story gaining traction.

Coke and Hookers's picture

I wouldn't mind being POTUS. I hear there's a lot of vacationing and golf involved - not to mention parties at the WH with tons of bitches and spiked kool-aid.

But seriously, I'm following things in Iceland and Europe pretty closely although I don't really have time to absorb everything that's going on. I haven't yet seen an article on Iceland that's anything close to factual or captures in any way what's goin on there. Michael Hudson comes closest. I suspect the same applies to other countries that I'm not following as closely, including Greece.

One point in my post needs explanation kind of. The massive amount of kronur held by foreigners that are trapped inside the country should of course crash the krona down to nothing but it doesn't. The reason is that there are two fixed exchange rates for the krona, both more or less fixed against the Euro. The rates can be described as the general (domestic) rate and the privileged ('off-shore') rate. The general rate is now about 160 kronur per euro. The other rate is about 250 kronur per euro.  These rates are controlled by the central bank, particularly the general rate. Now, the difference:

General rate: If you are a normal person slaving for a wage and want to sell a euro, you get 160 kronur for your euro.

Privileged rate: If you have bunch of euros you want to sell, the Icelandic central bank will pay you 250 kronur for each euro. That means that if you have a stash of euros and want to invest in Iceland (which is hard except in real estate) you get  1/3 discount. If you're a poor tourist who wants to invest in hotel accommodation or Icelandic schnapps, you get zero discount.

The purpose of the fixed rates is 1) to protect the value of the foreign kronur at the behest of the EU and the IMF (general rate) and to 2) 'encourage influx' of foreign currency (privileged rate) so these trapped kronur can be paid out at full (general) value.

The Icelandic government is just a proxy government for the EU/IMF and their buddies and they are eager to join the EU utopia despite 2-thirds of Icelanders being opposed.

Thunder_Downunder's picture

You forgot to mention the most pertinant thing in the Ireland V Iceland debate, Iceland is paying down its debts, whilst ireland is still accumulating them.


Irelands 'expansion' is an illusion, when its money runs out end of this year, we'll see how much expansion it has then.



philipat's picture

Iceland told the Banksters to fuck off and let the Banks fail. Are we missing something here?

disabledvet's picture

I'm a fan of Nelson and David Rockefeller economics myself. As in "here's your phucking billion bucks you worthless cocksucker." At one time they damned near owned the whole planet. Not me. I'll never have a problem understanding where they come from however...nor came from...either. I'd love to go Salmon fishing in Iceland of course...who wouldn't? Had a girlfriend from Iceland a long, long, LONG way back. Great person. Is Iceland in any way shape or form comparable to a 12 trillion dollar economy called the USA? You've GOT TO BE KIDDING.

Bullionaire's picture

Krugman vs. CFR???  This article is about as useful as Dems vs. Repugs.


The Tylers are baiting us yet again.




Bringin It's picture

Krugman vs. CFR??? - Same vs. Same

New American Revolution's picture

Certainly Iceland hasn't enough gold to back its play, but the United States does... I hope.   And if the Federal Reserve sold it off over the years, it was illegal and we're takin it back.  Sorry.   The point is to revive a classical gold standard which regulates credit, and remove and replace the FED with a Suffolk type central bank owned 2/5ths by Congress with the remaining stock publicly traded with percentage restricitions.   Sure the 2B2Fails will fail, but they have wills now.   Sure a lot of the princely holdings a few will take a beating, but to hell with Wall Street, and welcome to Main Street.   Stability, stability, stability.   And if it is the dollar and the United States as such, the entire world will have to conform.   Even China, most of all China, but everyone must follow.  This is the amazing economic power of Liberty, which is its own unique economic model of wealth creation that cannot be beaten unless you allow it.  

We live in a world of tryanny, and where ever we plant the threat of Liberty it will grow and consume everything against it.