The Western method of fighting the financial crisis has merely forestalled the inevitable. The central banks’ strategy of giving away money to the TBTF banks through assets purchases on favorable terms and zero-cost loans has created an asset bubble led by bonds that will eventually deflate with disastrous consequences. While the Fed is busy printing money, our own government runs high budget deficits that have the effect of propping up favored industries rather than helping Americans. Compare federal outlays to the defense industry with the cost of extended unemployment insurance, food stamps and Medicaid, if you disagree.
There is an alternate path. Iceland has returned to growth after being left for dead in the wake of the GFC in 2008. Its plan is worth considering, particularly for the PIIGS. Rather than taking bailout loans to preserve the banks balance sheets of the banks, particularly those of France, Germany, the Netherlands and Austria, at the expense of the taxpayer, follow Iceland:
- Allow the banks to fail but protect small depositors.
- Give debt relief to consumers, especially for mortgages.
- Devalue the debts through a devaluation of the national currency.
- Control the government budget by reducing favorable tax treatment for the wealthy and reducing spending.
- Prosecute those responsible for the crisis.
Points 1, 2 and 3 would be especially helpful for Spain and Ireland. Greece needs all five with an emphasis on numbers 4 and 5. The Greeks need to prosecute the government officials who lied about the deficit in the first place and the elites who continue to dodge taxes. The Lagarde list is a good place to start.
No plan is perfect, and there will be adverse consequences to following this course of action:
- Persistent inflation as markets need to regain trust in the new national currency.
- Brain drain as professionals flee to jurisdictions with better prospects.
- Capital flight because the adoption of a weaker currency will increase the country’s risk profile.
- The legacy of default. Investors will be wary of lending the country money for years, so it will have to pay higher interest rates.
Points 2 and 3 will occur anyway in an economy beset by a depression, so we are talking a matter of degree. I believe that brain drain and capital are lower in Iceland than they would have been if it had followed the course of action of Ireland. Ultimately, the benefits of this policy outweigh the consequences, which is easier for you to see than for me to explain:
After both enduring banking crises, Iceland has grown at a much better clip than Ireland. The Emerald Isle also has something that Iceland does not, outrageous budget deficits. Ireland will run about a 14% budget deficit this year, Iceland less than 2.5%. Ireland’s huge deficit is choking growth with GDP contracting 1.1% in the most recent quarter.
One of these days, a PIIGS politician will point to Iceland’s example, and voters will begin listening. Then, it will only be a matter of time before they take a chance to end economic depression and restore their lives.