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As the crisis in Europe continues to unfold another crisis is slowly coming to an end. The economy in Iceland has finally started to grow again. What’s interesting about the two crises is the dramatic difference in the ways they were able to attack their problems.

While both have implemented austerity measures there have been vast differences. In particular, Ireland, embroiled in the flawed single currency euro has been unable to devalue their currency while at the same time being forced to succumb to the pressures of foreign bankers.

In Iceland, they have benefited enormously from being able to devalue the Krona. Finance Minister Steingrimur Sigfusson recently said:

[Devaluing the Krona] significantly increased our export business and got us ahead of our competitors which, without a doubt, helped us through this difficulty and continues to drag us along and eventually out.

In addition, Iceland did not force the public to accept the losses of private bankers. In a recent Bloomberg interview Ólafur Ragnar Grímsson, President of Iceland explained why this was important:

The difference is that in Iceland we allowed the banks to fail… These were private banks and we didn’t pump money into them in order to keep them going; the state did not shoulder the responsibility of the failed private banks….How far can we ask ordinary people — farmers and fishermen and teachers and doctors and nurses — to shoulder the responsibility of failed private banks….That question, which has been at the core of the Icesave issue, will now be the burning issue in many European countries.

Tryggvi Herbertsson, an econ professor at the University of Reykjavik described why the two approaches are having dramatically different results:

That alone (forcing bondholders to take losses) has made for a very different result within the two countries. Ireland is now over-leveraged (with debt) and their banking system continually weak. The difference in Iceland is that our banking system is clean and once the debt has been written off, we have a healthy banking system but in Ireland the system is broken.

This is the proper process. If you go through a bubble economy and you need to correct it, the answer is not to convert private debt into public debt. Rather it is to restructure the debt to the level of the assets.

The parallels between Japan/Sweden and the Ireland/Iceland saga are striking. In the early 90s, Sweden and Japan suffered substantial financial crises following asset bubbles. In Sweden the banking system was nationalized whereas in Japan they allowed the banks to earn their way out of the crisis. The results were dramatically different as Sweden recovered quickly and Japan muddled along for years. In Iceland the banks were punished and I believe they have laid the foundation for sustainable long-term growth.

In Ireland they are only just now beginning to confront a crisis that has only grown worse by the day and the newly implemented austerity measures are truly savage. With no ability to devalue their currency and a necessity to appease foreign bankers it’s difficult to understand how Ireland’s economic woes will end any time soon. Judging by the unemployed in the two countries it’s safe to say that the results speak for themselves as Iceland begins to put Main Street back to work and Ireland continues to layoff workers:

click to enlarge images

In January 2009 I called for the USA to go Swedish on the banking system by forming a RTC type unit to force the bondholders to take losses, avoid moral hazard and maintain some semblance of capitalism and an environment where losers lose. Here we are almost two years later with unemployment at its highs and an economy that can’t seem to get off the ground without more government aid. Even worse, we have not allowed the excesses in the economy to fully clear.

While the economy is certainly improving in recent months, the math still doesn’t add up. What has changed since before the crisis started? The problems that caused this crisis in the USA have not been dealt with and you could even make the argument that the losers have been emboldened by the Bernanke Put and a government that thinks capitalism can run smoothly without any losers. We’ll see how this unfolds in the coming decade.

So far, the results are not good, and if Iceland and Sweden are any precedent then it’s clear that we made a huge mistake in choosing to save the banks in 2009.

Source: Ireland, Iceland and Letting Banks Fail