Iceland's Best-Laid Plans Fall Apart

Here's how fluid things are: Last week, Iceland nationalized Glitnir, the country's third-largest bank. Today, it unnationalized Glitnir, putting it into receivership instead: Clearly the bank's liabilities were too large for the Icelandic government to take on.

Yesterday, Iceland pegged its currency to the euro; today it unpegged the currency, saying "there is insufficient support for this exchange rate".

And all those promises about Iceland backstopping deposits at its banks?

"The Icelandic government, believe it or not, have told me yesterday they have no intention of honoring their obligations here," [British Chancellor Alistair] Darling told the British Broadcasting Corp.

In other words, pretty much the entire we're-all-in-this-together plan that I lauded on Monday has unravelled by Wednesday.

And still Iceland looks in better shape than Pakistan, and we're only at the very beginning of the global sovereign (as opposed to financial) crisis. There will be more government debt scares before this is all over.

Comments

[longtermstocks:]

Global recession? How long do you think this will last? Best estimates I have seen is 1-3 years.

2008 Oct 08 02:46 PM

[derryl:]

We're seeing one of the periodic large scale writedowns of debt that are an arithmetic necessity caused by a flaw in the world's money-creation system. Almost all new money that enters the economy during economic growth cycles begins as a bank loan which, to the borrower, is "debt". Chartered banks are not allowed to lend out their depositors' savings and chequing account balances. Even if they could lend out all of everyone's money, a rapidly growing economy requires more money than currently exists. Bank loans are the creation of new money. A bank loan of $1000 for 1 year at 8% interest puts $1000 of new money in your account which you spend/circulate into the economy. But in 1 year you have to repay $1080. The bank loan created $1080 of new debt but only $1000 of new money. There is now $80 more of monetary "debt" in the system than there is monetary "money". If this was a closed system and the $1000 was the only money in the system, at the end of one year the borrower could not possibly repay $1080 because the extra $80 does not exist. There may be $80 more of "economic" value in the system, but there is only $1000 of "money" in the system. This arithmetic works all the way up the financial scale. $1 trillion of loans at 8% interest adds $80 billion per year more monetary debt into the world economy than it adds monetary money. So after 2 years you're $160 billion short of money to pay all the interest. After 12 1/2 years you're $1 trillion short. That is, at 8%, it takes 12 1/2 years before there is twice as much debt in the system as there is money. There's only the $1 trillion of money, reloaned every year at a new 8% interest. But now there's $2 trillion of debt, which can only be repaid with money, not with carrots or new houses or other economic goods. Money has to repaid in money. Eventually this debt situation gets so lopsided that large scale writedowns of debt have to happen, to more evenly balance the amount of "owned" money in the world with the amount of debt in the world, which is what we are seeing now. Unfortunately these arithmetic corrections cause serious economic disruptions to the real economies of the world. I don't know what the solution is, but it seems to me that you shouldn't have to destroy economies just to fix what is essentially a flaw in our accounting system.

2008 Oct 08 03:58 PM

[danish:]

No. Don't blame accounting systems. Double entry accounting has worked for centuires, and will keep track of the $80 interest receivable which is a book keeping entry. The borrower of $1000 loan is expected to have produced collateral for the loan and to have a business plan to use this money to trade and to make far more than $80 in earnings to repay the loan and to take his share of profit. The bank must have known this. All that is hepenning here in simple terms is that the collateral collapsed and the $1000 receiveable has turned into a bad debt and must be written off. So if the bank did not have enough provisions for bad debt then the bank is doomed to fail. In fact, thanks to accounting systems that opened up the can of worms.

2008 Oct 08 07:41 PM

[mangy cat:]

darling, icesave froze my deposits

then let's invade iceland
and as a sidebar get our 1000 year revenge
on canute (who like dubya in iraq, who couldn't get the waves to obey him, but sent a chill of fear through the souls of the invaded saxons)
or william the conqueror (another viking, albeit with some polish from his sojurn at the moulin rouge in gay paree)

2008 Oct 09 09:24 AM