Monday, 14 November 2011
Iceland, The Euro, And High Interest Rates
An acquaintance of mine and me were discussing a newspaper article arguing for the adoption of the Canadian dollar in Iceland. Without getting into too much detail, the author of the article said the adoption of CAD beneficial for Iceland due to the fact that both economies were rich in energy and raw commodities (if you know Icelandic, the article is here). Furthermore, the Canadian banking system is one of the safest one in the world - which is true - and the currency is stable - which is also true, probably because the banking system is sound. One can of course make the same case about the Norwegian krona and the similarities between the economies of Norway and Iceland but anyway, adopting the CAD was meant to be beneficial.
I would like to stress that I don't have a clue whether Iceland should adopt a foreign currency or not, let it be the CAD, NOK, USD or whatever else. And the reason is simple: I, like everybody else, do not know which will be better because there is massive uncertainty in the decision ("unknown unknowns"). Furthermore, it hinges on the personal risk appetite of everybody.
My favourite analogy to explain this is that of the car insurance: if you buy a full-cover car insurance (you have an independent currency which you can devalue if the economy runs into trouble) you are tempted to drive faster (take risky economic decisions). But if you decide to turn down the car insurance (use a foreign currency which cannot be devalued if the macroeconomy runs into trouble) you'll have the incentive to drive more carefully. But of course, nothing says you will, you still might drive like a maniac or hit black ice and crash the car. And I trust Icelanders well to drive like maniacs - by soaking up private debt - even if we used a foreign currency.
We can endlessly, because of different risk appetites and the impossibility of quantifying them for a sensible mathematical model, argue which is better, to buy the insurance or skip it. And everybody would be "right". So quite frankly, I think the currency quarrel is rather futile, especially because it is not the fundamental problem of the Icelandic, or any other, economy. Discussing private debt and debt creation should come first, currency regime second. But that's never even thought of amongst neoclassical economists who don't know Minsky and the real-Keynes and still consider the market to be efficient and people rational. Please, give me a break!
But the quarrel is there, no matter how futile it may be. But in all honesty, this is not a quarrel anymore. The truth is that there is an ideological tug-of-war regarding the currency and the monetary question in Iceland where politics and extremism are rampant. There are roughly three camps: the ISK supporters, the EUR supporters and the smallest "lets adopt whatever" group, predominantly making the case for CAD, NOK or USD.
Customary to Icelandic public discussion - not that it's only Icelandic unfortunately - some people, from all camps, deny to accept the reasonable argument the other camps make. The ISK supporters mitigate or even deny the krona’s role in bankrupting the economy while highlighting the ongoing EUR debt crisis and the positive effects the ISK devaluation had on the current account. The EUR supporters mitigate or deny the fact that the devaluation of the ISK is assisting the economy to get back on its feet while ignoring the EUR debt crisis and highlighting the cases of Estonia and Finland who adopted the EUR and are doing fine.