The Icelandic Debt Relief

The hottest story coming from Iceland now is the one about the government-initiated debt relief to households. Here is my take on it, focused only on handful of all the questions and issues related to the act itself and, perhaps more importantly, the potential economic development in the future. Especially on that front we have a sea of unanswered questions. Is this going to be inflationary? What about economic growth, unemployment, investment levels, etc.? The balance of payments? Will this help or hinder the abolishment of capital controls?

First some useful links (in English) that I found. They are unfortunately not many... classic Icelandic lack of communication problem... (if you've got some others, please leave a comment):
FAQ on the website of the Prime Minister's Office
The news itself on the same website
Bloomberg - Creditors in Iceland Banks Face Pressure to Speed Up Settlement (by an Icelandic journalist).

The basics
Framsóknarflokkurinn (e. The Progressive Party, PP - they are conservative) promised to carry out a debt jubilee if it would be elected into power in the last general elections. They were. The other half of the coalition is Sjálfstæðisflokkurinn (e. The Independence Party, IP - conservative).

Those two parties did not agree on how the debt should be cancelled. The PP wanted to straightforward cancel it. They were talking about up to ISK 300 billion just before the elections, the actual amount turned out to be half that. The IP thought that cancellation would be impossible since it would either be simply illegal on the grounds of property rights and / or too expensive for the State in case the State was going to foot the bill for cancelling the debt of households. Their take was to use the tax system and create incentives for people to use the 3rd pillar of the pension system - the private pension holdings - to get tax-free additional income to be spent on paying down debt and only to pay down debt.

The outcome is a mix of both. ISK 80bn. (roughly GBP 400 million) of household debt will be outright cancelled. Additional ISK 70bn. are to become available via allowing people to use their 3rd pillar pension savings in the next three years, to pay down their household debts.

So what's the crack? 
Icelandic households will get ISK 150bn. (GBP 750 million) of their household "cancelled", spread over a four year period. I say "cancelled" because they are in fact paying down ISK 70bn. of it themselves, the only thing is that they get to use tax-free pension savings to pay down that part. And that makes perfect sense by the way: why save in an illiquid form at 2-3% real interest when you have debt to pay that charges a 4-5% rate of interest.

The rest, ISK 80bn., will be outright cancelled in four annual instalments although the borrower will feel the positive impact on his monthly payment burden immediately. Each household that has an indexed mortgage, partially or wholly, (check this link to see how indexation of Icelandic mortgages works), specifically declared to buy a property for own use (buy-to-let mortgages are excluded!) will get a maximum of ISK 4 million of the debt written off. Non-indexed loans get no write-off but the tax-free pension savings can be used to pay additionally onto the principal in the future. The tax-free pension savings can also be saved and later used to buy a flat. This is why they say that even current tenants will benefit from the measures. If the household got its debt cancelled via e.g. the 110% measure this will be accounted for and the current write-off will consequently decrease.

The following is a copy-paste from the slides about the measures. The way you should read this is the following. The x-axis is the time when an ISK 15 million mortgage was taken out. The graph (grey area) shows the nominal amount of that debt today (Remember, the principal of indexed Icelandic loans INCREASES in value parallel with the CPI. That's the reason why an ISK 15 million mortgage taken out in e.g. September 2001 would amount to about ISK 25 million today according to the graph). The blue area is the debt after the debt has been cancelled and the light brown (beige??) area is the amount of the mortgage once a 3 year private pension pay-down has been accounted for. So the decrease is read vertically and depends on when the loan was taken out. Click to enlarge.

The principal of an ISK 15 million mortgage and how it is affected by the jubilee, depending on when it is originally taken out

Now, most of the questions, and some answers, about how and why and what for and all that can be found in the FAQs from the Prime Minister's Office. So head over there to read further on how the whole thing is carried out. I would rather spend time on some other issues, such as:

Is this significant?
That depends on how you look at it I suppose. This jubilee is not gigantic in comparison to the debt that has already been cancelled since 2008. On that note, I honestly think this nice info-graphic, which is circulating on Facebook from a group that is politically, well, not keen on the current government, says it all. To give the current government some rightful credit (pun intended): their measures are more significant, by a mile, than the previous government's measures (because they had nothing to do with the pink part of the left column).

Comparison of how much household debt has been cancelled in Iceland since The Crash.

The headline ("heimsmetið") is a reference to the prime minister who said that his government's jubilee was a "world record". The left column is debt that was cancelled during the coalition rule of last government. The colours represent the following: purple (12bn) - special interest benefits, pink (155bn) - correction due to illegal FX-indexed loans (this came through the justice system and had nothing to do with the former government), orange (8bn) - special debt measures, yellow (48bn) - the 110% way (any debt above 110% of your property value was written off), grey (15bn) - increased interest benefits, blue (70bn., the IP's campaign colour) - Tax-free pension savings, green (80bn., the PP's campaign colour) - debt jubilee.

So in comparison to the previous write-off of debt in Iceland, governmentally initiated or not, the current jubilee is not so huge.

However, it is significant from the point of view of proving that this is politically possible! And that's something for other nations to learn from! Jubilees do not need to be a thing of biblical times! (But of course, that does not mean that they are always a smart move!)

But how are they paying for all this?
Right, that's a bit hazy to be honest. The short answer on the list of FAQs on the website of the prime minister's office is a classic nonsense answer that doesn't add any value:

"How is the debt relief financed? The Treasury will collect increased revenues in the next four years to cover the cost of additional state expenditure resulting from these actions. The actions will therefore neither be financed by additional Treasury borrowing nor with the granting of state guarantees."

Right, so the no-bullshit answer is that you're going to increase taxes - or "collect increased revenues..." Then just say it!

Where are they going to "collect increased revenues"? From the old banks. Through taxation. Specifically, they are going to tax the estates of the old banks, i.e. the bankrupt banks since 2008. Their liquidation process is going veeeery slowly, to a large extent because of the capital controls and the tug of war between them and the liquidation process of the old banks: the capital controls hold it back but the estates have to be liquidated in the end before we can abolish the capital controls. Well, that's a nice one: like being a driver with two back seat drivers, one demanding you drive faster and the other demanding that you slow down. Which one are you going to make unhappy?

The government is going to make the old banks unhappy. Besides outright taxation on the them to pay for a debt jubilee for households, they are considering changing laws that would force them to speed up the liquidation process.

I've got two immediate concerns about this.

First, those are two birds in the bush but not one in the hand. Are we definitely sure that they can tax the old banks? This sentence alone from the slides says it all (slide 56): "The committee [behind the debt jubilee] assumes that the measures will be fully funded over a period of four years" (i. "hópurinn gefur sér þá forsendu að aðgerðin verði fullfjármögnuð á fjórum árum.").

Great going guys, I do this all the time as well! I always just book my vacation to French Polynesia and just assume that I can finance it! ISK 80 billion!? Pennies mate, I'll pick them up off the floor one day!

And even if they can tax the old banks specifically (there are some concerns about whether it would be constitutionally possible or not), won't the old banks, which are the main owners of Arion and Islandsbanki, not just pass at least part of the cost onto their customers? Competition in the banking industry in Iceland isn't great you know.

Second: OK, if we can tax the old banks to get cash for a debt jubilee, couldn't we have used the money for something else? Like not practically shutting down the Icelandic public radio? Or pay decent wages to doctors, nurses etc.? Not putting myself up against the debt relief as a principle, just pointing out that we didn't have to spend all the cash on it.

Or maybe we can tax them even more and spend that tax income on something nice!?

But how do they actually do this?
1. The mortgages are split up into "primary" and "secondary" parts.

2. The primary part (about 87% of the mortgage to be written down) is the new debt of the borrower. This loan has the same loan stipulates as the original loan, i.e. same rate of interest, indexed to CPI, etc.

3. The secondary part is interest and indexation free. There are no payments of that debt. Both of the loans are on the balance sheet of the borrower and the financial institution that owns the original loan. The total payment burden therefore contracts immediately and not over four years.

5. Annually, the State buys back 25% of the original amount of the secondary loan from the financial institution (hence the fact that this will take four years to finish). This is roughly ISK 20 billion annually, hence the total ISK 80 billion write off. The debt is then written off. The income to fund this is meant to come from the estates of the old banks themselves.

What about the economy?
The government estimates that with all this they will manage to get household debt below 100% of GDP. Such a debt level is still quite high and may still be a barrier to economic growth and financial stability, especially since interest levels in Iceland are stupefyingly high in comparison to other economies.

Nevertheless, this should help. Analytica, a consulting company back home, reckons the effects of the jubilee will be the following for 2014 only:
- economic growth: +0.1%
- inflation: +0.1%
- current account balance: -0.2%
- consumption: +0.4%
- investment in new properties: +2.0%

My take in short
Now, there are some good things about this measure.

First of all, they did it! Jubilee is here, well done guys! You proved this is politically possible and economically this does not seem to be an absolute nonsense. So this opens up the possibility of doing this in other countries. Whether that would make economic sense has to be discussed for each economy. Some very indebted households will feel quite relieved and this will have positive impact on the economy although the impact may be short lived (see more why below). The tax-free pension part of it all also makes perfect sense and simply boils down to the fact that it is not smart to save on 2-3% rate of interest when you owe debt bearing 4-5% rate of interest.

But I do have to admit that I have concerns, besides the obvious ones like the taxation issue (which may well enough not be so important). There are a few reasons why.

First, the primary loan, or the new loan, that the borrower has to pay off will still be indexed, just like the original loan that now is being partially written off. We will therefore still have all the negative effects of indexing mortgages in Iceland, including more volatile inflation, higher inflation, higher rate of interest, lesser effectiveness of the monetary policy and the risk of having to have another debt jubilee in 10 years time or so.

Second, and closely related to my first concern: although there is no direct increment in money supply because of the measures we can, I believe safely, assume that not only will we have some potential demand-pulled inflation immediately in the wake of all the jubilee but increased credit demand as well (especially if we have an increase in moral hazard due to all this: will people take on more debt because they anticipate another debt jubilee in the future?). As the increased credit demand will be met with new loans that increase the money supply we will end up with further inflation pressures. And because the principal of indexed debts will grow with more inflation we will get some, or even all, of the "jubileed" debt back. The Central Bank will also respond with an interest hike to try to hold credit demand back. That will hit the borrowers with non-indexed loans as their interest rates are potentially readjusted upwards. (More effective and sensible way of limiting credit growth and inflation would be to impose direct credit controls and connect them to the banks' own net holdings of liquidity in foreign currencies. But I doubt the Central Bank will go down that road: you can't teach old dogs how to sit).

Why, oh, why did they not make it compulsory to change the new primary loan into a normal non-indexed loan? A golden opportunity to get rid of this pest that indexed mortgages are has been wasted!

Third, although the net assets of the old bankrupt banks will contract (assuming everything goes according to plan) we will still have "considerable" pressure on the balance of payments because of increased consumption and demand. Now, of course, part of the reason for those measures is to revive household consumption. But if we will get into even further riskier waters with the balance of payments than we are in, doesn't that just signal that the exchange rate is too strong? And imagine what will happen when and if the exchange rate goes down: inflation goes up, principal of debt grows back, we're back on square one.

So again: why, oh, why did they not abolish indexation parallel to those measures?!

Fourth, and this is perhaps my most serious concern. We haven't fixed the institutional drawbacks of the Icelandic economy. Besides still having the indexation on mortgages, we still have a high self-imposed rate of interest stemming from the pension system. (It is regulatory required to get a real rate of return of 3.5% and it controls assets equal to about 120-130% of GDP. What do you think will happen to the long term rate of interest with such gigantic buyer of financial liabilities who demands a high minimum rate of interest. Has anybody heard of monopsony?). We also still have high short-term rates, to a large extent because of the indexation.

So I fear that the net effects of this debt jubilee will not be significant in the long run. At least from an economic point of view. Politically, this may fuel some fires, even in other countries where over-indebted populations may be nudged to demand jubilee there as well. In some cases those potential jubilees might make sense. The taboo of debt relief has just been delivered a blow. Maybe we can actually discuss it in a more sensible manner from now on and not with cries coming from both sides.

That is all well and square, but when it comes to the Icelandic economy, I fear we will only have short spurts of economic bounce back. It is not enough to cut the leaves of the weed, we need to dig out the roots as well.

UK & Iceland GDP comparison

After the recent GDP figures from ONS, the general reaction was rather pessimistic. FT had e.g. this tweet and article:

True, this doesn't look good. In fact, after the revisions, UK GDP volume is now further below its top before the financial crisis than Iceland's GDP is. The following graph is based on data from ONS and Statistics Iceland. The top is given the value 100 (3Q07 for Iceland but 1Q08 for the UK). Chained volume measurement, seasonally adjusted (yes, the Icelandic data are SA although they don't look like it).

Back on track: Iceland is edging closer to its GDP volume top before the crisis. The momentum is also stronger.

Iceland's GDP is now 0.4% closer to its top before the crisis than UK's GDP compared to its top. Then again, Iceland had its top two quarters ahead of the UK.

But - there is always a "but" - this is a volume measurement. And although economics teach us to think in volumes and real measurements, we arguably do not rely on barter (and never did) in our commerce. We use money and money is different between economies: try paying with Queen's money in Iceland and you'll be a laughing stock (I've tried, the guy just grinned at me) just as you will be if you try using the ISK in the UK.

So what happens if we price the volume produced in the same currency, say the GBP. That comparison makes sense: we could be producing the same volume as before the crisis but is it worth the same?

The UK volume is already priced in pounds so no need to handle that in a special way. But the Icelandic volume measure uses the ISK as a measurement stick and that measurement stick has changed significantly since before the crisis. If we measure both of the volumes in GBP, the following graph is the result.

Still long way to go: measured in GBP, the Icelandic GDP volume does not seem to be edging must closer to its previous height

Notice the drop in the Iceland data in 2006. This is the "Geyser crisis", a short wake up call to the fact that we were in a bubble. But it did not last long; politicians and prominent businessmen claimed everything was peachy, the housing bubble restarted (held up with exchange-rate linked loans which have now been deemed illegal) and the banks kept on growing. Then, finally, the party ended.

To my British friends I say: sure, you're not in the best of situations. But if it makes you feel better, you're not in the worst.

Wages in Iceland According to the Tax Man

A Facebook friend of mine posted data on there about the gross wage income of tax payers for the last years. The data got me thinking and I came up with the two graphs below.

Explanations are in order. First, the data is gross pre-tax income in the form of wages, including wage-benefits (car sponsorships etc.) and pension payments. The gross income amount is divided by the number of those persons that posted that income to the tax man. Furthermore, the years are the years of which the income took place. The data comes from this Facebook friend of mine, Elias Petursson, and he has it from the Directorate of Internal Revenue (a very cumbersome name for the tax collector).

So in 2007, the average tax-record-maker made nearly 4.8 million ISK in pre-tax income (2011 prices). That is equivalent to 58 thousand USD (again, in USD 2011 prices).

But then came the crash. In 2008, the average gross pre-tax income had fallen down to 4.5 million ISK. The figure went on downwards, bottoming out in 2010 at 3.75 million ISK. A mighty fall of 21% in pre-tax gross income in only three years! Only last year did the pre-tax gross income increase, but it is still 18% lower than it was in 2007. And this excludes all the effects of the tax hikes!

But there is more. The collapse of the currency by 50% - you needed 64 ISK to buy 1 USD in 2007, in 2011 you needed 116 of them after having bounced back from the 124 ISK/USD low in 2009 - decreased the purchasing power of the average Icelander abroad significantly. The 58 thousands USD gross pre-tax income in 2007 turned out to have become only 33.5 thousands in 2011.

The pre-tax income of the average Icelander has decreased significantly since 2007, both in ISK and USD alike. Red is the USD figure in thousands, on right axis. Blue is ISK in millions on left scale. Both figures are detrended with the respective price index and all figures are in 2011 prices.

Now, the axis on the graph above don't add very much detail. If we however make an index out of the figures, we come up with this.

The pre-tax gross income of the average Icelander has decreased by 18.3% since 2007. Measured in USD however, the fall is 42.7% since 2007. Notice the slow upward move since 2009 though. Again: USD in red, ISK in blue (fixed prices)

So the populace of the IMF Wunderkind has had to settle for a contraction in USD-based gross pre-tax income of more than 42%. Well, we can always look at the bright sides: since the USD income bottomed out in 2009, the growth is 12.3%. Maybe there is something behind the GDP growth figures after all.

Yet, I must wonder what happens once we take the tax burden into the account.

The Optimistic GDP Forecasts and IMF's Turnaround

Islandsbanki published its economic forecast for the Icelandic economy late in September. Their expectations: 3.2% growth in 2012 and increasing after that.

I sat down and looked at some other forecasts in comparison to get a feeling for the realism behind them. I cannot say that any of them is realistic for 2012 except the IMF one. And funny enough, IMF is in fact turning around on its policy on Iceland and the problem we have on "offshore" kronas. IMF isn't as optimistic about its wunderkind as they used to be when they threw that "Iceland and IMF" conference one year ago.

GDP forecasts range from 2.4% (IMF) to 3.2% (Islandsbanki) in 2012. CBI stands for Central Bank of Iceland.

OK, so the range for 2012 is 2.4% to 3.2%. That compares to 2.4% GDP growth the first 6 months of 2012 compared to the same period the year before. That means that to reach 3.2% growth (Central Bank of Iceland (CBI) and OECD expect 3.1% growth in 2012) the economy needs to grow by 4.0% in the second half of 2012.

4.0%. Right. Well, that's not going to happen. Islandsbanki's 3.2% expectation is way off, we can immediately write their 2012 forecast off. Same really goes for CBI's and OECD's 3.1% forecast.

The most interesting forecast is IMF's. It's interesting not only because it is the most realistic one but it also signifies a turnaround on IMF's behalf when it comes to Iceland.

IMF in 2011: "We nailed it!"
In August 2011, IMF projected 3.1% GDP growth in Iceland. It expected 2.5% growth for the full year 2011, which compares to the latest estimate of 2.6%. Well done! IMF generally expected "a tentative economic recovery": the inflation was rising, the krona depreciating slowly and uncertainty was (and is) still high due to the Icesave dispute. However, "access to international capital markets [had] been regained" and "outlook was for a moderate expansion" while "concerns persist about the sources of medium-term growth." IMF constantly mentioned the growth in private consumption, an economic factor that practically caved in in 2009 and 2010.

But the most prominent IMF position was that of the handle of the crisis. A whole conference was set up in October to celebrate the good job done and famous international economists came to Iceland to check out the crisis Wunderkind. In November 2011, IMF's eyes to the possible unorthodox handling of the crisis had opened and Iceland's case suggested "alternative way out of crisis."

Iceland had basically taught IMF that atypical "we must save the creditors!" policies weren't the only one available. Good stuff, very important that IMF realised this.

IMF in 2012: "We nailed it BUT..."
Now, IMF has realised that it may have to extend even further the Icelandic case of "let the creditors drown". The reason: the offshore kronas.

The offshore kronas are funds, denominated in krona, that are stuck in the economy behind the capital controls. Their sources can be of any kind, ranging to the Glacier bonds issued during the 2004-2007 Party to normal households' savings that are eager to get out of the economy on expectations alone that the value of the krona will collapse the instant the capital controls are lifted. Estimates of the whole offshore krona amount run from 400-1,000 billion ISK (25%-60% of GDP or thereabouts).

On 28 September, IMF issued a Concluding Statement. There, we can see IMF arguing that "significant reduction (or elimination) of the “overhang” of liquid offshore krona" is one of the preconditions for lifting the capital controls. That was always known. What is a turnaround is the way IMF is now willing to do it:

"To accelerate [reducing the stock of liquid offshore krona] it is necessary to strengthen the incentives for holders of liquid offshore krona to participate in the liberalization strategy. A key step will be to curtail expectations that capital controls will be lifted soon, including by removing a reference in legislation to a terminal date for the controls. In addition, the strategy should clarify that the conditions under which liquid offshore kronas are allowed to exit will become less favorable over time

And they continue:

"Once incentives are in place, the authorities could open the next channels envisaged in their strategy—bond swaps and an exit tax. The objective of the bond swaps would be to reduce the stock of offshore krona before introducing an exit tax and ultimately lifting the controls. Swapping short-term krona-denominated assets into long-term euro-denominated bonds would distribute the pressure on the balance of payments over several years."

This is a turnaround. IMF is now accepting the not-so-unlikely possibility that in order to ever lift the capital controls in Iceland, the Icelandic authorities basically have to fry the creditors even more. IMF padded Iceland on the back for not rescuing the banks in 2008 and thereby let the creditors of the banks take the hit. Now, they are directly saying that Iceland would need to take one more step and straightforward threaten the holders of liquid offshore krona: "the strategy should clarify that the conditions under which liquid offshore kronas are allowed to exit will become less favourable over time."

IMF changing?

The funny thing is that those ideas are old. One of the MPs of Iceland, Lilja Mosesdottir, has for a long time urged a more critical stance on the offshore krona issue. She has spoken about a German-1948-type adoption of a "new krona" (assets in ISK redenominated in a new currency, which's exchange rate is a function of the nominal value of the asset being redenominated, e.g. 1:1 for low amounts, wages, etc. but 10:1 for high amounts and offshore krona) and an "exit tax" if offshore krona owners want to swap them out for EUR or any other foreign currency. She in fact used to be in the government but went rogue due to what she felt was the government's softness towards IMF. 

Now, IMF has basically taken up her stance.

And why? Maybe because they are afraid that their Wunderkind isn't in the good shape they hoped to.

But maybe because they are generally accepting the fact that "debt that cannot be repaid, won't be repaid" and creditors should simply accept it. That would be the most wonderful thing if IMF finally realised that and actively applied that policy in its future bailouts.

The new GDP figures

Statistics Iceland issued new figures on GDP growth three days ago. As I've been flat chat in finishing my PhD I haven't had the time to dig into them properly until now. They tell us pretty much the same as the last figures: the economy is fragile and a wolf would not have to huff and puff much to blow it down.

First of all, the GDP growth of first six months of 2012 was estimated to have been 2.4%. The previously posted 3.1% growth of 2011 was reevaluated downwards to 2.6% - there goes any reason for the central bank to up the policy rates further! GDP per person is still way below what it was before the crash happened: five years later we are still only getting 91% of the GDP per person we had.

Still long way to go! Although the economy is slowly bouncing back the GDP levels per person are still meagre 91% of what they were 5 years ago.

Furthermore, and what is most important, the investment levels are still laughable in historical context. Total investment has still not gone up above 15% of GDP when the normal ratio should be close to 19-20% or thereabouts. Industry investment is only slowly coughing its way upwards when in fact a lot more investment is exactly what the economy needs! But no need to be surprised about that: the offshore krona problem is still around and interest rates are too high. Is it any wonder that the economy is not bouncing back properly!

A very severe problem is in fact arising due to the low investment levels: we are not keeping up with amortisation! The machines we use to produce whatever we are producing are breaking down faster than we can replace and fix them. To expect a proper economic recovery with reducing capital stock is like expecting to be able to run faster when you're 80 years old than when you were 25.

Investment, especially industrial investment, is still only a shadow of itself. Categorised figures only stretch back to 1997 but next graph shows how slowly total investment is recovering.

Total investment (blue line) is still insufficient. Investment is in fact so low in fact that we are not managing to keep up with the amortisation of capital with the obvious consequence that the stock of capital is reducing (red line, right axis). How exactly are we going to improve productivity for the longer run if investment is not even enough to keep up with the amortisation? Red dot is 1H2012.

As expected, when investment is low the level of employment is as well. A break in the correlation between total investment and unemployment seems to be visible after the 2008 crash. The effects of emigration on the employment figures should not be taken lightly. Employment will not bounce back until the level of investment recovers.

A structural break seems to be present in the data on unemployment and investment levels after 2008. A likely explanation is the emigration to e.g. Norway and other popular post crisis destinations of the Icelandic worker. 

A reposted figure from Unemployment in Iceland. Don't expect the total number of worked hours per worker to grow much while the level of investment is as low as it is. The GDP growth is a froth! 

Is Iceland OK now? Economic figures comparison

I have been silent for a while here, apologies for that, as I'm on a vacation in France and working on the last draft of my PhD thesis on the sideline. Some exciting updates - from a nerdy point of view - coming up though and once the thesis is out of the way I'll get into proper research for the book I'm (supposedly) writing on the Icelandic economy.

Anyway, the hottest buzz on and about Iceland nowadays is that it's out of the recession.Gylfi Zoega, one of the foremost professors of economics at the University of Iceland, and a member of the monetary policy committee at the central bank of Iceland, said the recession was over. Krugman, who seems very fond of Iceland (come on over again and spend your dollars, we need them!) said that the country had broken all the rules, contrary to Ireland, "and things are not too bad."

Not too bad indeed: 4.2% GDP growth between 1Q12 and 1Q11. Iceland is back on track! How about "une petite coupe de champagne?"

Anyways, I've got my (usual) doubts and I've expressed them repeatedly (such as here, here and here). So as I was paging through the newest issue of The Economist I decided to use the figures at the back there to throw up this comparison of economic figures from all over the world.

Figures from the newest issue of The Economist. Iceland's figure are from Statistics Iceland or calculated by myself. The CA/GDP figures are estimates for 2012, same goes for the Budget Balance figures. In the case of Iceland, I use the total CA/GDP figures (-7.0%) but some want to exclude the old banks from those figures since they are in receivership. If skipped, the figure drops down to -0.1%. Click to enlarge.

This table can be fuzzy to read on its own to judge between the economic health of the economies in question. So I used the figures there to construct the following simple comparison table.

The following table does nothing but to give "points" to countries according to their relevant position to the other ones. As an example, the GDP growth in Greece is worst, so Greece gets 1 point for GDP growth. China is on the top, so they get 18 points for GDP growth. Likewise, only Iceland has worse current account deficit than Greece so the Mediterraneans get 2 points for that comparison. The total points of all the countries are then summed up in the right most column.

Looking at this table, Iceland's 4.2% GDP growth isn't so impressive any more. Like I said almost a month ago "well, yes, there is growth" but unfortunately, there seems to be not much  more. Iceland's "not too bad" economic performance is still pretty damn bad.

The comparative rankings of economic figures, using the data in the previous table. Norway wins (98 points) followed by Germany (82) and Sweden (80). Greece loses (23 points), Spain gets 29 points and Italy 34. Iceland is next (35 points).

The "economic points" of each nation (same data as in the table). Well done Iceland, you're in league with the best!

P.S. When are we going to start talking about the budget imbalances of Netherlands? Is 5.1% budget deficit just a-OK because Spain is rocking it at 6.5%?

(edit: 21:50) Initial calculations were wrong on the budget deficit comparison. That has now been corrected.

Guess Who's Emerging From The Crisis?

In reply to Krugman's post with the same headline. The graph below is the same as his except the red line is the Icelandic GDP measured in deflated Special Drawing Rights. That measurement of GDP is still far behind the fixed-krona prices.

Obviously, if (when) Greece defaults and exits the euro, the Greek GDP in euros will look somewhat similar right afterwards. But that's "OK", they won't be in a "recession" (two consequential quarters of decreasing GDP) any longer... we would at least hope.

GDP in Iceland, quarterly seasonally adjusted figures. Top value is 100 in both cases, but since the krona began falling before the GDP in krona did, the SDR top is earlier. Notice also the "mini crisis" dip in 2Q06 when Danske Bank and some other more sober analysts declared Iceland's then economic growth unsustainable. The SDR deflator is estimated by using the G7 inflation index issued by OECD. 

Edit: maybe it's time to reconsider the definition of recession. Does it make much sense that the worth of an economy's GDP in foreign currency can collapse by more than 50% and later, when the GDP in the domestic devalued currency begins to come back slowly, considered to be "recovering"?

Still some way to go

A slightly longer time series than in the previous post. Apparently, Iceland has still some way to go when it comes to clawing back the lost economic ground.

Nominal GDP in Iceland, expressed in Special Drawing Rights (the IMF "currency"). Even though GNP in kronas is making its comeback, the same can't really be said about the value of that GNP in foreign currencies. The trend line is for the period 1971 - 2001 (on average, 0.19 billion nominal SDRs added to GNP each year).

So had we followed the trend from 1971 - 2001, we would be producing 8,0 billion SDRs worth of goods and services. Instead, we're at the 7.2 billion mark. And my guess is that we wouldn't be fighting as severe debt bubble at the same time as well.

What I find amazing however is that the trend up to 2001 is linear, which means that the annual growth must have been falling during the time period (otherwise we would see an exponential trend in the GNP data). Notice also that the data above is not corrected for population growth or inflation of SDRs.

When that is taken away, the long term economic performance of Iceland doesn't seem that impressive any more. But I haven't compared this to e.g. OECD or Scandinavian countries or other peers. So I'm going to say the Icelandic performance is bad until I've seen how the performance of other economies is, maybe they are just as defective.

Real GNP in Iceland per capita (nominal GNP corrected for inflation of SDRs and population growth). The trend line is again for the same period as before, i.e. 1971 - 2001. Also, the deflator of SDRs is estimated by using the G7 inflation index published by OECD.

If the data here are roughly correct, the real value of GDP per capita in Iceland in SDRs, i.e. in foreign currencies, is back to its early 1990s level. The debt bubble and the consequential financial crisis wiped out 20 years of economic progress. This is what the Minister of Finance/Agriculture/Fisheries called "throughout confirmation" of the return of economic health.

In the meanwhile, the Central Bank thinks the best way to fight a balance sheet recession is to raise the interest rates!

The New GDP Figures

Statistics Iceland issued a new set of quarterly GDP figures for Iceland just before the weekend. The results: 4.2% real growth (seasonally adjusted) between 1Q11 and 1Q12. The Minister of Economic Affairs - or his assistant as the Minister of Economic Affairs is also the Minister of Agriculture and the Minister of Fisheries - immediately wrote an article in the most read newspaper, saying that "the [economic] improvement had been thoroughly confirmed."

Well, yes, there is growth! But not because the government is doing anything about it - it's always easy to have a comparatively better economic situation than during an outright economic collapse - and rather simply because Koo's balance sheet recession bounce-back is in play.

I wrote about in December: the Icelandic economy was in a "Lehman Brothers shock" where the actual bankruptcy effects and the sheer collapse of the financial system had been the main contributor for the collapse in GDP. But once the financial panic cleared out of the system the GDP growth came back, automatically, as the economy calmed down. In the meanwhile, balance sheet recession was inevitable since too much corporate and household debt made it impossible for the economy to grow at a rate that was even close to what it had been growing at before.

I might be fooling myself and under the spell of Galbraith ("faced with the choice between changing one's mind and proving that there is no need to do so, almost everyone gets busy on the proof") but I'm going to stick to that case: the Icelandic GDP growth is due to an automatic bounce-back from the financial collapse and panic and the "thoroughly confirmed" economic improvement is in reality an economy that is burdened with a balance sheet recession.


I've got some points to argue why:

1. GDP growth is considerably lower now than it was before, even measured in ISK. Notice how comparable the quarterly GDP growth figures are to Koo's "Lehman Shock" theory (see next set of figures).

Growth in GDP, measured in ISK, is still below what may be considered as historically normal. The sluggish growth is a sign of a balance sheet recession where debt and debt deflation are holding the economy back.

2. The above GDP growth figures are in the domestic currency. Icelandic GDP measured in Special Drawing Rights (SDRs) is merely the shadow of itself - a 65% shadow of itself to be exact since the value of Icelandic GDP has collapsed by 35% since its top in 2007. Admittedly, this is better than the horrendous 45% collapse straight after and during the collapse but again, that is an automatic bounce-back from the panic and not genuine "thoroughly confirmed" return of economic health.

Icelandic GDP measured in non-CPI deflated SDRs (billions of SDR per quarter). Compare the Iceland's GDP growth figures to Exhibit 16 from Koo's paper

3. Investment is still not coming back, causing historically very high unemployment. I know +7% unemployment may not sound much in the ears of a young unemployed Spanish person but for Iceland, that's pretty high. Those are, as far as I can figure out, numbers that are more or less comparable to U-3 unemployment (no U-6 unemployment figures are available).

Investment as a share of GDP, four-quarter moving average. Investment has hardly bleeped above 15% of GDP while it needs to be much closer to the 20% value to be considered "normal".

4. The debt deflation is quite simply so obvious in the the new Central Bank's data on financial stability that we need not discuss the matter any further. The Icelandic economy is in full-swing debt deflation! And contrary to what the Central Bank might think, raising the interest rates is not the right thing to do in such a situation!!

Debt of Icelandic households, % of GDP. Blue = indexed; purple = FX linked; orange = nonindexed loans, comparable to normal mortgages in Europe; green = overdraft; dark blue = leasing contracts

Number of individuals on list of deferred payments (red line: number of bankruptcies and unsuccessful attached properties)

Debt of non-financial corporates as % of GDP. Blue = CPI indexed; purple = nonindexed, normal loans; orange = FX linked (great idea, lets mostly indebt us in foreign currencies!!)

Debt of non-financial corporates, European comparison (% of GDP). Does anybody know the Icelandic word for "debt deflation"?

So I'm afraid I'm just as bearish as before: the Icelandic economy is in the fastest debt deflation process that I've ever seen. 

The main thing that makes this possible is the around 40% discount the Icelandic banks received as their "birth gift" when they were established in 2008: the loan portfolio was transferred from the old banks into the new ones at a 40% discount which was not forwarded to the borrowers who saw their debts, in many cases, grow in monetary terms due to indexation of mortgages. 

As long as the banks are milking out the discount they received in 2008, the economy will not collapse entirely again. But that's only for the short term. If the debts are not gotten rid off, the problem will persist. And the intrinsic systemic factors lead to ever growing value of debts, due to high interest rates and indexation on mortgages. The financial system has to be reformed bottom up - pension funds and indexation are on the top of the list and close thereafter is the monetary policy - simply because it will not stand the test of time in its current form. The Icelandic financial system is built to collapse, just as it was before 2008.