Helping Iceland

Iceland is a small country in big trouble.

During the heady times of economic growth, its banks expanded operations far beyond what the country could possibly support. When the global financial crisis came, all three collapsed. Millions of depositors in Britain and the Netherlands would have lost their savings.

When banks collapse nowadays, fortunately, governments intervene. The governments of both Britain and the Netherlands guaranteed the accounts of their citizens. In total, this cost said countries approximately 3.9 euros (or 5.3 billion dollars).

Understandably, said countries were also angered at picking up the tab of Iceland’s failed banks. The root of Iceland’s current troubles lies in their demands that Iceland repay the €3.9 billion. To force Iceland’s hand, Britain – in a rather mean gesture – used anti-terrorism laws to freeze Iceland’s financial assets. This helped crush the country’s economy.

Now, there are two problems with the demands of Britain and the Netherlands. Firstly, Icelanders really do not want to repay the money. To the average citizen, suffering for the mistakes of a few bankers smacks of unfairness. Giving money to what many view as a big bullying country is also unpopular. In a recent referendum on the question, 93% of voters rejected a deal to repay Britain and the Netherlands.

Secondly, it’s practically impossible for Iceland to repay the money. The country’s population, after all, numbers only around 300,000. The €3.9 billion in debt amounts to almost half of its GDP. Imagine if the United States owed $6.5 trillion to another country because of Goldman Sachs.

The best step for Britain and the Netherlands would just be to forgive Iceland’s debt – or, if that fails, to negotiate a very generous deal. Third World countries have their debt relieved all the time; there’s no good reason for Iceland to be an exception.

Perhaps United States can lend a hand. €3.9 billion is a lot for Iceland, but practically nothing for a country of America’s size. It may not even need to actually spend money to help Iceland; Britain, after all, still owes the United States £40 billion pounds (inflation-adjusted) that it borrowed from it to fight WWI.

More fundamentally, this situation may end very badly for the West. Iceland’s predicament brings to mind the massive reparations Germany faced after WWI – something which ended disastrously for all countries involved. Already hostility to Britain and the Netherlands is quite high in Iceland; it will probably rise further. Last November the president of Iceland accused its neighbors of betraying Iceland during its time of need.

There may come a time when the West is likewise in a dire strait – whether it be war, economic peril, or something else. It may need all the help it can get. Then Britain and the Netherlands may rue taking a country like Iceland for granted. In the best case scenario, Britain and the Netherlands get their €3.9 billion, and Iceland forgives and forgets. In the worst case – one of those “unknown unknowns” – their bullying may end up costing the West far more than €3.9 billion.



Iceland Veers Left

Though progressive by any standard, Iceland is a relatively conservative country befitting a thousand year old country that seen its share of hardships. Its latest round of hardship, a spectacular economic collapse, is today the catalyst for Iceland's leftward turn at the polls. Free-market conservatives were trounced.

Since 1991 until very recently, the Independence Party, a right-wing party with a neo-liberal free-market ideology influenced by Margaret Thatcher and Ronald Reagan, had dominated Icelandic politics. Under longtime Independence Party Prime Minister David Oddsson, Iceland privatized the country's state-owned businesses, remaking the economy along Thatcherite lines. Traditionally, the Icelandic economy had been more regulated than in most other Western economies but the Independence Party would open the country to a liberalized investment environment. As entire sectors were privatized, regulations were erased.

The privatization  would include the state-owned banks, which under private owners grew massively by borrowing and lending overseas. In effect given the lax regulatory environment, Iceland's bank sector become one giant hedge fund. When it was all said and done, Iceland's banks would hold liabilities twelve times of Iceland's GDP. Iceland has been mired in crisis since late September, when the country's three largest banks collapsed under the weight of these debts. Cleaning up this mess has not been cheap for the small mid-Atlantic island nation of 320,000. Current estimates run to $10 billion, or about $30,000 for every man, woman and child in the country. The collapse of the banks alone is expected to cost taxpayers nearly $3 billion, on top of another $3 billion the government has invested in the new nationalized banks to keep them afloat.

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The IMF and Eastern Europe

More than 10,000 protesters gathered in Kiev to protest against the government and against measures being imposed on the Ukraine by the International Monetary Fund. The police estimated the crowd at 8,000, but other estimates were as high as 20,000 and it is the second mass protest in as many weeks.

The demonstrations came at the end of a tumultuous week in a tumultuous country. On Wednesday, an overwhelming majority in Ukraine's Parliament, the Verkhovna Rada, voted to move up and hold presidential elections on October 25. On Thursday, deputies from the pro-Russian Party of Regions swarmed the podium in the legislature, blocking the doors ahead of an important vote on measures demanded by the International Monetary Fund (IMF) as a condition of further aid.

In November, the IMF extended a $16.4 billion loan to the Ukraine.  The IMF had approved the emergency loan package back on November 6, 2008 but suspended the credit's second tranche after disagreement over implementation of the programme. At issue was the size of the budget deficit. The Ukraine  received the first $4.5 billion tranche but the IMF will not release any further funds until the Ukraine agrees to steep budget cuts that would affect public sector salaries and pensions. The IMF loan was suspended last month due to Prime Minister Tymoshenko's reluctance to make the unpopular move of cutting social spending ahead of the presidential election.

The Ukraine had boomed in recent years benefiting from higher commodity prices and from an inflow of investment capital as the country undertook a liberalization of its property and financial sector embracing neo-liberal free market reforms. Now the Ukraine is among the countries hardest-hit in the global financial meltdown, which has depressed demand for the steel and chemicals that are crucial sources of its export income. Industrial output fell by nearly one-third in February, year-on-year, the national currency, the  hryvnia, has shed nearly half its value against the US dollar since September and the economy is expected to shrink by 6 percent this year.

What makes the Ukraine so interesting is that the country is a cleft country. It's split down the middle literally. The Ukraine is divided between the Orthodox East and the Catholic West, between a  Ukrainian-speaking West and a Russian-speaking East, and between those who look to be part of the West and those who seek to restore historic ties with Russia.  And the division is basically 50-50. Here's an assessment by Ibrahim Özturk in Today's Zaman, a Turkish newspaper:

The Ukraine is a country at a crossroads. Not only is it among those being hit hardest by the current global financial crisis, but it is now flirting with actual dissolution. The country's economy is fundamentally weak, and ongoing political strife has made economic reforms necessary but impossible. Furthermore, the country is the cornerstone of the geopolitical battle between the West and Russia. Its weakness makes Ukraine dependent on outside powers, but outside powers appear to be working to pull the country apart.

Ukraine's dependence on foreign capital for development has been badly abused by foreigners, international organizations and domestic oligarchs. Capital went to services (banking, trade and consumption sectors) rather than to the manufacturing industry to upgrade existing structures and increase productivity.

The country's budget deficit is 2.8 percent of its gross domestic product (GDP) and is likely to increase before it decreases, as declining industrial output triggered by the global recession will inevitably reduce expected tax receipts.

Moreover, Ukrainian currency problems are also quite severe. Foreign investment has been leaving Ukraine's equity markets and speculators have been attacking Ukraine's currency, the hryvnia. As confidence inside Ukraine slides, bank runs are taking place. In my view, this could be the worst news, as it will force the country into default and even into internal chaos.

The full story on the protests in the Ukraine in the New York Times.

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A Cacerolazo In Reykjavik

Thousands of angry citizens have joined noisy weekly protests against the government's handling of the economy, clattering pots and kitchen utensils in what some commentators called the "Saucepan Revolution."

A cacerolazo in Reykjavik? Not surprising given the depths to which Iceland has been plunged. Iceland has been mired in crisis since late September, when the country's three largest banks collapsed under the weight of debts (more on 'securitization' below the fold) amassed during years of rapid expansion. The value of the country's krona currency has plummeted over 30%, hitting many Icelanders who took out special loans denoted in foreign currencies for new homes and cars during the boom years. In addition, Iceland must repay billions of dollars to Dutch and British citizens who held accounts with subsidiaries of collapsed Icelandic banks. Prime Minister Geir Haarde's government attempted to combat the crisis by nationalizing the banks and negotiating about $10 billion in bailout loans from the International Monetary Fund and from a number of countries, including other Nordics, Russia and the United Kingdom. Still, economists expect the Icelandic economy to contract 9.6%. Life for an Icelander may yet again be just "salted fish". The above clip is from the second day of the biggest protests against the government in Iceland since 1949 when people protested against Iceland joining NATO.

A cacerolazo (cacerola is Spanish for pot) is a form of popular street protest and demonstrations in Latin America which consists in a group of people creating noise by banging pots, pans and other utensils in order to call attention to political and social grievances. Cacerolazos date back to Salvador Allende's Chile when housewives took the streets of Santiago and other major Chilean cities to protest stagflation and severe shortages in 1970-1973. The empty pots weren't good for anything else. The practice remains fairly common in Latin America and has spread elsewhere. Cacerolazos erupted last Spring when Argentine President Cristina Fernández de Kirchner attempted to raise export tariffs on a variety of agricultural commodities setting off six months worth of political and social unrest in the South American country. Now cacerolazos have come to Reykjavik.

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The Financial Sector Becomes a Call Option

It's a good thing that the US markets were closed Monday for the Martin Luther King holiday. Pity they weren't closed today. The DJIA fell below 8,000, losing 4%, its poorest performance on any Inauguration Day since the index was started 124 years ago. The tech-heavy Nasdaq and the broader Standard & Poor's 500-stock index both plunged more than 5%. The S&P is now down 49% since its peak and the DJIA is off 45% from its high.

Leading the collapse is the global financial sector which has in essence become a call option. The catalyst for the collapse was news out of the United Kingdom where shares of the Royal Bank of Scotland plunged 68% on Monday after the bank admits it was poised to report £28bn ($41 billion USD) in losses. The shares fell another 74% today. Stock markets around the world absorbed the news poorly. Sydney was off 4% on Monday. The Nikkei was off 2.3% on Monday and then another 2.6% on Tuesday. In early trading on Wednesday, the Nikkei is off another 1.9%. It has so far lost 10.7% for the year.

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