Deep Freeze: Iceland’s Economic Collapse

A new book has just rolled off red hot — or should that be ice cold? — from the printing press, written by Professor Philipp Bagus and Professor David Howden:

Here are the contents:

  1. Introduction
  2. Maturity Mismatching
  3. The IMF, Moral Hazard, and the Temptation of Foreign Funds
  4. Currency Mismatching
  5. The Consequences of the Boom: Malinvestments
  6. A Timeline of the Collapse
  7. Why the Fed Could Save Its Bankers, But the CBI Could Not
  8. The Necessary Restructuring
  9. Concluding Remarks

I have yet to read the book myself, so I am unable to do a review, however the foreword has been written by our very own Toby Baxendale, so I am sure the book will be very good. Here is that foreword:

By Toby Baxendale

The two young Professors Bagus and Howden document the sad story of the Icelandic government’s policy mistakes — the artificial creation of a boom, and the savage bust that was the inevitable outcome of this boom. Little have we learned since the wisdom of Mises and Hayek showed us the way concerning business cycle theory. The former are intellectual heirs of the latter two giants of 20th century economics and they present the case of the small nation of Iceland, within the context of the global economy, analyzed via the lens of what has become know as the Austrian Theory of the Business Cycle, extremely well here.

This is a short book and I hope it will encourage others to write about other bigger nations: after all, we are all very much interdependent. I hope they will write via the insights of the great teachers of the Austrian School. For the majority of economists who assume that the marginal revolution has all been absorbed into mainstream economics and that the Austrian School has nothing to add on the matter, I would urge them to pause and reflect on the Austrian theory of the business cycle — the case-proven status of it as outlined in this book — with reference to Iceland and think about what they are doing when they advise governments to artificially “stimulate demand.”

I write this as someone very much involved in the Icelandic economy. As a wholesaler and retailer of fresh fish in the UK, Iceland is probably ten percent of my lines of supply. For some twenty years, I have dealt with the various parts of the Icelandic fishing community and their buccaneering fishermen turned bankers. Be under no illusions, these are hardy people. Much as I do not intend to make a generalization about a population, these are the heirs of the Vikings: they live in an extremely harsh environment and they will bounce back very quickly if allowed to by their government.

One successful cod and prawn processor was telling me that, although he was bust, as most Icelandic companies are, he remembers that it was only thirty-four years ago that he used to stay with his grandfather in a stone-and-grass-built house, with no heating and fresh running water. This current economic collapse would be a setback in the scheme of things but that was all, according to him.

Bagus and Howden describe how the Icelandic business community were encouraged to borrow in Japanese Yen and Swiss Francs with their attractive low interest rates. Commeth the bust, I was asked to “rescue” many of these firms. The key problem with the banks essentially owning all the bankrupt highly leveraged businesses (that were and are essentially good ocean harvesting fishing businesses, albeit loaded over the eyeballs in debt), was that they were in turn owned by the government. The government, not wanting the lifetime of fish quotas to get into the hands of a nasty foreign creditor, would not and still does not allow them to go bust. This irresponsible action on behalf of the government will ensure these zombified fish companies will continue undead for many years to come.

The reality is that they need new fresh capital and the only way they can get this is for the government to let undead businesses go bust and to allow a reorganization in their management and capital structure to take place. No one in a zillion years will buy companies with more than 30 times leverage to pre-tax earnings!

Seeing the demise of formerly solvent companies suddenly becoming insolvent with borrowing in Swiss Francs and Yen was something I would not wish upon anyone. Whilst individuals have personal responsibility for their actions, if the Icelandic State is setting the conditions so that the rational course of action is to participate in the boom, then culpability must fall, in the final analysis, with the originators of the problem: the Icelandic Central Bank.

The fact is that the whole economy of Iceland collapsed and the Central Bank of Iceland, who set the scene to cause the collapse, still exists in its current form. Will they ever learn? If they were a private company, they would have wound up with their assets sold to the highest bidder. “Be done with them all,” should be the cry, these failed, manipulating regulators. This is, clearly, what we should be saying to all Central Banks around the world.

While the central bank was fiddling as their collapsed economy, I remember fishermen coming into port after trips at sea with a hold full of valuable fish deteriorating minute by minute. Buyers like my company could not transact with them, as we could not convert sterling or euro into krónur (the market did not exist). At one point in time, my Finance Director and I had a case packed with sterling, dollars and euro ready to get on a plane and physically give cash in exchange for fish. Fortunately, we found a very accommodating travel agent, who could not believe his luck, that there were these two English guys with hard currency who actually wanted some of his “worthless” Icelandic krónur. For him, Santa Claus had arrived early. We did a deal with him and used the stock of money (krónur) with which he had been lumbered to facilitate the purchase of fresh fish; needs must be met in these circumstances. In fairness to the Icelandic Central bank, they told us (20 minutes before officially going bust via email) not to wire them money to supply to our fishermen as they themselves were going bust!

To make matters worse the new Icelandic government has decided in its infinite wisdom that the people of Iceland own the fish quotas. Over 20 years, 5 percent of these quotas will be confiscated off the current quota owners each year so they can never be owned by foreigners! What the Iceland government does not realize is that a banker in Geneva or Tokyo does not want fish quota, he wants cash! In reality these foreign bankers will sell this quota back to the Icelandic fleet owners, who will be willing buyers at a discount. I hope that reason will prevail and these fishing quotas be privatized rather than the current long-term trajectory with the Icelandic fishing industry being zombified.

Chaos is never a good economic policy. Central planners, as with central banks, can no more set the cod price of the day than they can set the price of money. Do not interfere with the peoples’ money. In the case of Iceland, if left alone they would have been chugging along with a great source of sustainable raw material — the fish. This is fished in the some of the world’s finest fishing grounds. They also possess a tremendous source of cheap geothermal power, which can be slowly and painstakingly used to rebuild a wonderfully long-term, enduringly prosperous economy.

Enjoy the read.

Written By
More from Andy Duncan
The Eclectica Fund Management Commentary, May 2010
Hugh Hendry, of Eclectica Asset Management, predicts that a downturn in China...
Read More
0 replies on “Deep Freeze: Iceland’s Economic Collapse”