Iceland's lessons in bankruptcy for Britain
By
Associate Editor
David Stevenson Apr 24, 2009
Print this article
The public borrowing numbers in this week's Budget were gobsmackingly bad. And as we pointed out in yesterday's Money Morning (Why the budget will cost us all a fortune), those were just the official figures, based on Alistair Darling's delusionally optimistic hopes for a recovery. In reality, the end result is likely to be even worse.
The shocking state of Britain's finances means a downgrade to the UK's triple-A credit rating is increasingly possible, if still remote, suggests The Telegraph. And, as many investors can only hold AAA bonds, vast amounts of gilts would have to be dumped if the national credit rating is cut. The country's creditors could then take fright, pulling the rug from under the government by refusing to buy enough gilts to fund its ballooning deficits.
That would leave Britain with only one real option: to ask the International Monetary Fund (IMF) for a bailout, 1976-style, just as Iceland was forced to do last year when its banks collapsed.
There's a clear parallel. Both Britain and Iceland tried to become "sovereign hedge funds", letting their banks borrow much more in foreign currencies than the country's entire annual output. Both were then forced to fork out wads of taxpayers' money just to keep those lenders going when many of their loans went wrong.
Iceland's currency collapsed when investor confidence evaporated. The pound's now in danger of going exactly the same way as Britain's debts stack up.
Yet since its bailout, Iceland has rather slipped out of the headlines. So, several months on, what's life been like under the IMF's "recovery" plan of slashed state spending and financial rectitude? Has it really been, as an unnamed senior cabinet minister told The Telegraph's Andrew Porter earlier this month, "nothing to be ashamed of" and in fact, just "like going to a spa to recuperate"?
Nowhere near. There have been several street protests and the odd riot. Hardly surprising when you see some of the 'adjustments' that Icelanders have had to accept.
For a start, the country's still just about bust. The Icelandic krona – probably the best barometer of the nation's health - has halved against most major currencies since the end of 2007, and even against sickly sterling it's down by 60%. That's ramped up import costs, helping to push consumer prices up by 15% a year from 7% a year ago. Yet wages are rising at an annual rate of just 6.7%.
So your average Icelander is seeing costs climb at more than twice the rate of incomes. That means it's serious belt-tightening time, even for those still in jobs (the dole queues have lengthened from 1% to 9% of the workforce in the last six months, with 10% on the cards by year-end).
But even as consumer prices are soaring, asset prices are plunging. The stock market has virtually sunk without trace. The total market capitalization has plunged by fully 98% in US dollar terms from the 2007 peak. House prices are dropping at double-digit rates in real (i.e. inflation-adjusted) terms.
Meanwhile, thousands have lost their savings, while those who borrowed in foreign currencies have seen their debts rocket. Car sales are down over 90% year-on-year. Consumption has collapsed and is set to shrink by almost a quarter in 2009, says the finance ministry. All in all, the IMF reckons Iceland's economy will shrink another 11% this year.
You get the picture. It's an economic horror story. But does this mean the end of intelligent life in Iceland as we know it?
Of course not. Life goes on, even in the face of economic collapse. In fact, things might even be starting to perk up again. It's handy that Icelanders are generally well-educated and quick to move or retrain for new jobs. Further, the IMF's "boot camp" welfare cutback measures are kicking in. "There are good signs due to the very flexible economy", says the IMF's man in Iceland Franek Rozwadowski. "The exchange rate is stable and inflation is slowing".
"Iceland should have the basis for becoming a symbol of how quickly an economy can recover - we should aim for no less", says Svein Harald Oygard, Iceland's new central bank governor. "We already see goods and services exports exceeding imports".
In other words, rather than trying to slug it out with the financial big boys, Iceland's returning to what it does best - tourism, renewable energy and fishing. The last made up more than a third of overall exports last year, helping to slash the trade deficit to a fraction of its 2007 level. There's still the foreign creditor problem, as Iceland's banks still owe billions of euros and dollars they can't repay. That will take time to resolve. But Rome wasn't built in a day.
"What this all means for Icelanders is stretching the pain out for a long time", says Michael Lewis in Vanity Fair, "and they will be less prosperous in the long-term. But I don't think they'll be taking the same sort of risks again".
So a trip to the IMF's not all bad news then? Well, only to a point. Iceland can at least go back to basics, away from its brief but disastrous dabbling in the financial world, and return to tourists and fish.
But for Britain, it's a different story. Our economy is so tied into the financial sector, which coughed up 14% of 2007's total tax-take and 28% of that year's corporation tax bill, that we can't just walk away. Though the City's status has already taken a major knock from having to be bailed out, and would be hurt further by a cut in our national triple-A credit rating, we've simply put too many of our eggs in the banking basket.
So if Britain is eventually forced to go down an IMF-scripted path, we'd be hit even harder than Iceland. Prices of assets such as houses, shares and gilts will fall a lot further, and stay in the doldrums for several years. The only silver lining is that at least we'd be spared the next round of spending excesses by madcap politicians who've already run up the biggest national debt ever.
As for Iceland, it's still somewhat early for investors to pile in. But UK holidaymakers might be more interested. If they're unable to afford a trip to Europe, the Far East or the United States, for the moment they might still be able to drum up enough cash to visit Iceland's geysers.
Published in
Economics
| More
articles
by
David Stevenson
Related articles
-
By Matthew Partridge, Feb 10, 2012
-
By Tim Price, Feb 10, 2012
-
By Matthew Lynn, Feb 10, 2012
-
By Matthew Partridge, Feb 10, 2012
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.