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Monday, September 17. 2012
Iceland was a mess after the 2008 meltdown. By 2012, while GDP per capita is still at depressed levels, unemployment is also down dramatically and growth has returned, making Iceland a 'star' among the embattled European nations.
It helps, somewhat, to be a homogeneous and isolated isle. It also helps to let financial institutions fail so debt can be washed out properly.
I'm not a fan of rap music, but Russ Roberts and Don Boudreaux at Cafe Hayek have done a good job making economics entertaining for the younger crowd. I sent their Hayek vs. Keynes series of videos to my son at college. There is an appropriate correlation to the events in Iceland and Hayek's views. There is no Keynesian stimulus taking place there.
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A quibble, Bulldog.
Don't you mean Iceland is homogenous and not heterogeneous? Or am I missing something?
. . . heterogeneous and isolated isle.
hetergeneous? Don't you mean homogeneous?
Ooops, sorry, didn't mean to double post - didn't see this when I started typing my post below.
Bulldog: There is no Keynesian stimulus taking place there.
The banks were nationalized and dismantled. Icelanders refused to cover the losses. The króna was devalued. This reduced the value of savings, reduced the burden of debt, reduced effective income, and encouraged export growth and tourism. Iceland also has a strong social safety net. The effect was to spread the pain, while keeping as many people working as possible. The danger is inflation, which they are attempting to control with rate increases.
These are all actions that are consistent with Keynesianism.
This NOT consistent with Keynesian philosophy.
The banks went bust. Keynes would've called to keep them afloat.
Expansion of the social safety net was meaningless in the long run, as unemployment snapped back to moderate levels after a brief period of difficulty precisely because of the debt destruction which was allowed to take place.
Confusing cause with effect and correlation with causation is not the least of Krugman's, or Keynes', problems.
Wait, my mistake - Keynes didn't care about the long run. Of course, he never defined it, which is always useful when trying to make a point.
So, in the short run, market forces won out and debt was destroyed. Clearly not Keynesian.
The social net may have expanded briefly, but the deficit was reduced. Not Keynesian - even you will have to admit this.
The government did get involved (the level to which this is meaningful is open to debate), but the damage was done and the results are apparent.
Krugman can make arguments about how Keynesian all this is - but he'd be terribly wrong. That's never stopped him before, of course.
There is a lesson for the US to be learned from the financial crisis in Iceland. As I understand it, the central bank of Iceland had insufficient resources to cover the massive foreign debt of the private banks in Iceland and collapsed. The people of Iceland subsequently refused to condone the efforts of the private banks to convert their private debt into a public debt. How anyone can reconcile that action with "Keynesianism" I can't begin to imagine.
In the US, the Federal Reserve has followed the same misguided course as the central bank of Iceland and systematically converted the private debt of both US as well as European-based private banks that operate in the US into a public debt, over the continuing objections of many fiscal conservatives that the private banks should be (and should have been) allowed to fail. The US Federal Reserve cannot be equated with the Icelandic central bank, but at some point even the US Federal Reserve will find itself overextended in the course of its current reckless policies and will lose the confidence of other central banks around the world. At that stage, the American taxpayer should do exactly what the Icelanders did in order to begin the nation's journey on the road to economic recovery: repudiate the public debt.
After it was too late, Icelanders decided that, as a matter of public policy, their private banks should have been allowed to fail. The US should have decided the same and forsaken the massive government bailouts and buyouts, which saved the banks but will lose the nation. Eventually we may have no alternative but to do what the Icelanders finally did and declare national bankruptcy.
As a further nail in the coffin of the "Keynesian" nature of Iceland - remember, Krugman supported TARP, but when he saw it wasn't working, he called for Swedish-style nationalization of the banking system.
At the point he made this call, his goose was cooked. Now he has to backtrack. His support for Iceland hinges on the nationalization of the banks. But the banks were busted....so whether they were nationalized or not isn't meaningful, the reconfiguration of the banking system was what was important to Krugman. In his mind, the nationalization is what saved the day.
This isn't anything but hooey. Any bank - call it "Zachriel's Bank" opening in the wake of the busted Icelandic financial mess would have attracted investment because it was stepping into a gaping hole. The fact nationalization took place is window-dressing, and while it seems to support Krugman's view, the value of this decision will not be apparent for a long time. In the short run (Keynes' favorite), the correlation makes a small case for nationalization, simply because it correlates. There is no clear cut causation.
We will know more in time, particularly if nationalization eventually leads to some other, less desirable, place.
Though isolation helps extend the life of a nationalized entity, which was part of my point in calling out Iceland's unique position in the world.
My guess is that as long as the rest of the world muddles along getting taxpayers to cover capital losses (Hayek's view opposed this, Keynes did not explicitly oppose it), Iceland's nationalized approach will have the appearance of value. If the rest of the world gets its head on straight, Iceland will look hopelessly lost.
Bulldog: As a further nail in the coffin of the "Keynesian" nature of Iceland - remember, Krugman supported TARP, but when he saw it wasn't working, he called for Swedish-style nationalization of the banking system.
You're confusing multiple aspects of the financial crisis. If the crisis were due to a run, but assets were essentially sound, then providing liquidity could prop up the banking system. However, if the assets were not sound, then propping up the bank only costs the taxpayer money.
Insolvency was the fundamental problem, not liquidity. Nevertheless, there was the short term problem of the collapse of the banking system. It was essential to fix this problem immediately. That doesn't preclude the dismantling of the banks by the government.
Devaluation is an important tool of modern economic theory. Most economists agree that Greece should devalue its currency to realign their economy, but can't as their debt is in Euros. The alternative is for banks to writedown debts. Otherwise, Greece will have difficulty resolving the crisis while remaining within the Eurozone.
Bulldog: remember, Krugman supported TARP, but when he saw it wasn't working, he called for Swedish-style nationalization of the banking system.
Krugman, September 28, 2008: "Brad DeLong says that Swedish-style temporary nationalization is the right answer to a financial crisis; he’s right."
Insolvency is still the major problem, as is collapse. By allowing collapse to occur, as Iceland did, the issue was washed away.
You're confusing dismantling of banks by the government with collapse. Iceland's collapsed, and were allowed to do so. It was only after the losses were incurred that the government stepped in - though anyone could have taken this step.
Fear of total collapse of the financial system is misinterpretation of what was occurring. It was the fear used to instigate a government intervention, though in the past no such total collapse had ever occurred with dire long term results. Letting the losses be assumed by those holding the debt and capital cleared the path, not government intervention.
Fear is a great motivator, and typically what government interventionists use to create the desire for greater intervention. Remember, the 'black banks' were the ones with the least regulation and the most liquidity and solvency. In the event of a collapse - what do you think these investors would have done? I know they were ready to pick over the bones and reconstruct the system from the ground up - unless some got a free ride on the back of the taxpayer. Which is what they got.
Devaluation isn't a 'tool'. It's a market reaction. The US could devalue (indeed seems to be attempting to) the dollar until every good produced here was bought abroad. But it would trigger a reaction other central banks to do the same - another 'race to the bottom', just as the trade protectionists did in the 30's. Devaluation is the new trade protection. If it is done with good reason, and markets support it (as occurred in Iceland), then intervention is really only acknowledgement of market conditions, rather than an attempt to manipulate markets in your favor.
Greece should devalue - why they even attempted to join the Euro was insane. Now they are paying a price for trying to rig a system. They will have to drop out eventually because the market for the Euro can't support them without devaluing the Euro as a whole - which is really just 'keeping up with the Jones', since the US is doing the same thing.
You confuse government intervention with market recognition of a problem.
Even so - you did not address the clear points I made regarding Keynes and Iceland. You, as usual, try to shift the discussion to seemingly more favorable ground.
This was after the first bailouts failed.
I am imprecise by saying Krugman supported TARP.
He supported bailouts. Until the results did not occur in the fashion he'd hoped for. Then he shifted. TARP was, after all, just another bailout. He just didn't like that bailouts simply increased moral hazard - which was the #1 argument against them all along, from others. Took him a while to get on board, but then had to find a solution which was just as misguided. After all, nationalization is just a different kind of bailout, isn't it?
Bulldog: Insolvency is still the major problem, as is collapse. By allowing collapse to occur, as Iceland did, the issue was washed away.
That's right, though Iceland is a very tiny economy compared to the U.S. or Europe. A collapse of the U.S. banking system would bring on an extended economic decline. Instead, the U.S. is growing, albeit weakly.
Bulldog: Fear of total collapse of the financial system is misinterpretation of what was occurring.
That is incorrect. The entire banking sector was in free fall, and threatening the entire global economic system. In particular, banks didn't know which other banks were exposed to toxic assets, so they were afraid to lend money even to other banks. The liquidity problem was a symptom of the proliferation of toxic assets. It was like the plague, with everyone running away from each other, and towns shutting their gates.
Bulldog: In the event of a collapse - what do you think these investors would have done? I know they were ready to pick over the bones and reconstruct the system from the ground up - unless some got a free ride on the back of the taxpayer. Which is what they got.
Yes, and in ordinary situation, that is what should occur. However, the damage to the financial and economic systems would have been vast and deep. It was bad enough as it was.
Bulldog: Devaluation isn't a 'tool'. It's a market reaction.
Countries have some control over their currency, through interest rates and other measures. Instead, Iceland allowed its currency to devalue significantly, with the effects we mentioned above.
Bulldog: After all, nationalization is just a different kind of bailout, isn't it?
No, because it decapitates management. And it allows an orderly wind-down or restructuring of the concern.
Once more, the discussion shifts. Sigh.
Rather than discuss the point you originally argued against - the lack of a Keynesian stimulus (is there one? NO) - you've now moved into the realm of what happened and trying to justify the actions which took place, even though you originally agreed with your hero, Krugman, about letting failure occur (though through nationalization as a means to an end). So we've gone from claiming Keynes was right to claiming Socialist economics is really what drives Keynes - which is incorrect, too.
Let's see about your specific responses.
The US is growing weakly. Can't disagree. But Iceland is growing faster after letting its collapse take place. There was some pain, over a shorter period of time, but things have stabilized and are growing once again. This is a good reason to let debt be destroyed rather than wringing it out over time, as we are.
Prove it. Fear is powerful and many memes and beliefs are built up. We continue to say this in much the same fashion that people believe, wrongly, that WWII ended the Depression. Evidence strongly indicates both are incorrect. The BELIEF this might occur led to a culture of fear and overreaction. There was no historical precedent upon which to base this.
You prove my point by saying "in an ordinary situation". This WAS an ordinary situation. It was made extraordinary due to fear and the planting of doubt by journalists and politicians. I have no doubt what would have happened once the banks collapsed - new ones would have arisen, purchasing up the dead collateral. Bad situation, worse than it was? Yes. But if you believe the solution applied was the right one, I have the benefit of history on my side - 1921 - when debt was allowed to be destroyed and the economy bounced back quickly after a deep but short depression. The only other precedent for what we're going through today is 1873, which followed some very similar paths (rampant speculation, malinvestment, fraud, manipulation of fiscal, monetary and trade) leading up to, and dealing with the problems. In neither scenario did the financial system collapse, but one had a healthier response than the other.
Control, as you mention, does not exist. They have limited management of direction. If not supported by markets, a devaluation can cause massive damage - and has. Since protectionism is generally eschewed as a policy by many nations today, devaluation is one of the few remaining methods governments attempt to employ to manage trade. It has limited value, UNLESS the economic conditions support the move. In Iceland, the move was correct, and likely would have happened naturally anyway. It's a moot point - government 'did' it, markets would've forced it. You're simply choosing who did the work, not following the path of cause and effect.
Decapitating management is meaningless. All you've done is replaced one set of heads with another you deem 'better' without the benefit of knowing if they truly are better. More importantly, you've made the new heads immovable except by political fiat. Which, as we all know, is damn near impossible. You also create a situation of potential favoritism in loans and banking, rather than one geared toward proper investment.
Let's use GM as an example of what may have occurred with nationalized banking - because it is. We, as taxpayers would have underwritten the debt (whoops - we did), provided funds to continued operations (we did), and even used the political clout to determine manufacture of certain vehicles (we did - with the amazingly wonderful Volt, rushed out the doors prior to proper analysis and marketing...it's a wonderful vehicle that will save the world AND the economy).
Hell, who needs nationalization when you've used a bailout to do the same thing, but kept all your crony buddies in the pink?
Yeah, the solution of nationalization would work - it's doing wonders here in a proxy situation.
Error - I wrote "Control, as you mention" and I meant "Control, which you mention" This changes the essence of that sentence.
Bulldog: Rather than discuss the point you originally argued against - the lack of a Keynesian stimulus (is there one? NO)
They didn't engage in a fiscal stimulus, but they did engage in currency depreciation, much as Keynes had recommended regarding British sterling.
Bulldog: So we've gone from claiming Keynes was right to claiming Socialist economics is really what drives Keynes
Have no idea where that came from.
Bulldog: But if you believe the solution applied was the right one, I have the benefit of history on my side - 1921 - when debt was allowed to be destroyed and the economy bounced back quickly after a deep but short depression.
That was a monetary recession induced by British and U.S. regulators to stave off inflation. It ended when they made it end.
Bulldog: The only other precedent for what we're going through today is 1873
Ensuing from a financial panic, and known in its day as the Great Depression, but today as the Long Depression.
Bulldog: Decapitating management is meaningless.
Of course it's not meaningless. It holds management responsible, and allows orderly restructuring or dismantling of the concern. Much like bankruptcy, except courts aren't constituted to deal with financial panics. Simply put, there were no buyers.
Agent Cooper: As I understand it, the central bank of Iceland had insufficient resources to cover the massive foreign debt of the private banks in Iceland and collapsed. The people of Iceland subsequently refused to condone the efforts of the private banks to convert their private debt into a public debt. How anyone can reconcile that action with "Keynesianism" I can't begin to imagine.
While covering liquidity runs is something most economists would support as the proper role of a central bank, covering bank losses is not something that Keynes would agree with.
Agent Cooper: After it was too late, Icelanders decided that, as a matter of public policy, their private banks should have been allowed to fail.
Sure they should have been allowed to fail. They were nationalized.
Agent Cooper: The US should have decided the same and forsaken the massive government bailouts and buyouts, which saved the banks but will lose the nation.
The banks should have failed, but that doesn't mean they just collapse. Rather, there has to be a process of removing the old hierarchy, then restructuring or unwinding the concerns. Bankruptcy wouldn't have worked, because with the financial system in turmoil, there were no buyers.
Agent Cooper: Eventually we may have no alternative but to do what the Icelanders finally did and declare national bankruptcy.
Won't happen in the present circumstance. The U.S. has a growing $15 trillion economy, and it is more than able to meet its obligations.