Iceland’s stunning comeback gives Eurozone food for thought

GUESS which developed country could enjoy the fastest growth this year? Come on? Alright, then – it’s Iceland. Its economy expanded by 2.4 per cent quarter on quarter in the first three months of the year, its fastest pace since its meltdown, boosted by exports, tourism and consumption. Annual economic growth was 4.5 per cent, the highest since the first quarter of 2008. Unemployment has tumbled to 5.6 per cent in May from 6.5 per cent in April, figures out yesterday revealed. That is to be compared to 24.3 per cent in Spain and 21.9 per cent in Greece, where a shocking 52.8 per cent of under-24s are on the dole. Iceland is now able to borrow on the global markets, paying around 5.8 per cent, substantially less than what euro members such as Spain or Italy are faced with.

The contrast with the news from other troubled European economies is astonishing. We learnt yesterday that Spanish house prices fell 11.1 per cent year on year in May, taking them down by over 30 per cent since their 2007 peak. Not only is that disastrous for homeowners – including UK investors – but it means that more people will be plunged into negative equity, and therefore the total bad debt in the Spanish financial system could be even greater than previously thought. Iceland famously did everything the IMF or the global economic establishment thinks you should never do: it allowed banks to go bust, it defaulted on its debt, it reneged on international deals and so on, putting taxpayers first. It fell out severely with the UK government, among others. Yet its economy has bounced back, its people have found work again and the country is on the mend. Many people in nations such as Ireland that have bankrupted themselves bailing out banks look on in envy.

Am I saying that Iceland is a perfect role model? Of course not. Some of the shock therapy worked; some was counter-productive. But sometimes total collapse followed by a swift rebound works better than a long-drawn out death. There were lots of downsides to Iceland’s policies, and I’m not even referring to the obvious ones. Its massive devaluation transformed its competitiveness but helped push up Iceland’s prices by a quarter. Its capital controls were ugly and have chased away investment. Its mass mortgage write-offs helped those who had borrowed in foreign currencies but were hardly fair at a time when savers lost money.

But a sanitised variant of what Iceland did – default, debt-write offs, shutting bust banks and devaluation – combined with dramatic supply-side reforms would undoubtedly make more sense for an economy such as Greece. That, of course, would require leaving the euro. Yes, there would be intense pain (though there is already lots of that right now) – but within a couple of years Greece, rather than Iceland, could easily be the fastest growing Western economy.

Meanwhile, the madness continues. Spanish 10-year yields hit a new Eurozone-era record of 6.83 per cent yesterday. The spread (or interest rate differential) over German bonds is now a massive 5.39 percentage points. As Ashraf Laidi of City Index points out, it took 10 days of five per cent-plus spreads between Spanish and German 10-year yields before Spain obtained a bailout. It took 16 days of such spreads for Athens to obtain its first bailout; 24 days for Dublin to get bailed out; and 34 days before Lisbon was rescued. Given that Italy’s yield gap is moving ever closer to the nightmarish five per cent, business as usual is no longer an option. Unless radical new solutions are found, voters will increasingly be tempted by an Icelandic solution, warts and all.

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