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Tuesday, 28 July 2009

Iceland’s krona proves the magic wand as Europe ails

Out in Iceland’s Eastern fjords, Alcoa has raised aluminium production to record levels – and metal matters as much as fish for exports.

“The smelters are running full speed,” said the new-broom finance minister, Steingrimur Sigfusson. So is Mr Sigfusson himself. Last week he launched three new banks on the ruins of the old. Normality is returning. “We are going to get through this better than feared. We’re feeling real activity in the economy, and much of this comes from a favourable exchange rate,” said Mr Sigfusson.

Iceland’s great lurch towards casino capitalism over the last decade has a cultural logic. “We are a fishing culture: when the herring is there, we take it,” said Andri Snaer Magnason, author of `Dreamland: A Self-Help Manual for a Frightened Nation’.

There was no easier catch on offer than the Greenspan bubble and the global “carry trade”. How could fishermen resist?

In one sense it was a terrifying shock for the 310,000 inhabitants of this Norse-Celtic outpost of lava rock to see their currency, banks, and global image crash in a single week last autumn. Yet nothing has really changed.

“Everything still feels normal. The services of the state are intact. The swimming pool is open. You can still have a decent heart attack in Iceland,” said Mr Magnason.

“Friends who lost jobs in banking have already found new work, and you could say the krona has worked as a buffer for us. We all went down together, and that has led to healthier recession without mass unemployment.”

The jobless rate has risen to 9.1pc. This is below the eurozone average of 9.5pc, and is stabilising much earlier.

Those who point to Iceland as a scarecrow exhibit of what happens to a small country caught in a financial storm without the shield of euro membership have the matter backwards, as will become ever clearer over the next two years.

The OECD expects Iceland’s economy to shrink 7pc this year. This is much better than Ireland at minus 9.8pc, and recovery will come sooner. So next time you hear the Sacra Congregatio of the euro faith incant yet again that EMU saved Ireland from a terrible fate, know that they deceive only themselves.

You take your punishment early with devaluation, as Britain did on leaving Gold in 1931, or ending the D-mark torture in 1992, or now. You look a sorry sight at first, but sweet vindication comes later.

It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Greece, and rising.

At Iceland’s central bank – mercifully, no longer listed beside al Qaeda as a terrorist body by UK authorities – Governor Svein Harald Oygard says currency therapy is working as it should. “If you lean back and look you can see that fall of the krona accentuated the shock at first, but it is also now working as a turbocharger for recovery.

“We’ve seen a strong hit on wealth and asset values, but the story for real economy is very different.”

Devaluation is always double-edged. Some 13pc of households in Iceland hold mortgages in euros, Swiss francs, or God forbid, yen. Their debt levels doubled overnight.

Some 70pc of corporate loans are in foreign currencies. Exporters are hedged. Those that earn in krona are not, and a “large number” are now in dire straits.

The Governor is a Norwegian who cut his teeth in the Oslo banking crisis of the early 1990s. He was brought in as a troubleshooter after the last crew was literally banged out of the Sedlabanki by the Saucepan Revolution in February.

With justifiable pride, he showed me the latest trade figures. Iceland has defied the global shipping crash to eke out an 11pc rise in exports over the last year. Even China has seen a fall of 21pc.

Iceland will be back in surplus by next year, from a peak deficit of 25pc of GDP. You could say the same about Latvia, which has stuck to its euro peg under orders from Brussels. But there is a big difference.

Latvia is balancing its books by crushing demand. Exports are down 28pc, but imports are down even more. The result of this Stone Age policy is economic contraction of 18pc this year, and 4pc in 2010 (state data).

Icelanders have taken a hit, of course. Unions have accepted ‘real’ wage cuts of 10pc. Health care and welfare is being cut 5pc, education 7pc, and the rest 10pc. This is comparable to what is happening in Ireland, but again there is a difference. Dublin faces a Sysphean task as collapsing tax revenues force ever deeper austerity: Reykjavik is over the worst.

It baffles me why rating agencies still talk of downgrading Iceland’s debt to junk. The country should emerge with public debt of 80pc to 100pc of GDP – much like Britain. Yet Iceland also has the world’s best-funded pension system at 120pc of GDP. It is the two together that counts.

In their angst, Icelanders look wistfully at the apparent safe port of EU membership. The Althingi has voted to start entry talks. But the storm will have blown over well before an EU referendum is held in two or three years. By then the delayed cluster bomb of Europe’s unemployment will have detonated. Try selling EU protection then.

By Ambrose Evans-Pritchard
This article first appeared in the Telegraph

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