A Nordic America
Last Sunday I did an offbeat post on Denmark, today I thought I’d pick another Nordic country—Iceland. This will be lighter and shorter and probably completely forgettable, but I’m burned out after two long monetary posts this weekend.
Here’s my thought; Iceland is to the Nordic mainland what America is to Europe. I got this idea watching a Lars von Trier film called “The Boss of Them All.” I don’t agree with his politics, but at least Von Trier’s satiric films don’t insult your intelligence and pander to your prejudices. In the film there was a scene where a group of visiting Icelandic businessmen were portrayed as having a very gruff and aggressive style. Later when I started reading about the Icelandic banking crisis, I noticed frequent descriptions of the men who had built these financial empires as being aggressive, swashbuckling figures, so I’m going to assume that there is some reality behind this stereotype. What lesson can we draw from this?
Let’s start with a bit of dime store sociology. Perhaps when we compare Iceland to Norway, or America to Britain, we are noticing cultural differences based on patterns of immigration. People with a more aggressive, entrepreneurial, materialistic personality are more likely to undertake the dangerous but potentially rewarding risks of moving to a new land. And for either genetic or more likely cultural reasons, this trait carries through to today. I’m sure lots of people have offered this hypothesis about America, but until recently I had never given Iceland much thought—indeed I assumed that it was culturally similar to the rest of Scandinavia.
So what does this have to do with monetary policy? Nothing. But it might have something to do with banking. It is interesting that the U.S. and Iceland had two of the most spectacular banking crises. And it’s also interesting the the most “European” part of America, New England (where I live) avoided the worst excesses of both the sub-prime fiasco, and the earlier S&L fiasco. Are these failures a part of our culture?
There is an important “market failure” in all modern banking systems—government deposit insurance. This allows banks (and S&Ls) to borrow large amounts of funds at near risk-free rates. If you combine deposit insurance with a fairly deregulated, entrepreneurial banking culture, it can very easily lead to explosive growth in banking institutions. But as many have noted, this means that losses are (partially) socialized and profits are privatized. In good times we libertarians rarely think about the fact that the entire deposit side of bank balance sheets are not really loans from the public to banks, they are (de facto) loans from the federal government to banks (with funds that were in turn lent to the government by us depositors.)
I have read that multinational Icelandic banks expanded so aggressively into Western Europe that their liabilities were something like 10 times Iceland’s GDP. There seems to have been some confusion about whether the Icelandic government was actually responsible for those deposits, (and I don’t know the details of this dispute), but policymakers need to recognize that in the real world there is a tacit expectation that depositors are protected, whatever the government’s official policy.
What lessons can we libertarians draw from these crises? Being a pragmatic libertarian, I am sometimes accused of wanting to compromise with the devil. But I see economic reform as like playing that game where you have to remove one stick from a pile, without any other sticks moving. It is very important which stick is chosen first. Deregulation is rarely complete, and as we saw in the 1980s S&L crisis, or the California electricity fiasco, if you remove the wrong stick first you can discredit libertarian ideas. (I’m not convinced the sub-prime fiasco is related to deregulation.)
In my previous post on Denmark I spoke approvingly of the Singapore model, even though Hong Kong is arguably a more laissez-faire economy. But if we are going to have a welfare state (and I think that is inevitable), then Singapore is certainly worth taking a look at. Sometimes half a loaf is better than none at all. This is also why I am opposed to radical reform of our monetary system—we don’t understand macroeconomics very well, indeed we only know a few things:
1: The economy seems to do better when nominal income is growing at a modest but steady rate.
2. The effect of sharply falling nominal GDP is devastating.
Given that we have very little information about how a monetary system with no government would work, I’d rather try to get this system to work better. This is a difficult argument to make when the Fed is screwing up this badly, but I don’t see any feasible alternative. I am also confident that our system can be reformed. Between 1982 and 2007 it worked much better than in the previous 20 years, and after this crisis is over I hope and expect we will make even further improvements. In this regard, I may be out of touch with many of my readers.
I am actually pretty confident about Iceland’s future too, despite its current difficulties. Although I don’t know a lot about the country, I have always wanted to visit it. For a country of only 300,000 people, it has an amazing list of accomplishments:
1. I recall reading somewhere that they read more books per capita than anyone else. I have heard that they have produced some outstanding modern writers (which I have not read.) I have read some of the sagas however, which are strangely engrossing—like looking into another world. In reference to the 900 year-old stories, Borges said “In the twelfth century, the Icelanders discovered the novel””the art of Flaubert.”
2. They have produced some fine films, although nothing particularly notable. What I find amazing is that I have more pop CDs from Icelandic groups than from all of continental Europe, with over 500 million people. (Although I suppose this is more a reflection of my lack of interest in Europop music.)
3. I believe that they are the only developed Western nation with a flat tax. (Someone correct me if I am wrong.) This again may reflect their entrepreneurial spirit. BTW, their economy is not just based on cod fishing. They have a thriving biotech industry that somehow utilizes their population’s long genetic isolation, to research for genes linked to particular diseases. They also have lots of clean energy, etc.
4. What little I have read about their political history is quite appealing, suggesting they might have been one of the most libertarian places on earth during the middle ages—but again, someone will probably correct me on this point. That’s the beauty of the internet.
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9. March 2009 at 06:48
Interesting hypothesis and good read. I think this article may interest you – http://www.vanityfair.com/politics/features/2009/04/iceland200904?printable=true¤tPage=all
9. March 2009 at 07:20
‘…t’s also interesting the the most “European” part of America, New England (where I live) avoided the worst excesses of both the sub-prime fiasco….’
Actually, as Stan Liebowitz has pointed out, the ‘reform’ of the mortgage lending industry started in Boston:
http://www.independent.org/publications/policy_reports/detail.asp?type=full&id=30
And you can see Milton Friedman debate, among others, a future President of Iceland here:
http://video.google.com/videosearch?q=milton+friedman+iceland&hl=en&emb=0#
9. March 2009 at 17:42
WG, Thanks for the article–it was very good. When I read that sort of thing I always have the feeling they exaggerate the craziness somewhat. But I’m sure what they did was pretty risky, even without the trading cats for dogs examples. I wonder what would have happened if the world banking system hadn’t imploded. How long would Iceland have been able to keep going? Remember, Iceland got in trouble at least a year before the final crisis, and somehow survived that earlier episode. Also, that debt of 850% of GDP, surely they cannot be expected to pay that?
Patrick, If you are referring to the Boston Fed policy of encouraging sub-prime loans, I agree. I was thinking more of the banking industry in New England. I believe that it is somewhat more conservative–but I’m really just shooting from the hip here. One interesting thing about New England (and I’m actually a midwesterner) is that it is politically liberal and yet in some ways very conservative. In my state there are no casinos, the divorce rate is very low, the savings rate is (I think) relatively high, drinking is strongly discouraged (many towns are “dry”, etc.) It’s the opposite of Vegas. But again, I’m just throwing this idea out there.
11. March 2009 at 22:31
Scott – just a quick note concerning dime-store sociology. $4.9 trillion worth of credit has been extended to the emerging market economies – 74% of that has originated with West European banks. Now, obviously, US taxpayers are on the hook for much of that through AIG, but the notion the US banks, and Icelandic banks, were reckless, while European banks were careful is just a media myth. The West European banks were leveraged out (50 – 1) more than US institutions (30-1), and Barclay’s was reportedly 60 – 1.
Sorry to comment so late on this post – been a busy few days. And keep up the good work!
12. March 2009 at 05:18
Jean, You are completely right. I was thinking about the original subprime crisis, but there are several things that annoy me about the European (schadenfreude)reaction (especially early in the crisis.)
1. They complained that the crisis was the U.S.’s fault, because of the subprime loans. But surely the people most responsible for the subprime mess were the lenders, not the borrowers. And there were lots of European banks directly or indirectly making such loans. And of course we now have problems in many European housing markets.
2. You are absolutely right about the high leverage ratios in many European banks.
3. And another point I have been emphasizing on this blog is that much of the recent worsening of the crisis actually reflects reverse causation. Monetary policy has not been aggressive enough at trying to maintain growth in nominal GDP and that lack of aggression has allowed NGDP to fall sharply, greatly worsening the debt crisis. And if you look at monetary policy, the ECB has been even more clueless than the Fed (see my Let Bernanke be Bernanke post.)
I still think there might be a slight cultural difference along the lines I proposed, but I obviously fell far short of establishing that fact.
12. March 2009 at 13:04
Jean, Scott,
Believe it or not : Wall Street and the City fooled EU to the core, this is the reason why they’re over-leveraged.
The agressivity of Investment Banking is a fact, and I’d consider the UK equals the US in this respect. The UK issued half of the toxic products presently on the market.
The U.S. and U.K. just dumped their toxic assets to continental UE with the help of the rating agencies.
Synthetic CDOs are a perfect example of that type of manoeuver.
Now this is a really mind-bogging aussie article about synth CDOs, an abysmal insight into Investment Banking nefarious schemes :
http://www.businessspectator.com.au/bs.nsf/Article/A-tsunami-of-hope-or-terror-LHRJP?OpenDocument&src=sph
Wall Street fooled EU through London. EU bought everything and they’ll pay for generations their insane confidence into imperialists.
U.S. was the carmaker, UK the reseller, and EU the blonde cab driver with the cheque.
The car broke down, now the blonde is bankrupt.
Just like in the car business, the carmaker can afford the blonde’s default, but the salesman goes bankrupt in the middle. Watch for the UK to fall just like Iceland reseller did.
Iceland is not “a Nordic America”, it is just “a Small UK”.
If the UK holds on, the cops will go to the blonde’s place, and that is the point where the story turns truly Tarantinesque…
13. March 2009 at 02:01
I don’t know which countries you classify as developed Western nations, but Estonia has a flat tax. Wikipedia lists a few more: http://en.wikipedia.org/wiki/Flat_tax#Countries_that_have_flat_tax_systems
13. March 2009 at 03:10
Malavel, Yes, I knew about Estonia. I was thinking in terms of the old division between Western and Eastern Europe. I suppose this reflects my age, and may be outdated, but I still tend to think in terms of the older group of developed economies which were roughly Western Europe, North America, Japan, and Australia/NewZealand. I think Iceland was the first (and only) in this group to adopt a flat tax. Flat taxes are now fairly common in Eastern Europe, and also I believe in Hong Kong and Singapore.
13. March 2009 at 03:11
Malavel, Yes, you are right about Estonia. I was thinking in terms of the old division between Western and Eastern Europe. I suppose this reflects my age, and may be outdated, but I still tend to think in terms of the older group of developed economies which were roughly Western Europe, North America, Japan, and Australia/New Zealand. I think Iceland was the first (and only) in this group to adopt a flat tax. Flat taxes are now fairly common in Eastern Europe, and also I believe in Hong Kong and Singapore.
18. March 2009 at 23:19
Um, Michange? Dude, what are you on about? Banks, and investments firms, took on too much risk, but the ultimate ’cause’ behind this crisis is the misalignment of spending and saving around the globe. Chinese workers save 50% of their wages. Their continual purchase of US debt was a subsidy to US consumers, and you (nearly) always got more (consumption) of anything you subsidize. German, and other European, banks cannot make profits at home, because domestic demand is so low – so they lent insanely large amounts of money to the emerging markets. The US government stepped in to ‘save’ AIG because otherwise European banks would have collapsed. AIG had insured Deutsche Bank and Societe General. Anybody know if AIG covered Unicredit and Raiffeisen?
19. October 2011 at 23:19
as a sociologist-in-training, i would say that in terms of sociological theory, what you’re suggesting is totally plausible. you can probably look to the work of economic sociologists on this note. How about this review piece by Stanford’s Mark Granovetter: “The impact of social structures on economic outcomes” http://sociology.stanford.edu/people/mgranovetter/documents/granimpacteconoutcomes_000.pdf
Granovetter mentions the work of sociologists who studied social relations on stock trading floors, etc.
29. October 2011 at 05:59
Thanks Andrew.