No one is confused about the general differences between Greece and Iceland. One is a sunny destination on the Mediterranean. It can boast it’s the birthplace of democracy and most people think of it in romantic terms. The other is a frozen volcanic island with what seems to be an indecipherable language and a love of pickling all things from the sea.
However, when it comes to economics, many people talk about Greece and Iceland as if they are cousins. Other than the fact that they both had a debt crisis, the financial systems of the two countries could not be more different. It all comes down to three things… the type of debt that went bad… the truth… and control.
Iceland saw its private banks leverage up dramatically in the early 2000s. They offered high interest rates to depositors. They made loans far and wide based on what became questionable collateral. When real estate blew up, these banks were on the fast track to insolvency.
The government immediately nationalized the big banks, eliminating all value for their stock and bond holders. It told uninsured foreign depositors that they would get nothing.
Naturally, this didn’t make the country popular across Europe, and particularly in Britain, where many of the foreign depositors resided.
Then the government devalued its currency by turning on the printing press…
It used the funds to make good on the overall debts of the country to depositors and Icelandic government bond holders.
The outcome is that Iceland experienced a huge inflationary spike as its currency fell. Import prices exploded. Export prices (for all that pickled fish) fell dramatically.
Its unemployment, which had ticked higher, began to fall. In a few short years the country was back to business as usual, minus the extraordinary financial shenanigans that had landed it in trouble.
Now Compare That With Greece
The Greeks joined the euro by showing that they had met economic standards necessary for membership. Among other things, their annual national deficit was running 3% of GDP, and they were meeting requirements for capital controls as well as capital access.
The interest rate on Greek government bonds, meaning what they had to pay to borrow money, was high… but that was to be expected for a small, albeit storied, country.
The problem was, everything was a lie.
After the credit crisis hit and the Greek government showed up in Brussels with empty pockets and a tin cup, the euro zone officials began asking where all the tax revenue had gone.
It turns out the Greeks had NEVER run a 3% budget deficit. It was always more like 5%, 6%, or even 7% in the “good” years. They had simply hidden the truth from everyone, regulators and investors (bond buyers) alike.
In the worst year, 2009, the ultimate size of the deficit is still up for debate. The Greek government claimed it was 8% at the time. An independent auditor now says it was more like 15%. Outside observers put it higher.
Oddly, the Greek government is prosecuting the independent auditor it hired because the government claims a report of the deficit at 15% amounts to treason. Go figure.
The Greeks have nationalized banks that have failed, and will probably have to nationalize more of them. But the main problem in Greece is government debt, not private debt.
In response to a government debt crisis, most nations would simply print more currency – just like Iceland did – to give themselves breathing room to pay off debt with cheaper currency and to boost exports while limiting imports.
But Greece can’t, because it doesn’t have control.
By joining the euro, the Greeks gave up their right to print more currency whenever it suited them. This monetary straitjacket is also what gave investors the confidence to lend to Greece at greatly reduced interest rates over the years since it joined the euro. If a country cannot devalue its currency on a whim, then bondholders are more comfortable that their value will be maintained.
Of course, this is causing the Greek government to meet its current crisis the only other way possible – by increasing taxes to bring in more revenue and cutting expenses to keep more of the revenue. This austerity is bringing with it extreme pain across the country and there is no end in sight.
What is Really Killing Greece
What is killing Greece is not austerity. It’s the reality of having to learn to live within its means (or very close to it), when it has never done so and it has no control over the situation.
When you’ve been lying about your debt forever and finally someone makes you live within a budget, it’s painful.
When you take millions of your kinsmen with you, it’s brutal.
The path forward for Iceland is clear. The country will continue to grow its exports, inflation will fall back to modest levels and unemployment will drift lower. In short, the country will be boring and moderately prosperous.
At the same time, Greece is playing a game of brinkmanship with the rest of the euro zone countries. It’s betting it can renege on some tenets of its bailout and remain in the group because the other countries need Greece to pay off at least some of its debt.
This uncertainty is tearing at the very heart of the country, killing industries and causing massive withdrawals from banks. At this point, the way forward for Greece is anyone’s guess.
The way forward for you is more certain. Continue to pile into the dollar. As the euro crumbles, the dollar will continue to rally.
Ahead of the Curve with Adam O’Dell
Europe Scrambles After Greek Election
The spot currency market (Forex) opens for the week every Sunday at 5pm EST. This makes it the first market to “digest” news that emerged over the weekend.
So what did it think of the latest news out of Europe? It was optimistic at first… but that optimism quickly faded.
We can see this in the chart, which shows how the Euro (EUR/USD) traded before and after the weekend’s Greek election.