Philipp Bagus and David Howden: Deep Freeze: Iceland’s Economic Collapse

If you believe in a Creator, then you must acknowledge that He (or She) possesses an incredible sense of humour. Without this, how do you explain Iceland?

God must have smashed innumerable comets into the Earth to provide it with billions of tons of cool blue water to wrap trillions of tons of hot red metal, to form an unstable rice-pudding skin between them, which did its best to hold these competitive elements apart in a thin bubbling veil of steaming blackness.

Married together by massive gravity, and whirled apart by centripetal momentum, gigantic physical vectors of radioactivity, weight, and pressure encouraged these antagonistic liquid magmas and waters to form a volcanic border of fractured tectonic plates, which generated enormous scarred crack zones and eruptive hot apocalypse spots around the globe, as God’s good Earth spun in its frozen solar-heated void, in a nondescript arm of the Milky Way galaxy, in a bygone corner of a far-flung Universe.

To amuse Himself, perhaps one dull Sunday teatime, God must have toyed with the Earth further, to possibly put off the enormous tedium of Monday; He squeezed the Earth between His omnipotent fingers, while watching Master & Commander on Blu-ray, for the nth time, to create the most virulent global explosive crack He could imagine.

(Which to me definitively proves that God must be male; a female deity would have kept things much tidier.)

On top of this pulsating orange broken scar, ripped into the deep Atlantic floor, through which boiling seas poured to fight hissing plumes of upwelling magma, God placed the rocky raft of a new country.

To provide a decorative punchline, He named this new raft Iceland, rather than the much more appropriate Fireland.

Hardy Vikings then appeared, one stormy sea-washed morning, to face up to God’s challenge of life on this barely-cooled basaltic rock; could they live in this harsh place and survive?

Much to His grudging respect, they could. Indeed, they made a great fist of it, and created a society of liberty and community, which grew so strong that it could throw off the challenge of an admittedly enfeebled Empire, when the doughty Icelandic people disrespected Her Britannic Majesty’s Royal Navy in the 1970s, by winning the Cod Wars against the descendants of Patrick O’Brian’s Jack Aubrey and Stephen Maturin.

But God must have grown bored again, following these spats over state-sanctioned fishing rights, because He decided to inflict His remarkable island with a second volcanic storm, this time via a maelstrom which consisted of burning paper, rather than a flurry of splattered magma, and government stupidity, rather than the voluntary human action of individual responsibility.

God had failed to beat back the Icelanders with a hostile physical environment. Could He defeat them instead, and test their fierce Norse mettle to destruction, with a hostile financial environment?

Fortunately for the rest of us, and particularly perhaps for the Irish, the Greeks, and the Portuguese, this second deific challenge is detailed gloriously in the new book, Deep Freeze: Iceland’s Economic Collapse, written by Professor Philipp Bagus and Professor David Howden, which is freely downloadable for your Kindle or iBook pleasure via the messianic Ludwig von Mises Institute.

In much the same way that East Germany and West Germany formed the perfect means of comparing complete socialism and partial socialism, the isolated case of Iceland formed an almost perfect storm of a standalone test-tube to examine the money-crank experiment of fiat paper currency, a diabolical pathway to fiscal hell followed by all of the world’s short-sighted and feeble-minded governments since 1971 — and all of the personally selfish corrupt individuals within them — when Richard Nixon took the Bretton-Woods U.S. dollar off the final tattered shred of a voluntarily-accepted commodity money standard. This thereby allowed an almost infinite abuse of power amongst government officials around the entire world, based upon the oil-based momentum and former pre-eminence of the dollar, as the pyramidal fulcrum of the exploded Bretton-Woods global currency system.

With the final link to gold cut and the pyramid finally floating free — untethered from reality and held in check solely by the intelligence, self-restraint, and common decency of a transitory officer corps of elected Beeblebroxian politicians and a much larger army of permanent Vogonic bureaucrats — it was merely a question of how long it would take for reality to catch up with the almost infinite paper currency bubble that the world’s central planners were about to blow up, to test these new unknown limits of financial paper gravity.

Historically, hard money limits were first established in England by the various pre-millennial Anglo-Saxon tribes, with 240 silver pennies, known as sterlings, making up a Troy pound of silver. After centuries of royal debasement by the invasive British Crown established by Norman bandit marauders, particularly by that Mafiosi war-mongering rogue Henry the VIIIth, a new governmental hard money standard was re-established by Sir Isaac Newton in 1717, when he used his imperial office as Master of the Royal Mint to impose a bimetallic standard to force the creation of a gold standard:

“I humbly represent, that a pound weight Troy of Gold eleven ounces fine and one ounce allay is cut into 441⁄2 Guineas, and a pound weight of Silver eleven ounces two penny weight fine & eighteen penny weight allay is cut into 62 Shillings. And according to this rate, a pound weight of fine gold is worth Fifteen pounds weight six ounces seventeen penny weight & five grains of fine silver, recconing a Guinea at 1l.1s.6d. in Silver money.”

Thus was born the British state’s gold sovereign, the famous cavalryman of St. George, with four and a quarter sovereigns being approximately one fine ounce of gold, which is ironic, seeing that it was the sovereigns of old Great Britain who had destroyed the old silver pound with their perpetually rampant gluttony and greed.

And so, here we were again with our more modern caretaker-kings, ripping off the world’s common people to fund their extravagant lifestyles and their never-ending grabs for personal power and avarice — just think of Tony Blair or Gordon Brown if you’re struggling with that one — with concentrated doses of corrupted power and Keynesian ideological madness viewable under the Deep Freeze microscope of the special Icelandic situation.

As with all my favourite books, Bagus and Howden come at the problem from an unorthodox angle. To be cunning, however, they begin straightforwardly enough for an Austrian-based book:

“The real reasons for Iceland’s collapse lie in state institutions by the state into the workings of the economy, coupled with the interventionist institutions of the national and international monetary systems.”

So far, so predictable. But then, immediately following this bland opening, there’s this:

“Iceland’s crisis is the result of two banking practices that, in combination, proved to be explosive: excessive maturity mismatching and currency mismatching.”

Say what? I awoke at once from my cortical slumber.

Now, here I must declare an interest. Although I wish I were an independently-wealthy dilettante and a full-time member of the England cricket team’s Barmy Army, perhaps spending a few months in each rainy season stuffing envelopes for Lew Rockwell fund raisers — to do something vaguely half-useful with my life — I am alas in the dreadful position of needing to earn a meagre crust to get by each year, via the teaching of people in private circles about derivatives, structured financial products, and fundamental financial analysis. (Rates available on application, with availability considered for Bar Mitzvahs and weddings.)

Therefore, you might imagine that I would have few problems with excessive maturity mismatching and currency mismatching.

However, despite knowing my durations from my convexities, at this point in the book, which was only page five, I was scared.

What on Earth were Bagus and Howden talking about?

Would they be gentle with me? Would they explain the Icelandic situation in ways a man could understand even when he was drinking a beer and stoking up a barbecue, even when he had …temporarily, you understand… forgotten everything he is supposed to know professionally during a working week, while he wears a suit?

Luckily for me, they could.

“Iceland has something in common with other developed economies that the recent economic crisis has affected: its banking system was heavily engaged in maturity mismatching. In other words, Icelandic banks issued short-term liabilities in order to invest in long-term assets.”

Thank the Lord.

And so the book continues, as it delves into areas of fiscally-obscured complexity, to explain this convoluted Icelandic smörgåsbord of financial impropriety. They render its hidden colours into daylight in much the same way that Sun Tzu explained the Art of War; comprehensible chunks of knowledge are levered out from spirals of incomprehensible chaos, chapter after chapter, to enable even a simple barbecuing man such as myself to understand the whole thing.

But they go even further than that; they also enable our steak-eating tong-wielding hero to understand how such a situation can be fixed and how it can be prevented from happening again.

After revealing how the Icelandic banking system rode its dangerous roller coaster of short-term loans being used to finance long-term investments, they deconstruct how it then met a grey brick wall of crunching credit restriction (which I’ll let them explain much better than I possibly could).

To satisfy Rothbardian respectability along their route, the authors also mark their book with the usual de rigueur badges of Austrian authenticity; e.g. quotes from the Master himself, Ludwig von Mises, including one of my favourites from A Theory of Money and Credit:

“For the activity of the banks as negotiators of credit the golden rule holds, that an organic connection must be created between the credit transactions and debit transactions. The credit that the bank grants must correspond quantitatively and qualitatively to the credit that it takes up. More exactly expressed, ‘The date on which the bank’s obligations fall due must not precede the date on which its corresponding claims can be realized.’ Only thus can the danger of insolvency be avoided.”

Iceland thus broke the golden rule of Von Mises, first expressed almost a century ago. It therefore paid the predictable consequence, just as the rest of the government-loving world will pay the predictable price when it finally faces up to the similar silvered rule of Max Keiser, that all paper currencies invariably shrivel away to nothing.

(Mervyn King, of our own Bank of England, always appears to be such a reasonably intelligent cove, that you wonder if he realises this too, or whether he does the visual equivalent of sticking his fingers in his ears and singing a loud song, every time he thinks about the upcoming collapse of his own paper pound. Perhaps he hopes he will be retired before this happens, so the blame can then be attached to his successor? Sorry to disappoint you there Mervyn; that may fool those who believe in the sanctified bureaucratic wisdom of central government planners. However, the rest of us will know better, and so will the history books, especially the one to be entitled ‘What Were They Thinking?’, which will rightly deride the delusional money-crank stupidity of those who will continue to admit that they once believed in paper money. If I live long enough, Mervyn, I even think I know who the author of that future masterpiece will be, if Bill Bonner turns down first option rights on the title.)

In Chapter 3, The IMF, Moral Hazard, and the Temptation of Foreign Funds, Bagus and Howden really begin to expand their tag-team onslaught against the common enemy of our current Keynesian paper money Emerald City godlings, and other lesser wizards, as they drill further into the deeper core of an underlying problem:

“In some ways, Iceland’s financial crisis could be recorded in the history books as much like the crises in Mexico, Russia, Brazil, Argentina, or any number of Asian nations. However, it differs in two major ways. First, the extent of its boom and subsequent collapse are much greater than anything experienced in the aforementioned developing countries. More important, and more puzzling, is the fact that Iceland is the first developed country to suffer a financial calamity of this scope since the Great Depression.”

Using the idea of Iceland as their perfect fairy cake experiment, Bagus and Howden tease out every centrally-planned machination designed to manipulate and cajole the world’s productive populations into unknowing governmental fiscal servitude.

As Richard Cantillon noted in his Essay on Economic Theory, enslaved humans usually produce for their masters about half the amount of finished goods that freed slaves produce for themselves. The great trick of the world’s elite may therefore have been to yoke the rest of us into debt slavery, without us realising it, to feed their insatiable greed for power over the rest of us and to extract wealth from the rest of us, thereby avoiding Cantillon’s half-production trap, and thereby avoiding the need for they themselves to be in any way useful to anyone else.

Thus, taxpayers may grumble at the trillions of paper money tickets used to bail out the failed financial entities owned by the elites, but they’ll grudgingly go along with it, so long as they feel that they in some way they control the public ‘servants’ that rule over them, who are of course beholden to these elites via the instruments of public debt employed by our rulers to keep buying power-enhancing votes from the ruled.

As an aside, if we examine the current Irish situation in which each Irish taxpayer has been saddled with a debt of €500,000 euros — and rising — as against an average salary of €35,000 euros — and falling — then we can see just how far down the green baize casino table the debt slavery dice have been rolled by these elites; I wonder if they continue to believe that nobody in Ireland will ever read Murray Rothbard’s article, Repudiating the National Debt, as summarised in this quote?

“In order to go this route, however, we first have to rid ourselves of the fallacious mindset that conflates public and private, and that treats government debt as if it were a productive contract between two legitimate property owners.”

This heads-we-win, tails-we-win situation is, of course, in direct contravention of the iron rules of proper Schumpeterian capitalism, in which creative successes succeed and destructive failures fail, to the huge benefit of society, particularly productive talented people, and to the short-term harm of unproductive untalented wastrels. These losers thereby have entrepreneurial resources withdrawn from their grasping unlucky fingers and must rejoin the rest of us proles in the ranks of the employed, while those few who have proven themselves good at directing capital to fulfil the needs of the many, are allowed to get on with this vital job, with resources liberated from the bankrupt losers, plus profits from their own earned successes. Real laissez-faire free-market capitalism is thus almost magical in its self-balancing efficiency.

Perhaps one fine spring morning, after coming really close in the 19th century, we might even try it.

Our current elite experiment in insidious debt slavery has therefore lasted just over forty years. However, as this latest slavery construct collapses and the world reawakens to the 4,000 year-old benefits of honest money, Bagus and Howden explain the how? and why? of these obfuscated debt slavery mechanisms, via the litmus paper of Iceland and its own horrific acidic experience, in a transparent way which clears the misty opaqueness of how these elites have managed to keep this self-serving shell game going this long.

And nobody is more within the beating heartstrings of this supposedly untouchable club of elites than the International Monetary Fund, which in my own view should rename itself the Soviet Unification Corporate Kleptocracy (or SUCK) to telegraph to the rest of us what it is really all about; that they even considered Gordon Brown as their next grossly-overpaid puppet figurehead, perhaps tells you everything you need to know about this malignant self-serving organ.

The authors begin their examination by highlighting the explicit public purposes of the IMF:

“The Fund originally had four goals: 1) promotion of exchange rate stability, 2) cooperation of monetary policy, 3) expansion of international trade, and 4) to function as a lender of last resort.”

To cut a long story, the IMF lost the last three of these purposes in 1971.

Post-Bretton-Woods, central banks — especially those outside the satellite control of the Federal Reserve — started to argue with each other over monetary policies (vis-à-vis China and the U.S.); international trade agreements (for all their faults) have sidelined the IMF’s purpose on trade; and floating exchange rates have meant that the IMF stopped being necessary as a lender of last resort, as in 1972 the Greek central bank could print as many drachmas as it needed to fund the fiscal deficits of the Greek government. Obviously, we have seen a slight resurgence of this former IMF role, when emasculated governments such as the ones in Ireland, Portugal, and Greece, have had to beg for ECB euro support, but that is an entire story in itself, as previously covered by Bagus in The Tragedy of the Euro.

However, do government bureaucracies, such as the IMF, wither away and die when the mandate for their original creation withers away? Hardly. Grasping hold of that first straw, and its Keynesian-mandated role to ‘manage’ exchange rate stabilities, the IMF has evolved from a reactive backstairs 1950s organisation, into a pro-active 21st century regime, popping up all over the world to enhance ‘stability’. With self-aggrandising policies trying to turn the SDR (Special Drawing Rights) currency into a new global Soviet currency, the IMF has carved out an even larger niche than the one it previously occupied in its former Bretton-Woods existence, and thus forms the first layer in our cake of Icelandic fiscal destruction.

Having plotted out this layer, Bagus and Howden locate a central tendril in our search for understanding:

“In normal markets, lenders make loans to borrowers, and borrowers may enter bankruptcy. The debts are settled via a bankruptcy procedure in the court system; ‘this is how market economies are supposed to work.’ Risky countries, and, more importantly, their creditors, view the guarantee of bailouts as an insurance policy. Investors are less cautious about investing in developing economies as the IMF has implicitly guaranteed to cover their losses in the event of a financial calamity.”

This led directly to the following:

“This underpricing of risk led Icelandic banks to take on liabilities denominated in foreign currency. It also caused an increase in international speculation in Iceland as foreigners were lulled into thinking the króna was less risky than its fundamentals would have suggested.”

One of the cats is thus out of the bag.

Bagus and Howden then move onto currency mismatching, which once again bears the usual imprimatur of government interference in the natural working of free markets, thus wrecking them:

“As Icelandic interest rates were relatively high, investors indebted themselves in dollars, euros and yen at low interest rates and invested the proceeds in Icelandic assets. Like maturity mismatching, this is risky. When the currency that has been invested depreciates relative to the currency that is loaned, there may be considerable losses, resulting in the insolvency of the investors exploiting the carry trade.”

“As with maturity mismatching, the question that comes to mind about currency mismatching is why did Icelandic banks engage so heavily in this risky practice? And for that matter, why does anyone? The answer relates to implicit government guarantees. Because of implicit government guarantees, especially the possibility of obtaining IMF assistance in dire circumstances, people start to believe that exchange rate risk is reduced.”

Indeed, the authors even quote the former CEO of Kaupthing, Armann Thorvaldsson:

“I always believed that if Iceland ran into trouble it would be easy to get assistance from friendly nations. This was based not least on the fact that, despite the relative size of the banking system in Iceland, the absolute size was of course very small. For friendly nations to lend a helping hand would not be difficult.”

Ho, ho, Mr Thorvaldsson.

But how many of us think similarly? How many of us think that if we blow our private pension on a mid-life crisis, then ‘our government’ will come along and sort it all out for us? Well, perhaps we Austrians may be in a small minority of people who try to stand on their own two feet. However, Mr Thorvaldsson would perhaps have been right in his assumption, on an Icelandic collapse, if the rest of the world had failed to apply for the same credit crunch begging bowl at exactly the same time that he and his friends did.

This kind of welfare-mentality and moral hazard thinking was exacerbated in Mervyn King’s ‘Nice’ decade, when the British, European, U.S., and Japanese governments exported their monetary inflation to the conveniently remote sink hole of Iceland:

“Via currency mismatching, the main economies exported their credit expansion to Iceland. Thus, artificially low interest rates in Europe, the U.S., and Japan deceived entrepreneurs about the availability of real savings not only in their own currency areas but also in Iceland.”

In Chapter 5, The Consequences of the Boom: Malinvestments, Bagus and Howden further analyse the consequences of even more government interventions, both explicit and implicit, to explain how the financial services industry in Iceland grew so large, to the detriment of more traditional industries, where fishermen’s sons wanted to become derivatives traders and apply the Black Scholes Merton equation to contango aluminium option futures.

With the Central Bank of Iceland (CBI) backing all risky bank investments in 2001, as a ‘lender of last resort’, the Icelandic government expanded mortgages and long-term house building via their own Freddie Mac organisation, the Housing Finance Fund (HFF). They also encouraged other long-term capital-intensive investments, such as aluminium smelting.

Iceland thus became a bullet train heading at a hundred miles an hour into a future upheld via a paper Valhalla rainbow of massive fiat money infusions, which could fall away at any time.

And the problem for Iceland was this. You could take out a large mortgage in euro or yen, but if push came to shove, the Central Bank of Iceland could only print króna.

But who cares if the sun is shining? In eight years, between 2000 and 2008, house prices in Iceland increased 300%. And as we all know, house prices can only go up, even in a small country like Iceland which relies upon fishing, high-tech goods, and geo-thermal energy to make ends meet.

The train wreck scenario was thus pumped and primed, as the Keynesians like to say:

“In 2007, after ten years of growth, the big three Icelandic banks, Kaupthing, Glitnir, and Landsbanki, owned assets in excess of 1100 percent of Iceland’s GDP, comprising nearly eighty percent of the island’s total banking assets. An oversized and unviable banking model had developed. The pretense under which this system developed — that a central bank stood ready and able to bail it out if it came under pressure — would be called into question as the crisis progressed.”

Oh dear.

I will let Bagus and Howden explain what happened next. Suffice it to say, it lacked prettiness.

After working through the timeline, in concise detail, they then explain the three main props of the necessary restructuring process, which I’ll summarise below:

“Malinvestments — those misdirected resources and entrepreneurial errors — need to be liquidated. Prolonging their existence prevents the economy from moving production and consumption patterns to those that are conducive to long-term growth.”

“An oversized financial sector is not necessary for the country, nor is it healthy. It has removed resources from those areas where Iceland has a real competitive advantage. The financial sector needs to be allowed to shrink down to the size required by Iceland’s economy.”

“Lastly, the consumption-led boom bred a new type of Icelander. The inflationary economy of the boom years increased the time preference of the nation. Icelanders need to regain their traditional prudence about credit and spending.”

To conclude, Bagus and Howden defend the free-market system beloved of Austrians, and explain how the Icelandic economy was no such thing. This is in the finest tradition of Misesians everywhere. We should never give in to Keynesian evil and try to placate it with weasel words. We should always proceed boldly against it and smash it into the rancid dustbin of history where it belongs.

I can therefore heartily recommend this book to anyone who wants to understand how governments have got us into our current mess, and how they are currently using their own weasel words to try to push the blame for this onto those of us who believe in freedom and liberty, and the costs for wasteful government spending onto hapless taxpayers. They would like us to forget, of course, that they were ‘in charge’ the whole time, and were happy to receive enormous personal payments and pension rights while they were all chancellors, prime ministers, presidents, foreign secretaries, and central bank governors, pontificating to the rest of us on how they had abolished the processes of boom and bust in their nice decades of bubble expansion and gold sales.

Somehow, however, none of the subsequent bubble collapse was anything to do with them.

Well then, tax eaters. If that is true, then please hand us back your salaries so I can pay for my Barmy Army lifestyle, and stop taxing me, so I can become the dilettante I dream of.

In the meantime, the rest of us should read Deep Freeze, particularly anyone in Ireland, Greece, Portugal, Spain, Belgium, or France, or anyone else who is going to be forced to shoulder the risks of private banks to enable their governments to keep borrowing and spending in their name, and dragging them into the abyss of old age poverty and along the road of tax debt serfdom, while Iceland itself recovers, having refused to toe the line on IMF austerity.

Bravo, gentlemen. A fine book indeed.


About Andy Duncan

An Austrian Internet Vigilante trying to live Outside the Asylum
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