Iceland Recovery? Capital Controls and Devaluation Backfires…

Well Iceland’s supposed recovery seems to have been truncated as policies of capital controls and devaluation appears to have backfired.

From the Bloomberg:

Iceland’s private sector is running out of cash to repay its foreign currency debt, according to the nation’s central bank.

Non-krona debt owed by entities besides the Treasury and the central bank due through 2018 totals about 700 billion kronur ($5.8 billion), the bank said yesterday. The projected current account surpluses over the next five years aren’t estimated to reach even half of that and will equal a shortfall of about 20 percent of gross domestic product.

Kaupthing Bank hf, Glitnir Bank hf and Landsbanki Islands hf defaulted on a combined $85 billion in October 2008 after running out of cash to sustain their debt-funded expansions. The collapse plunged the economy into its worst recession in six decades, forcing the government to seek an International Monetary Fund bailout to stay afloat.

For now, the controls are still helping Iceland manage its debts by rationing payments. That means the largest foreign refinancing risk, which stems from repayments on two Landsbankinn hf bonds totaling 296 billion kronur, won’t destabilize the economy.

“Repayment of this debt is currently under capital controls,” said Benediktsdottir. “So we can use the capital controls to actually manage the outflow of those repayments. By doing so, we can keep both financial and currency stability.”

If Iceland capital controls have been "helping" manage debts then the private sector won't be running the risks of non-payment of foreign currency debt.

 

Iceland reportedly allowed her insolvent banks to go bankrupt, the Iceland’s President even bragged about this as I earlier showed. 

But the reality is that Iceland’s government bailed out the central bank by raising the amount of debt 5 fold where the latter has been heavily exposed to foreign creditors. 

The USD-Icelandic krona

The central bank bailout has been implemented with rigorous capital controls and devaluation, which mainstream mercantilists cheered as the magic wand for Iceland’s recovery.

Unfortunately for devaluation proponents, inflationism’s magic works only over the interim or the short term, where long term costs have now become apparent.

At the Geo-Graphics Blog of the Coucil of Foreign Relation (CFR). Benn Steil and Dinah Walker shows of the boom-bust cycle and the economic backlash (via relative underperformance with her peers) from a supposed devaluation based miracle…

Here it is, folks: Iceland, whose currency lost half its value against the euro in 2008, vs. Estonia, Latvia, and Ireland, all of which were euroized or pegged to the euro over the entire period . . .

 

In the updated figure, Estonia comes out on top, by a lot – well above Iceland, which performed no better than Latvia or Ireland, even using a starting date chosen by Krugman to make Iceland look as good as possible.

Yet Iceland “success story” now comes with a likely imitation of the Cyprus bailin model as the Iceland government mulls to remove its blanket authority for large depositors as well as depositor haircuts.

Notes the Zero Hedge, (bold original)

Following the crisis in October 2008, Iceland's government declared all deposits in domestic financial institutions were 'blanket' guaranteed - an Emergency Act that was reafrmed twice since. However, according to RUV, the finance minister is proposing to restrict this guarantee to only deposits less-than-EUR100,000. While some might see the removal of an 'emergency' measure as a positive, it is of course sadly reminiscent of the European Union "template" to haircut large depositors. This is coincidental (threatening) timing given the current stagnation of talks between Iceland bank creditors and the government over haircuts and lifting capital controls - which have restricted the outflows of around $8 billion.

Interventionism and inflationism only works to the benefit of the political class and their favored constituencies, while the rest of the society suffers…

Yet this has been to be the global trend