The purpose of this article is a post-event analysis of the performance of the Icelandic economy that refuses a bailout as compared to Greece which went for a bailout with the injection of funds from Troika. To simplify matters, we shall coin the bail-in and bail-out as (BIBO) for short. Of course in the short term it helped stabilized the Greek economy for a while but we want to know to what extent it had transformed the Greek economy in the long run with the accompanying terms and conditions and austerity measures. In this article we shall compare the performance of both the economies of Iceland and Greece with the economic indicators or metrics below from the year 2002 to the present. We believed we have been fed with too much toxics by the mainstream medias which are also own by them that capitalized on the age old investment axiom of good-to-good.
Does Government do what's right for us?
We have led to believed or should we say brought up with the perception that when someone does well then he/she will be blessed in return. Hence it gave rise to an old age investment axiom of good-to-good and bad-to-bad reaction which can be translate to good action leads to good reaction. So we always believed that whatever our Government does it will be for the better of us. So when they bailed out the banks, we believed that they are doing the right thing and we should leave everything in their good hands and expect good reaction. Right? WRONG ! We shall show you on our analysis below that whatever our Government does is not necessary the right thing to do. We have based our analysis on the following indicators or metrics.
- GDP per Capita
- Inflation rate
- Balance of Trade
- Government Debt to GDP
- Government 10Y bond
- Government Spending
- Consumer Spending
- GDP Per Capita ratio
Chart 1a & 1b (GDP Per Capita)
- Inflation Rate
Chart 2a & 2b (Inflation Rate)
- Balance of Trade
Chart 3a & 3b (Balance of Trade)
- Government Debt/GDP
It should be of immediate concern for any government to bring down their debt ratio to below 100% and preferably in the long term to below 50% which is more manageable. If not it will risked being entangled into a 'Debt Trap' meaning more new money needed to borrow to cover the previous debts. When this goes on eventually a country will have to succumb to its debts burden and collapsed.
As for Iceland, although its ratio is at 99.2% which seems critical but at a close look at it looks like the ratio is hitting a plateau in the last three years. The debt growth seems to be tapering off although there is a big jump since 2008. This can be explained by the increased in the borrowings after the crisis to finance its development costs.
Chart 4a & 4b (Government Debt to GDP)
- 10y Government Bond
Chart 5a & 5b (Government 10yr Bonds)
- Government Spending
As can be seen from the chart 6a below, there is a contraction in spending by the Greek government. By spending less, how can the Greek government instil economic growth and hence create jobs and help increase confidence among its consumers which eventually leads to increase spending. This also helps to explain why the inflation rate (prices) in the Greek economy kept falling. The Greeks will have no choice but to reflate its economy or else risk going into a deflation.
On the other hand Iceland seems to be stabilizing on its Government spending and thus able avoid any deflationary pressure on its economy in the future. A quick look revealed that the Greek government spending as of 2012 has fallen to less than it had in 2002.
Chart 6a & 6b (Government Spending)
- Consumer Spending
As you can see from the charts below since 2008, Icelandic consumers have been increasing their spending since 2009 whereas Greek consumers spending only seem to be improving since last year. So it will not be a surprise if the Icelandic economy rebound much sooner and hence performed much better than the Greek economy in the coming years.
Chart 7a & 7b (Consumer Spending)
Why Bank Bail-ins and Bail-outs (BIBO) will not work?
Short answer:
It violated some tenets of market economy such as interfering with the free flow of capital and also the neglect of the consumer economy.
Long Answer :
In the 'Wealth of Nations', Adam Smith pointed out that,
"To increase the wealth of a nation, he argued that society should exploit the natural drives or propensity to bettering their conditions of the people. Government should not repress self-interested people, for self-interested people is a rich natural resource. People would be fools and nations will be impoverished if they depended on charity and altruism".He also states that under a market system, the free flow of goods, services and capital even the poor and politically impotent can survive. In a market economy there will be less government which also means more freedom and laissez-faire in the economy. In contrast under a centrally planned system political power determine economic position where only the friends of the kings and lords can grow rich. Or shall we say centrally planned system breeds corruption and cronyism.
According to him under the market system, the invisible hand through prices and profits will determine not only what and how much to produce but also what price to charge. High prices will lead to high profits and this will sound alarm bells to the competitors to start producing more of that product and eventually will drive prices down to point where only normal profits can be earned.
In other words there should be no intervention in the flow of goods, services and capital in a market economy for if the government starts interfering then it is a signal that it is moving towards a non-market or centrally planned economy. If the invisible hand fails to regulate the economy then there will either be shortages or over production (excesses) of goods produced. Firms that are unable to respond to such situations will be driven out of business. This is where Joseph Schumpeter's 'Creative Destruction' will work its way into the economy. In Schumpeter's creative destruction it is a case for survival of the fittest. Young innovative and efficient will replace old, inefficient and unproductive companies so that the economy can regenerates itself again to be more dynamic.
For the past decades the economies of the Western World has gradually transformed from a 'Keynesian model to a Monetarist model'. Keynesians believed in using Government expenditure and taxes to encourage or discourage economic growth. In times of economic slowdown the government will increase spending and lower taxes and vice versa. On the contrary the Monetarists believed in the use of money supply to solve its economic problems. In times of economic downturn the money supply should be increased to encourage more spending in the economy and vice versa.
However for the past few years since the Global Financial Crisis in 2008, The Monetarist realized that the use of Quantitative Easing to increase the Money Supply to lift their economies from recession does not work. As a result The Monetarists in the Western world are now moving towards more government intervention in its allocation of goods, services and capital. The government decides not only on which companies are getting the bailouts and who are paying the taxes but also how much while at the same time neglecting the masses. As a result of this misallocation of resources shortages and excesses are appearing in areas that are not supposed to be.
This current mutation from a market to non-market economy will go on until its people starts asking : Who the hell is in charge of food production in this country? In a non-market economy the answer will be the government but in a market economy it is NOBODY. You may ask why? The answer lies with Adam Smith's invisible hand that performs its magic behind the scenes. As an example, in bread production the consumer does not know the bakery owner, the bakery owner does not know the farmer and similarly the flour producer does not know the land owner. Prices and profits will help to decide on what type and how much of different type of bread to be produced.
Conclusion
In conclusion we would like to point out that agreeing to bail outs only provides a short term relief but not necessarily the right solution for fixing the economy in the long term. As can be seen from the above in the long term Greece will have to pay the price. We might be biased in a way by just comparing one country but if you look into the rest like Ireland, Portugal and Spain, they are still not out of the woods yet. Iceland had done some bold moves by refusing bailouts and hence bankrupting its banks. So it might be a precedent for other countries to follow if it works.
Finally the following are the credit ratings of Greece and Iceland from various credit rating agencies.
From the above, needless to say whether Greece or Iceland has made the right decision. The result speaks for itself.
the record : Greece just received 2.8 billion euros as support from the IMF.