Why Iceland is Doing the Right Thing by Not Paying Britain and the Netherlands

I was recently reading some older posts on Andrew Clavell’s Financial Crookery, and came across a post from early January on the decision made by Iceland’s President Ólafur Ragnar Grímsson to let the so-called Icesave bill (with which Iceland agrees to pay back Britain and the Netherlands the deposits made by its citizens that were lost by its banks) be subject to a popular referendum that it surely would not survive. It didn’t, on March 6th 93% of voters wanted it dead, compared to a diminutive 1,6% who wanted Iceland to compensate the British and Dutch for its losses. Now, of course this is old news at this point, but I don’t think it’s too late to keep debating it a little more. I’ve included Mr. Clavell’s post here:

An avuncular Icelandic president appeared live on British TV screens last night to explain why he was handing over the envelope and stamp, if not the keys, so the 320,000 strong public can engage in jingle mail. It seems possible the doughty Icelanders will vote to repudiate direct, legally binding, sovereign obligations to Britain and the Netherlands foisted upon them by their uncontrollable banking sector.

In the US, low credit rating prospects with little ability to repay were offered virtually free money by fee grubbing securitisers. With little credit rating to protect, jingle mail provided them a free put option on house prices. When prices turned sour, they simply stopped paying the loans. Most now benefit from servicers’ incompetence to extend their rent free dwelling as long as possible in advance of foreclosure.

That is rational strategic default as the consequences are low and the lender incompetent – the borrower simply returns to status quo ante. In Iceland’s case, the lenders are not. If the population mails in the keys, they can forget EU membership, IMF loans, and prepare for a decade of eating boiled fish (hot water and fish being the only two natural resources in the remote island). Handing over the equivalent of $16,000 each to avoid this dietary choice may seem steep, but it is well worth considering.

It may be worth considering paying $16 000  a person to join the EU sooner rather than later. It appears, however, that the Icelandic people have done so and decided it’s not worth it. Don’t forget this country managed to become one of the richest countries in the world without an EU membership, even before its financial sector evolved into a booming bubble during the last ten years.

And while IMF loans (which tend to have strict conditionalities attached, anyway) may be out of the question, it could be in the interest of Iceland’s oil rich neighbor Norway (Evolution-Revolution’s native country) to extend credit to the former. Firstly, Icelandic EU membership will weaken Norway’s negotiating position vs. the EU with regards to important fish exports. Secondly, extending “a helping hand” to Iceland might be domestically popular in Norway – the two countries have long cultural, historical, and family ties. In fact, almost the entire population of Iceland is of Norwegian descent. And Iceland has played an important role as a keeper and creator of Norwegian culture and history. Snorre Sturlason, author of the epic Heimskringla, the most well known of the old Norse sagas and a quintessential piece of Norwegian culture and history, was Icelandic.

EU membership is another issue, but while it may be out of the question for now, defaulting on the debt is unlikely to threaten Iceland’s  already well established membership in the European Free Trade Area (EFTA); which anyway gives access to the EU Single Market. Arguably this is one of the most important benefits of EU membership generally speaking, but it is one that Iceland already has and one which probably won’t be affected by a strategic default. At any rate, the Icesave repayment scheme as it was would have cost Iceland 1,2% of its GDP over fifteen years. It is very difficult to imagine that the economic benefits of membership in the EU would come anywhere close to this. Econometric estimates are that because of the Single Market, GDP is about 1,7% higher in the member countries than it would have been in a hypothetical non-EU baseline scenario. This is the same, however, for non-EU EFTA members, such as Iceland (as well as Norway and Switzerland). Such estimates are highly model-dependent, but even if we take them at face value it is difficult to believe that it would make a big difference for Iceland to be an actual EU member when it already has access to the free market.

Another point to make is that, as opposed to for example Estonia or Latvia, Iceland has little to gain from EU membership in terms of international security or other general political goals. It is not like it’s next door neighbor is an increasingly aggressive Russia that fondly remembers Iceland as a province (which is the case with, a.o. the Baltic states and Georgia). Of course, poor relations with Britain and the Netherlands will most likely come with a price tag – the British have already called off a planned RAF mission to Keflavik Air Base. But again, this cost is unlikely to come anywhere near 1,2% of Icelandic GDP over 15 years.

If I were living in Iceland, I’d be more worried about having my diet limited to boiled fish by paying off the British and the Dutch than by not doing it. Of course, by defaulting, Iceland is screwing over foreign taxpayers. As it is, our Viking ancestors raided both the British Isles and the northern coast of the European continent with impunity for many years. While we ended this habit many hundred years ago, it is probably appropriate for Iceland to make an exception in this case.