Tuesday, July 13, 2010

Gunnar Tómasson letter to members of the Althing in Iceland

Distinguished members of Althing.

The envisaged reconstruction of the Icelandic economy is behind schedule, to put it mildly.

Gross national product (GDP) in constant IKR prices contracted by 6.5% in 2009 (original forecast was 9.5%) but its FX/dollar value fell by 28% (original forecast was 20%). As detailed further in my attached letter of last April 26 to Poul M. Thomsen, the IMF official in charge of Iceland issues, the IMF projects GDP in 2013 to be 4.3% higher in constant IKR prices than in 2008 but 25% lower in FX/dollar terms. I made certain related comments in the letter on Iceland's debt servicing capacity in light of the Brussels Icesave guidelines to which Mr. Thomsen has not responded. Therefore, it is timely for Iceland's Althing to undertake a detailed review of the economic program agreed with the IMF so that, absent change of course, further damage to the economy may be avoided.

In this connection I believe that the increased income and consumption taxes (and related increase of indexed loan principals) recommended by the IMF would make a bad situation worse and serve to postpone difficult actions to strike at the roots of financial disequilibrium in the economy. Iceland's Supreme Court has taken the first step in that direction with its decision ruling the FX-indexation of IKR loans illegal, but Althing must take the initiative to abolish the price-indexation of IKR loans. FX- and price-indexation of IKR loans have not only stood in the way of professional and effective monetary management over the years, but they are also weapons of choice for ruthless promotion of their self-interest by financial market parties which contributed greatly to - with some benefiting from - the collapse of the króna and the entire economy in October 2008.

The economic program agreed with the IMF was partly based on ideas in the field of mainstream monetary economics on which Alan Greenspan, former US Fed Chairman, commented before a congressional committee on 23 October 2008. "Those of us [who considered those ideas sound] are in a state of shocked disbelief [because] the whole intellectual edifice collapsed in the summer of [2007]," Greenspan said. For the past "40 years or more [he had been going] with very considerable evidence that that they were working exceptionally well." The IMF Executive Board has been of the same view for just as long but it has not re-examined its own modus operandi, cf. the monetary aspects of the AGS economic program which reflects an old and collapsed world-view.

The same is true of the Central Bank of Iceland, but its most recent statistics suggest that in the first half of 2010 the CBI provided 50 billion IKR in interest income on an annual basis to financial institutions for deposits with the CBI whose national economic value is hard to discern. Absent evidence to the contrary, here is about 50 billion IKR in government sector outlays which could be cut without any adverse effects - and might encourage financial institutions to search out profitable loan opportunities in the economy. But the main problem in government sector finance in the period ahead is how to create financial space for the Treasury to address urgent tasks following the Supreme Court's ruling on FX-indexation of IKR loans and, if Althing rises to the occasion, the abolition of IKR loan price-indexation.

According to CBI economic statistics deposits with deposit institutions were about 1640 bn. IKR at end-March 2010. Chances are that a large portion of deposits in excess of 5-10 million IKR are the product of opportunities for wealth accumulation present in the bubble economy which burst in October 2008, leaving a heavy debt burden for Iceland and its people. Information is not at hand on the distribution of deposits by amount, but if deposits in excess of 5-10 million IKR as of 30 June were about 1500 bn. IKR, then 10-20% taxation of such deposits would yield about 150-300 bn. IKR to the Treasury. Icelanders are not all equally able to lend support to Iceland's economic independence, but it cannot be truthfully said that wage-earners in general, the elderly and the disabled have not shouldered their responsibilities in this hour of urgent need.


Gunnar Tómasson, economist

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