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Only A Debt Moratorium Can Save Iceland
By Webster Griffin Tarpley, PhD
REYKJAVIK -- The Icelandic banking crisis must be seen not as an isolated event, but rather as a feature of a new world economic depression of unprecedented severity. The crisis of the Icelandic crown, combined with the insolvency of the three leading banks Kaupting, Landsbanki, and Glitnir, can only be understood as a by-product of the universal derivatives panic of 2007-2009 which precipitated the bankruptcy of virtually the entire Anglo-American banking system, including such large institutions as Countrywide, Northern Rock, IndyMac, Bear Stearns, Lehman Brothers, Citigroup, Merrill Lynch, Washington Mutual, AIG, Royal Bank of Scotland, Lloyds Bank, and untold others. Many US money center banks are presently insolvent (thus the term zombie banks) and are being kept alive under the "too big to fail" policy, which itself involves a violation of federal law. As the saying goes, you can't tell who is swimming naked until the tide goes out. Great embezzlers are frequently discovered in the midst of financial panics, and this is what has happened in the case of Iceland.
At the heart of this cataclysmic event we find the $1.5 quadrillion derivatives bubble, a speculative mania which over-arches and subsumes the nefarious activities of Kaupting, Landsbanki, and Glitnir, making them appear almost as petty larceny in a world where the largest financial institutions were animated by the spirit of Madoff. The crisis, in other words, was born in the deregulated confines of Wall Street and the City of London, and was made worse in particular by the policies of the British New Labour regime of Gordon Brown, a man who was deeply complicit in the unbridled derivatives speculation of the past decade, when he had served as the Chancellor of the Exchequer. A neglected but highly important feature of the initial panic phase of this depression is the impact of the beggar-my-neighbor policies of Gordon Brown, Alistair Darling, and Mervyn King, who followed the old British tradition of trying to unload some of the worst consequences of the crisis on the other countries, their banks, and their currencies. The suspicious role of Barclay's Bank and British regulators in the Lehman bankruptcy is a case in point.
In a larger sense, the Icelandic crisis represents the culmination of those reckless and irresponsible financial policies which can be lumped under the headings of the Washington Consensus and of economic globalization in general. In addition to the exorbitant growth of derivatives (credit default swaps, collateralized debt obligations, structured investment vehicles, asset backed securities, mortgage backed securities, etc.), globalization has promoted the limitless dominion of speculative flows of hot money across the globe, especially in the form of the deregulated currency carry trade, from which Iceland has suffered in a particularly acute form. All of these unwise and risky practices were validated by the extreme "free market" theories of the Milton Friedman Chicago school and of the Mises-von Hayek Austrian school, which had furnished the ideological basis of US and British governments since the time of Thatcher and Reagan, and which had been incorporated into a compulsory doctrine of the International Monetary Fund, World Bank, World Trade Organization, OECD, Bank for International Settlements, and other hegemonic institutions of world finance. These monetarist and neoliberal ideas have been imposed on the world economy especially in the form of the Washington Consensus -- the dismal litany of deregulation, privatization, unhindered flight capital and hot money flows, the primacy of speculation over production and of finance over economics, the abolition of the state sector, measures against labor, and the general race to the bottom. Worldwide, about 1 billion people live in hunger and under the threat of starvation ­ perhaps the most eloquent proof that 20 years of economic globalization have been a failure.
The supporters of these ideas are currently attempting to foment the illusion that a recovery of the world economy from the depths reached in late 2008 and early 2009 is now in progress. Using this illusion, hedge fund operators and zombie bankers are attempting to restart derivatives formation under new aliases with the goal of reflating and expanding the $1.5 quadrillion world derivatives bubble. The Bush-Paulson-Bernanke and Obama-Geithner-Bernanke administrations have given Wall Street financial institutions a combined credit line of $24 trillion in funds from the Federal Reserve, US Treasury, and Federal Deposit Insurance Corporation. Financial institutions have enjoyed 0% interest, while the auto industry, its suppliers, and its dealers have been driven into bankruptcy, while many factories and stores and close their doors because commercial credit has not been forthcoming from the struggling banks. Jobs in manufacturing industries are now a vanishing species in the United States, in particular.
It is imperative that Icelandic policymakers be aware that recent gains in world stock markets are nothing more than a mugs' rally at most, not much different in the last analysis from the Little Bull Market of spring 1930 under Herbert Hoover in the United States. These upwards blips may be harbingers of a coming hyperinflation. Whenever the financial indices may have been doing, it is absolutely clear that all measures of the physical economy has been continuing at depressed levels worldwide.
The World Trade Organization reports that world trade, the most important single index of world economic activity, now stands about one third below the year ago level in dollar terms. The Baltic Dry Index remains severely depressed, reflecting the same decline in maritime merchandise traffic. The official US unemployment rate is almost 10%, while the US unemployment and underemployment has reached almost 17%. If we add in discouraged workers who have given up on finding a job and have exhausted their unemployment benefits, we reach a level of 21%, a figure which for various reasons probably needs to be revised upwards to the neighborhood of 25%. (For purposes of comparison, we can note that the most severe unemployment in Germany during the 1930s was somewhat in excess of 30%.)
About 100 US Banks have been seized so far this year, while the FDIC's secret list of problem banks exceeds 400 institutions. It is widely expected that about 1,000 US Banks will fail over the coming year or so. In a with unemployment growing, increasing numbers of Americans are defaulting not just on their home mortgages (10% of all home mortgages are in default or behind on payments), but also on credit cards, auto loans, consumer credit, and student loans. Over the coming months there will be a cascade of upward adjustments in adjustable-rate mortgages (ARMs), leading to still more defaults and foreclosures. Many of these losses will accrue to banks. In addition, the country now faces a commercial real estate default crisis, with about $500 billion of real estate loans coming due, with an estimated default rate of about 50% or more. The fund used by the Federal Deposit Insurance Corporation to reimburse the depositors of failed banks is now at about 20% of the level prescribed by law, and the funds of the Federal Housing Administration have also dropped below the legal limit. Thus, another wave of banking panic cannot be ruled out as a time when the Federal Reserve interest rate for banks is already 0% and can hardly be lowered, and the ability of the US Treasury to come up with funds for another Troubled Assets Rescue Program TARP or bail out (to say nothing of the political willingness of the Congress to approve such an exercise) make a new round of support measures for the zombie banks appear unfeasible.
All of these problems are magnified by the weakness of the US dollar, which has declined against the yen and the euro even as the New York Stock market has advanced. It is now clear that world demand for US Treasury securities is weakening, with the Federal Reserve purchasing a large portion of all Treasury offerings in recent months. This tends towards the pattern set by the German Reichsbank in 1922-23, when the central bank was often the only buyer for German government securities. This parallel alerts us to the danger of dollar hyperinflation, as suggested some months ago by Jacques Attali, the economics adviser to President François Mitterrand of France, who spoke of a looming "planetary Weimar." Under President Jimmy Carter, the United States was beset by simultaneous inflation and unemployment, leading to the coining of the new term stagflation and the accompanying Misery Index. Under Obama, who has enacted no serious reforms of the financial system whatsoever, we face the peril of hyperinflationary depression or hyper-stagflation. It makes no sense to buy an admission ticket to this game.
The relevance of this quick sketch of the international economic situation for Iceland today is that there will be in the foreseeable future no world economic recovery which could provide assistance to Iceland. It is impossible to assume a revival of world trade or of international demand in most areas. Iceland must accordingly contemplate measures to generate its own economic recovery on the basis of its own guaranteed national economic assets, while doing everything possible to maintain national independence and national sovereignty, especially in the face of international financial institutions whose competence has been severely called into question by the recent crisis developments. If there were in fact a world economic recovery on going, it might make sense to offer concessions so as to be able to join in that recovery and share in its benefits. But this is not the reality of the world in late 2009, nor is this the perspective for 2010 and beyond.
Far from representing an exceptional case, Icelandic is merely typical of the situation of many countries in the current globalized economic depression. Iceland represents the human condition of our time in microcosm. Early on in the crisis, the Icelandic banks owed the world about $19 billion. At the beginning of the crisis, the Icelandic government estimated that the cost of crisis might reach $9.4 billion, about 85% of Iceland's 2007 GDP of $11 billion US. (All references to GDP are purely indicative, since the monetarist notion of GDP includes speculation, financial services, and derivatives on the same level as food, construction, energy and other components of the real physical economy, and are therefore misleading.) British Prime Minister Gordon Brown originally demanded up to £20 billion. In the more recent negotiations, Iceland has offered the Anglo-Dutch more than ¤2.7 billion for the UK and over ¤1.3 billion for the Netherlands, plus interest at 5.5%. This means the extortion of a sum which seems to be a little more than half of Iceland's annual GDP, but will soon grow to more than a full years Icelandic output, thanks to the magic of 5.5% compound interest.
Even so, Icelandic is not as badly off as the entire world in the current depression, and not nearly as badly off as the superpowers of the derivatives world, the United Kingdom and the United States. According to the Bank for International Settlements, the world derivatives bubble reached a level of $1.14 quadrillion during 2008. Because so many over-the-counter derivatives are not reportable (especially in the United States), a more realistic ballpark figure would be the $1.5 quadrillion of derivatives in notional value already cited. This astronomical sum can be compared to $55-60 trillion in world GDP, a figure much overstated by counting financial services, speculation, derivatives, hedge funds, leveraged buyouts, private equity, etc. This means that the world GDP represents a mere 4% of the total notional value of over-the-counter and exchange traded derivatives. This strongly suggests that there is not enough money beneath the moon to honor the assertions of the international finance elite that their derivatives represent value -- and this is independent of whatever ferocious austerity measures the bankers may succeed in obtaining. Something's gotta give, as the old song says.
If we estimate that inside the United States there are currently about $1 quadrillion of derivatives (in other words, about two thirds of the world total) as against a mere $16 trillion of GDP (again, an inflated figure), then total US output represents a mere 1.6% of the total derivatives burden. Again, the situation is obviously unsustainable. Any attempt to maintain the income streams demanded by these derivatives or to attempt to value these derivatives at the rates mandated by the bankers will threaten civilization itself. There is thus a world-wide choice between the attempt to shore up a collapsing and doomed globalize derivatives bubble on the one hand, and the maintenance of human civilization itself as we have known it, on the other. So Iceland's predicament, while certainly quite serious, is rather typical of the contemporary world after all.
In many countries, derivatives were illegal for many decades. In Germany, they were forbidden under the gambling laws. In the State of New York, derivatives were banned under an ordinance governing bucket shops, smalltime betting establishments. In the United States as a whole, derivatives were outlawed between 1936 and 1982. Even after derivatives were made legal, it took almost two decades to rehabilitate them to the point where various counterparties could confidently assume that they would stand up in court. It took all the efforts of Ronald Reagan, Alan Greenspan, Wendy Gramm, and her husband Senator Phil Gramm (R-Texas) to bring back derivatives in a process which culminated in the year 2000. But even this year, Senator Mark Warner (D-Virginia) asked Fed Chairman Bernanke whether a "bright line prohibition" of credit default swaps might be instituted, and Bernanke replied that the proposal deserved consideration, although of course he did nothing about it.
The notion that a sovereign national government can be forced to assume responsibility for debts incurred by private companies is a relic of the gunboat diplomacy of the late 19th century. Gordon Brown's use of the British anti-terror legislation must be considered an act of economic warfare, an act of war which removes this issue from the normal sphere of "the market," by anyone's definition. Given the barrage of punitive actions, threats, and intimidation coming from London and The Hague, we can say with certainty that any agreements entered into thus far by Iceland have been extorted under duress, and must thus be considered null and void. If Iceland were to accept the blackmail of the Anglo Dutch, it would be tantamount to national suicide. Your country risks undermining its entire future perspective for development and even for survival. Accepting the extraordinary and illegitimate debt burden which the Anglo-Dutch seek to impose is not a viable option. The Anglo-Dutch wish to extract their dubious financial debt pretensions from the real productive economy of the small nation of Iceland; this is a process which can only lead to mass emigration, depopulation, economic decline, foreclosures on homes and businesses, widespread personal bankruptcy, possible hyperinflation, and general economic despair and ruin. At the end of the day, it is also certain that the Anglo Dutch debt can never and will never be paid the exorbitant sums they have in mind. This is not a matter of opinion, but a physical impossibility.
Some suggest that the way out of this impasse could be found by having Iceland join the European Union. This may seem plausible on the surface, but nonetheless represents a grave misconception. Today's European Union is a creature of oligarchies, banks, and cartels, animated by monetarist and neoliberal economic doctrine, and filled with contempt for the ideas and needs of the working populations of the constituent countries. This was not always so: during the first or Cold War quarter century of the European Economic Community, European institutions were animated to a significant degree by dirigistic ideas coming from the American New Deal, from social democratic parties and from the labor movement, before a backdrop of postwar reconstruction. Leaders like Adenauer of Germany and de Gasperi of Italy also contributed positive impulses from the social and economic doctrines of the Roman Catholic Church, many of them in direct contradiction to be nostrums of the Austrian and Chicago schools. The last country to gain anything from joining the European construct may well have been Ireland, which benefited from the European Regional Fund in a way which would hardly be possible today.
After 1990, the combined effects of British monetarist agitation under Thatcher and Major, and especially the monetarist criteria embodied in the Maastricht Treaty have increasingly influenced Brussels. Another critical watershed has been the creation of the European Central Bank as a bastion of financier oligarchy. Outside of a tiny elite of Eurocrats and Eurogarchs, the European Union has encountered growing rejection from broad strata of the populations of the member states, as seen in the rejection of the flawed and unworkable EU constitution turned down by France and the Netherlands in 2005, and of the undemocratic and authoritarian Lisbon Treaty by Ireland in 2008. As Marie France Garaud, who had served as a minister of the French government, remarked in June 2005, the proposed EU constitution would have represented a perpetual guarantee of nothing but "la conduction oligarchique des institutions" -- the oligarchical management of European institutions. The European Commission can be relied on to favor the interests of banks and financial institutions over those of productive industry and human need in every case. Surely this is not the Europe which Iceland needs to join at the present time.
Even a small country can exercise world leadership in the present crisis by functioning as an exemplar of democratic reform of financial and economic affairs and pioneering a better way of doing things, without regard to the discredited orthodoxies represented by the international financial institutions whose prescriptions have been so tragically wrong in the recent past.
Any attempt to fulfill the payment schedule demanded by the Anglo-Dutch would cripple Iceland's economic and social development for decades to come. The political effects of a policy of compliance and fulfillment can only be guessed at, but the relevant historical precedents are very ominous indeed. When Weimar Germany attempted to comply with the reparations imposed under the Versailles Treaty, German politicians of the 1920s like Gustav Stresemann were easily demonized as disloyal "Erfüllungspolitiker" and were ultimately swept aside by a totalitarian fascist movement under Hitler. Most of the debt was finally repudiated by the Nazi regime after 1933 in any case. If Germany had declared a debt moratorium in the early twenties, whatever the consequences, the chances for maintaining a democratic state would have been much better.
Here are some essential components of a program to defend the general welfare of Iceland:
Iceland should officially and formally declare a comprehensive, open-ended debt moratorium. This should involve the immediate, unilateral, and unconditional suspension of all payments of principal and interest to the Anglo-Dutch, until further notice. Any future payments can only be the result of international treaty measures negotiated by the self-styled creditors with the government of Iceland as a sovereign state and ratified by the Althing .or by referendum. The debt moratorium has routinely been declared by national states in regard to sovereign debts which they had officially contracted. In these cases, international negotiations regarding the suspension of debt moratorium have focused on debt rescheduling, interest rates, conditions of payment, and related issues. In the case of Iceland, however, the overarching question is that of the legitimacy and legality of the alleged Anglo-Dutch financial debt in the first place. The procedure of transforming private debts of Icelandic corporations into public obligations of the Icelandic government through the decree of foreign states which act as the favored clients of supernational institutions is prima facie illegal. In other words, it is extremely doubtful that Iceland owes the United Kingdom and the Netherlands anything at all.
If Iceland declares a debt moratorium, the country will simply be following the path of a large number of countries during recent decades. Here is a list, which makes no claim to being exhaustive, of some 27 countries which have, from the point of view of the international bankers, defaulted between 1980 and 2004 ­ more than one default per year, suggesting that, under conditions of globalization, debt default represents a normal and physiological process reflecting the deep flaws and contradictions of the emerging world globalized casino and hot money economy. It will be noted that this list includes large countries and small countries, European countries and Third World countries, countries with extensive oil and other natural resources and countries not so endowed, left-wing countries, right wing countries, Moslem countries, Catholic countries, secular states, democracies, dictatorships, and even one nuclear superpower, the Russian Federation. There is no conceivable opprobrium or moral taint in joining this long list. The list includes Albania, Algeria, Argentina, Bolivia, Brazil, Bulgaria, Chile, Costa Rica. Dominican Republic, Ecuador, Jordan, Mexico, Moldova, Morocco, Nigeria, Pakistan, Panama, Peru, the Philippines, Poland, Romania, Russian Federation, South Africa, Turkey, Ukraine, Uruguay, and Venezuela. If one country defaults, we can focus on the incompetence of politicians and on the embezzlement carried out by individual Enrons or Madoffs. But when 27 countries default, we need to look at the defects of an entire world system and therefore at the remedies which sovereign states can employ in their quest for economic self-defense and for the exercise of their inherent right to economic development.
Agencies of the United Nations are keenly aware of the debt moratorium issue. "Debt-ridden developing countries already struggling with the economic crisis will be particularly hard hit if they do not receive some form of debt relief in the immediate future, Secretary-General Supachai Panitchpakdi said at the annual dialogue at ECOSOC among the World Bank, IMF, World Trade Organization, and UNCTAD on 27 April [2009]." Noting that temporary moratoria on official debt servicing would give them some breathing space, Panitchpakdi told the meeting:. "In the current global crisis situation, both debtor and creditor countries would probably be better served if scarcer foreign exchange earnings in the debtor economies were used for the purchase of imports rather than for debt servicing," But debt moratoria need to be permanent until negotiated agreement is reached, so as to avoid the insufficiencies of the Hoover Moratorium of 1931-32 (declared by US President Herbert Hoover on post-World War I reparations and war debts). The Hoover Moratorium had real promise as an idea, but it proved too short-lived to stop the German and British defaults of 1931, and ended in chaos.
This is not the place to attempt even a cursory overview of recent debt moratorium measures enacted by the various nations of the world. Some of the largest and most important of these have been Mexico in 1982, Brazil in 1987, and Argentina in December 2001. Debt moratoria sometimes involve attempted measures of coercion in retaliation against the country in question by international lenders and international financial institutions, particularly the International Monetary Fund. Countries exercising the sovereign right to debt moratorium have been sanctioned with lending freezes, exorbitant interest rates, and even the attempted overthrow their governments by means of subversion fomented from abroad. Government officials everywhere should by now be familiar with John Perkins' Confessions of an Economic Hit Man (San Francisco: Berrett-Koehler, 2004), which provides a typology of the methods used by international bankers. Nevertheless, it seems clear that the ability of nation states to harvest the beneficial effects of debt moratorium depends on the political skills of their leaders and the willingness of those leaders to mobilize mass support.
The most recent Argentine debt moratorium was declared in December 2001 during the short-lived administration of President Rodriguez Saa, in a time of grave political instability. It was therefore a real achievement that a democratic form of government was preserved. The Argentine debt moratorium was largely administered by the government of President Nestor Kirchner, who was able to negotiate a write-down of two thirds of Argentina's foreign debt by about 75%, meaning that the foreign debt existing at the beginning of the crisis was reduced by about one half. Argentina unquestionably faced serious domestic economic dislocations during the time that the debt moratorium was in force. However, it would appear that many of these could have been ameliorated and mitigated by the development of a more adequate social safety net, something which Iceland should be able to accomplish without excessive difficulty.
There is also always the possibility that a determined stand by a single country might precipitate the formation of an international movement of states or debtors' cartel in which economically disadvantaged states (the vast majority) would join together for a kind of collective bargaining to secure better conditions from the creditors, who already enjoy cartel arrangements of their own through the London Club and the Paris Club. We should also recall that the world is far less unipolar today than it was in 2001, thanks to the emergence of the Shanghai Cooperation Organization and related tendencies. The difficulties experienced by the United States and the British in attempting to impose economic sanctions against what they define as recalcitrant nations suggest that countries invoking their right to debt moratorium would not today experience the same pariah status which some have undergone in the recent past.
In short, there is substantial reason to believe that a debt moratorium could be instrumental in obtaining significant improvements in the economic and political situation faced by Iceland. For any country of the modern world to recover from economic depression, it is always necessary to remove the burden of fictitious capital generated during the bubble, which generally assumes the form of speculative claims on income from agriculture and industry. On a world scale, this would take the form either of outright bans on derivatives and similar toxic instruments, or else of measures designed to neutralize the derivatives problem through taxation, as in the form of the Tobin tax. In the case of Iceland, the eradication of the overhang of fictitious capital necessitates the permanent freezing of interest and principal on the illegitimate Anglo Dutch debt with a view to its radical write- down or its outright elimination.
The current offer to the Anglo Dutch of debt service amounting to 6% of future GDP growth guaranteed by the Icelandic government between 2016 and 2024, while conceding a 5.5% rate of interest on all supposed arrears, represents an approach which is antithetical to and incompatible with the strategy of a debt moratorium. This offer of a percentage of future economic growth is counterproductive and unwise, and Iceland will indeed be fortunate if the Anglo Dutch reject it and instead reiterate their demand for full and unconditional payment.
Unfortunately, such a percentage approach is not new and has failed in the past. Professor Michael Hudson wrote of this offer in the London Financial Times of August 17, 2009 that "this agreement is, so far as I am aware, the first since the 1920s to subordinate foreign debt to the country's ability to pay. Iceland's payments will be limited to 6 per cent of growth in gross domestic product as of 2008. If creditors take actions that stifle the Icelandic economy with austerity and if emigration continues at current rates to escape from the debt-ridden economy, there will be no growth and they will not get paid." But this assertion is not accurate, and ignores the very well-known and thoroughly unsatisfactory results obtained with a similar method by Peru under the initially wildly popular Alan Garcia Perez regime during the years after 1985, with which Professor Hudson must surely be familiar. As John Crabtree of Oxford Analytica wrote of the Garcia experience, "for the first time, a heavily indebted country was unilaterally limiting debt payment to its own perceived capacity to pay."
Alan Garcia's July 28, 1985 proposal to Peru's creditors took the form of an offer to pay them in the form of debt service 10% of the export earnings of Peru. Even though 10% is more than 6%, Garcia's proposal was more realistic than what Iceland is considering today. This is because GDP growth as such does not directly provide foreign exchange earnings in the form of dollars or euros or SDRs which can be used for the payment of international financial debt. Foreign exchange can be obtained primarily through exports. One can imagine a country with a growing GDP which nevertheless has little in the way of foreign exchange earnings, or even might have a foreign-exchange deficit, in which case GDP growth would have very limited impact on the elusive Keynesian chimera of "ability to pay." Garcia was at least focused on the specific economic variable -- foreign exchange earnings in the form of dollars -- which bore most directly on how Peru would pay foreign debt service. But even though the Peruvian position had the virtue of specifically addressing on export earnings, it nevertheless failed to provide any solution to the issue of Peru's international debt.
Within the 10% offered by Peru, Garcia prioritized newly contracted debt which was to be paid in full, followed by multilateral lending agencies who were to get paid up to the amount of new credits coming into Peru. Then came government creditors, and last of all private banks. But sometimes the Peruvians allowed themselves to be stampeded by the US and the IMF into making last-minute debt payments to avoid being declared in default. These moments of weakness were all the easier since payment had not been completely terminated. (By early 1987, Peru was violating its own policy in the other direction, since it could no longer afford to pay the promised 10%.) Garcia thought that the bankers would be impressed by his moderation, but they treated him as if he were incomplete default. In October 1985, Peruvian debt owed to US banks was declared "value impaired," forcing the US lenders to set aside larger loan loss provisions. Peru now faced a bankers' steering committee chaired by Citibank. In April 1986, the IMF, seeking to impose a program of monetarist shock therapy on Peru, demanded the immediate payment of $70 million in debt arrears. When Garcia failed to comply, the IMF blacklisted Peru as ineligible for new loans, placing the nation in the same category with Vietnam, Zambia, Somalia, Guyana, Sudan, and Liberia. Peru was then denied any new loans by the World Bank and the Inter-American Development Bank.
At the same time, the 10% policy meant that Peru could not join with other countries who were interested in promoting debt moratoria. This was a grave disappointment for Garcia, who had hoped to organize large parts of Latin America around his 10% solution. The 10% policy emerged over time as a dangerous half measure which was linked to other dangerous half measures, such as the failure of the Garcia regime to mobilize national credit for domestic production. When Garcia tried to correct his early mistake after two years in office by attempting to nationalize 16 banks and finance companies along with 17 insurance companies, his political support collapsed. Inside Peru, Alan Garcia was now more widely blamed for the crisis than was the IMF, which all Peruvians had previously agreed was the villain. Despite Garcia's desire for moderation and gradualism, foreign lenders refused to invest, and domestic investors converted their funds into flight capital. According to one historian, the 10% policy failed to deliver: "despite the posture of limiting debt repayment to 10% of exports, more went out in debt payment than came back in new loans." According to the World Bank, Peru's GDP declined by 8.8% in 1988 and by 14% in 1989. This amounted to Peru's worst depression of the 20th century, and it was accompanied by hyperinflation of 4500% per year, which finally had to be combated by means of a currency reform. For a multiplicity of reasons, some not related to debt, Peru underwent a decidedly authoritarian turn under Alberto Fujimori in the years after Alan Garcia left office. As for Fujimori, he quickly capitulated to the IMF and the World Bank. By 1994, he had also capitulated to the private banks. In the meantime, he had dissolved the Congress and suspended the constitution in the infamous "autogolpe" of self-coup of April 1991. The 10% or ability to pay strategy had undermined Peru's political institutions to the point where democracy itself had been eroded.
At first glance, the percentage ceiling approach and the debt moratorium strategy might appear to be variations on the same theme. They are not. The differences between the two methods are principled and far-reaching. The percentage approach implies that the debt is legitimate, and that it is only the Icelandic ability to pay that is in question. This represents a fatal weakening of the Icelandic legal-juridical and political-moral position, which is that the debt is illegal and being extorted under duress in violation of international law. This approach also undermines popular unity inside Iceland, opening the door to inevitable haggling about what percentage of export earnings can reasonably be devoted to paying the demands of foreign creditors, and related questions. With this approach, one part of Icelandic society will inevitably appear in the role of imposing austerity, sacrifice, tax increases, and cuts in the standard of living and vital social services on other Icelanders. This is a recipe for crippling internal divisions, as seen in Weimar Germany. With a debt moratorium, a clean break with the creditor powers is established. After that, no matter what might happen to Iceland in the way of economic sanctions and economic warfare, it will be seen as an attack by foreign powers acting without legal justification, and will thus increase social and political cohesion, and therefore the ability to resist foreign dictation.
The Icelandic debt alleged by the Anglo-Dutch is both illegitimate in toto and unpayable in practice. Since it is unpayable, why make a half-hearted attempt and pretend to pay it? Nothing but political confusion, demoralization, and a weakening of the Icelandic national will can result from this policy. The percentage approach represents a dangerous half-measure against adversaries whose aggressivity appears to know no limits. The percentage approach would get Iceland all the imaginable disadvantages, including the raging hostility of the Anglo-Dutch, the international financiers, the IMF, and the Brussels Eurogarchs, but none of the advantages that would come from a clean and orderly principled debt moratorium.
The percentage approach also recognizes the right of the Anglo-Dutch to exact 5.5% in compound interest on the alleged principal and arrears would be subjected. Under Versailles, Germany as the loser of World War I had to accept a 5% interest rate on the mass of reparations, meaning that Iceland is being treated worse than a conquered province. Even if Iceland were to succeed in paying a percentage of GDP or export earnings, the debt will increase through compound interest, and will grow much larger over time. This is the curious process sometimes referred to as bankers' arithmetic, which can be summed up in the proposition that the more you pay, the more you owe, and so on into eternity, unless and until the political authorities of the target nation summoned the political will to call a decisive halt to the process of looting.
To score any points at all, the advocates of the 6% solution would have to show that, under their method, the future loans that Iceland would receive would exceed the future debt service to be paid out. But there is no assurance of this. In addition, world trade is falling, not rising. It will be almost impossible to increase export earnings in a situation where, according to the WTO, the level of world trade is now 33% lower than it was a year ago.
Thus, any percentage approach will never resolve the problem of the foreign debt, but only pyramid both the debt and the difficulties. Any export earnings paid to the self-appointed Anglo-Dutch creditors would simply be lost to the urgent tasks of Icelandic internal development and economic modernization. The amount paid would not placate the hostility of the Anglo-Dutch, who would be free to block Icelandic exports with the help of the EU, and possibly impose other sanctions. The lesson of all these considerations is, once again, that Iceland needs to declare an immediate sovereign debt moratorium. At the same time, it is imperative to recognize that the successful prosecution of a debt moratorium strategy will require a national economic policy incorporating strong elements of dirigism and of mass participation in order to be successful.
In addition to removing the burden of the Anglo Dutch demands, it is advisable to implement measures to prevent the re-emergence of a bubble economy on the national scale. Icelandic banking needs to be re-regulated, establishing an incompatibility of commercial banking with proprietary speculative trading and also with insurance, as in the US Glass-Steagal Act. The notion of too big to fail should be abolished, and the notion of derivatives triage introduced. Bankrupt financial institutions which fit the profile of zombie banks need to be seized and liquidated forthwith, with their derivatives being canceled.
Iceland requires a 1% Tobin tax (also known as a trading tax or securities transfer tax) on all transactions involving over-the-counter derivatives, exchange traded derivatives (options, futures, and indices), stocks, bonds, foreign currency, commodities, and asset-backed securities. This Tobin tax would provide much-needed revenue for the national budget, while at the same time discouraging the destructive excesses of speculation which are at the heart of the current crisis.
It is not advisable to deal with the IMF, since IMF loans always bring with them the necessity of a letter of intent containing economic conditionalities which are uniformly destructive of national sovereignty and highly detrimental to economic growth. The history of the IMF offers no success stories, but only failures. Rather than becoming embroiled with the imperial IMF, Icelandic would be much better advised to seek support among its peers, that is to say among other nation states, in which context an equal partnership based on mutual advantage can be possible. Iceland should therefore conduct a vigorous diplomacy towards the Brazil-Russia-India-China BRIC combination, towards the Shanghai Cooperation Organization Members, towards the nonaligned countries, and towards the developing nations in general, with particular attention to oil producers. The IMF is the bearer of the Washington Consensus, a set of failed and discredited economic doctrines which are being increasingly rejected around the world in favor of a still evolving Beijing Consensus inspired by the principles of noninterference in the internal affairs of sovereign states and of mutual benefit. In order to escape the IMF's net of conditionality and Diktat, it is advisable to immediately pay off any and all IMF loans contracted thus far using funds borrowed from other nation states or from other lenders. The recent example of Argentina is instructive in this regard.
In a world dominated by the death agony of the various zombie banks of Europe and North America, it is already prohibitively difficult to obtain commercial bank loans on reasonable terms. It will be necessary for Icelandic to secure a guaranteed source of development credit for domestic purposes. The obvious solution is to nationalize the central bank and operate it as a department of the Finance Ministry, with the national money supply, interest rates, and approved categories for lending being determined by public legislation approved by parliament. This is far more democratic than the usual secretive practices of central banks. Iceland, in short, should become its own bank for domestic purposes, since there are no commercial banks in sight that could be equal to the task. We are thus talking here about national lending, not government spending. Recovery loans from the new national bank of Iceland should be issued at 0% interest for the duration of the world economic depression. These loans should be earmarked exclusively for productive purposes in the realm of tangible, physical goods production in such areas as manufacturing industry, agriculture, building construction, infrastructure, scientific research, mining, energy production, transportation, and other productive fields. Production also includes such local activities as auto repair shops, restaurants, dry cleaning establishments, tailors, taxi companies, trucking firms, dairies, farms, airlines, railroads, ferries, building contractors, home builders, painters, plumbers, and any other business which provides transportation or produces a physical product. Socially necessary activities like health services and education can also qualify. Financial services and speculation emphatically do not qualify for 0% national credit, and will have to turn to the private credit market. As long as national credit is channeled preferentially into productive activities, the loans can be repaid without difficulty and inflation will not become a problem. As an additional safeguard against the transformation of such loans into hot money flight capital for a new currency carry trade, capital controls and exchange controls must be maintained and strictly enforced. The Icelandic National Bank will also offer a rediscount guarantee for all forms of commercial paper pertaining to the national infrastructure program described below.
The Icelandic government and the national Bank will need to supervise available stocks of foreign currency with a view to maximizing their effective use. Foreign exchange should be used to build up strategic stockpiles of oil and other vital raw materials.
After the recent catastrophic experience with de-regulated financial globalization, it is time to re-balance Icelandic society away from the hypertrophy of financial services, speculation, and the casino economy in favor of a renewed emphasis on industrial and agricultural production, infrastructure, scientific research, mining, and building construction. In these troubled economic times, it is imperative to prevent debt issue is in the domestic economy from strangling essential national production. Iceland should therefore freeze any and all foreclosures of primary residences, farms, factories, businesses, and other enterprises for five years or for the duration of the world economic depression, whichever is longer. In the current national emergency, the supposed primacy or sanctity of debt and debt service must yield in every case to the requirements of maintaining the fabric of human society and necessary production.
Iceland should also consider the advisability of instituting a national economic recovery plan. Indicative planning has nothing in common with the failed command economies of the old Soviet bloc. Indicative planning involves drawing up a list of national priorities which can become the leading edge of economic progress over a period of several years into the future. Indicative planning goes back to the methods used by Jean-Baptiste Colbert in France in the seventeenth century, and by Alexander Hamilton in the United States in the 1790s. The American New Deal of Franklin D. Roosevelt incorporated elements of indicative planning, as in the case of the highly successful Tennessee Valley Authority (TVA) and other regional development plans. As part of a strategy of economic independence and rapid development, Iceland should introduce indicative planning on the model of the French Commissariat du Plan under De Gaulle after 1958 and the extraordinarily Japanese Ministry of International Trade and Industry (MITI) during the Japanese industrial boom.
The basic principle that needs to be applied to the specific situation of Iceland today is that the only adequate response to an international economic crisis is to promote an ambitious program of the national infrastructure and industrial projects capable of improving the productivity of labor and at the same time of augmenting the national stock of capital goods. A useful example for illustrating this idea can be found in another island nation, the Republic of China on Taiwan, in the years after the world oil shock of 1973-4. Taiwan has a land area about a third the size of Iceland and a much larger population. After the oil shock, the Taiwan government of Prime Minister Chiang Ching-kuo launched 10 infrastructure projects to be completed over a period of about five years. These included a major north-south highway with branches, the electrification of the rail line along the island's west coast, the construction of a railway line in the northern part of the island, a new international airport, two new ports, a new shipyard, a new steel mill, a new oil refinery with industrial park, and a new nuclear power plant. It is from these beginnings that Taiwan was able to move forward to acquire the status of one of the Asian Tigers or Newly Industrialized Countries (NICs) of the 1980s and 1990s. Iceland's choices in 2009 will of course be much different, but the general principle remains the same.
The economy of Iceland can no longer be based primarily on codfish and aluminum. These products will continue to be very important, but they must be supplemented by additional areas of economic activity. One obvious area for infrastructure development is the need to address the growing obsolescence of the internal combustion engine as a means of transportation. Again, motorcars will continue to play an important role, but they must be supplemented by the development of modern mass transit facilities based on the magnetic levitation or maglev technology which has been developed in Germany in the form of Transrapid, and which is now operational in commercial settings in both China and Japan. Because maglev rail is clean, quiet, and swift, Iceland is an ideal candidate for the construction of a national maglev system. For shorter distances, various forms of fast rail, traditional rail, and light rail can be adopted. This technology also addresses current concerns about the carbon impact of conventional automobiles.
As already indicated, these and other components of the national infrastructure program will be eligible for 0% long-term financing from the national bank. Their subcontractors will be eligible for a rediscount guarantee by the national bank of their commercial paper, bills of exchange, and other instruments related to these projects.
In addition to these infrastructural elements, Iceland would be well advised to consider a national mobilization to establish Icelandic world leadership in some critical area of science, research and development, technology and industry. In this case, the goal of national economic planning would be to establish the status of Iceland is the world leader and world market powerhouse in that specialty. The area selected should be on the most advanced frontier of human knowledge in an area such as aerospace, high-energy physics, biomedical research, information technology or some comparable field. It should be an area of high capital intensity, high energy intensity, and high value added. The specific choice of what specialty is to be cultivated would depend on the census of existing Icelandic capabilities combined with the forecast of the future needs of world economic development, and a guess cannot be hazarded here. Once the choice is made, all elements of national policy including credit, taxation, trade and tariff policy, labor market policy, education policy, diplomacy, and capabilities should be coordinated to maximize the success of this great national enterprise. A national Export-Import Bank to provide export financing for this project with export credit guarantees along the lines of the German Hermes and French government Coface systems, can also be instituted.
What is already abundantly clear is that the principal resource of the Icelandic economy will always be mental capital in the form of an exceptionally capable and qualified workforce which must enjoy the advantages of full employment in a high wage economy so as to permit the necessary levels of education as we look towards the middle of the 21st century and beyond. In this time frame, virtually every worker will need a college degree or the equivalent, and many will need an advanced degree, especially in science, engineering, mathematics, physics, etc.
Enderlein, Mueller, Trebesch, "Sovereign Debt Disputes," May 2008.
John Crabtree, Peru Under Garcia: An Opportunity Lost (Pittsburgh PA: University of Pittsburgh Press, 1992), p. 40.
Crabtree, p. 215.
Crabtree, p. 148. Another estimate is that Peru experienced 2.2 million percent inflation between 1985 and 1990; see James D. Rudolph, Peru: The Evolution of a Crisis (Westport CT: Praeger, 1991), pp. 132, 134.

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