In 2008, Iceland became one of the first countries in a long line of states to fall like a game of dominos. The Great Recession was an important economic and political event for both Iceland and the rest of the world. Unfortunately, we never really learned from it and the systemic causes.
From 2008 to 2011, Iceland’s three major commercial banks tumbled due to failures to refinance their short-term deposits and a run on deposits in the Netherlands and the United Kingdom. Bankruptcies, an immense currency devaluation and a stock exchange collapse soon followed.
Since then, political observers have opined on the matter, and there is a general consensus that it was the fault of the private sector as opposed to problems on the part of the Icelandic central bank, which had expanded the money supply exponentially. Here is what Björn Bjarnson, the former Minister for Justice and Ecclesiastical Affairs, wrote in a 2009 blog post:
“I have written a lot about problems in the business sector over the last 14 years, and I can only compare some parts of it to Enron. Here companies have been playing a game, using the media and publishing to make themselves look good. We only hope that the foreign media will soon begin to understand what has been going on.”
A Report on Monetary Reform
A report conducted by Frosti Sigurjonsson, commissioned by Iceland Prime Minister Sigmundur Davíð Gunnlaugsson, was released this month entitled “Monetary Reform – A Better Monetary System for Iceland.” The purpose of the report was to look at the causes and effects of 2008’s economic collapse. The report essentially concluded that it was because of fractional reserve banking that a crisis ensued. This monetary policy produced an astronomical increase in the money supply prior to the collapse.
It is recommended by Sigurjonsson that Iceland eliminate fractional reserve banking, create a separation of deposit and loan banking and an abolishing deposit insurance. At least two of the three measures would likely be supported by libertarian economists:
- Fractional Reserve Banking: only a small percentage of reserves are held in dispersal for depositors. If depositors wanted their money back then the whole system would collapse. As Ron Paul wrote: “Pyramiding more and more loans on top of a tiny base of money will create an economic house of cards just waiting to collapse.”
- Deposit Insurance: this policy measure produces moral hazards and unintended consequences (anyone remember the S&L scandal?). Depositors would be indifferent to how their financial institutions take risks with their money; the Federal Deposit Insurance Corporation (FDIC) only has one percent of all deposits it supposedly insures; and it allows banks to take unnecessary risks. Murray Rothbard stated: “The very idea of ‘deposit insurance’ is a swindle; how does one insure an institution that is inherently insolvent?”
The other aspect of the report is rather disheartening. Sigurjonsson suggests giving more power to the Central Bank of Iceland (CBI), even though the report named it as the main culprit behind the financial crisis. In one part of the report, the author accuses the central bank of losing control of the money supply, which led to heightened intervention, but in the next part the authors have faith the CBI would conduct monetary policy in a responsible fashion.
Sigurjonsson purported that private banks lent for speculation instead of worthy initiatives. However, he is unconcerned about the government or the central bank mimicking this behavior in the future. Why? Well, it’s likely he buys into the old Keynesian principle: the government needs to print new money to match the needs of the economy and the good of the country. Or, simply put, money printing is a chief component to economic growth, and this monetary growth will only be used for the good of the nation (of course it will).
Overall, he has faith the money supply would be kept in check and used in a non-inflationary manner.
This is plain naivete. Indeed, his plan would transfer the power of the money supply from banks to the central bank, which permits the government to spend whatever it pleases. However, much like Milton Friedman made the error in the 1970s, who can actually believe a central bank would limit its appetite for printing to the desired amount (two percent, for instance)?
Patrick Barron may be optimistic in this endeavor, however. He writes that perhaps the CBI would restrain itself to showcase the benefits of eradicating a fractional reserve banking system in favor of a 100 percent fiat reserve system.
“After that we can fight the next battle — prohibiting central banks from expanding the fiat money supply and then finally tying money to specie at a legally enforceable ratio,” wrote Barron. “At that point money production can be turned over completely to private hands and the central bank abolished.”
When the central bank is in control of the printing press, or anything for that matter, you must always be skeptical.
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