Mon Aug 17th, 2009 at 05:30:15 AM EST
Iceland's debt repayment limits will spread
The most remarkable thing about this article is that the financial world has changed to such an extent that a Financial Pornographer and Known Troublemaker like Professor Michael Hudson is now being published in the FT.
His core point is that countries that cannot pay debt, will not pay debt, and that it makes no sense for the international community to attempt to force them.
Can Iceland and Latvia pay the foreign debts run up by a fairly narrow layer of their population? The European Union and International Monetary Fund have told them to replace private debts with public obligations, and to pay by raising taxes, slashing public spending and obliging citizens to deplete their savings.
Resentment is growing not only towards those who ran up the debts - Iceland's bankrupt Kaupthing and Landsbanki, with its Icesave accounts, and heavily geared property owners in the Baltics and central Europe - but also towards the foreign advisers and creditors who put pressure on these governments to sell off the banks and public companies to insiders. Support in Iceland for joining the EU has fallen to just over a third of the population, while Latvia's Harmony Centre party, the first since independence to include a large segment of the Russian-speaking population, has gained a majority in Riga and is becoming the most popular national party. Popular protests in both countries have triggered rising political pressure to limit the debt burden to a reasonable ability to pay.
This political pressure came to a head over the weekend in Reykjavik's parliament. The Althing agreed a deal, expected to be formalised on Monday, which would severely restrict payments to the UK and Netherlands in compensation for the cost of bailing out their Icesave depositors.
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 above 2008's gross domestic product. If creditors thrust austerity on the Icelandic economy there will be no growth and they will not get paid.
Michael's reference to Latvia is based upon an academic relationship he had there.
Will Britain and the Netherlands accept Iceland's condition? Trying to squeeze out more debt service than a country could pay requires an oppressive and extractive fiscal and financial regime, Keynes warned, which in turn would inspire a nationalistic political reaction to break free of creditor-nation demands. This is what happened in the 1920s when Germany's economy was wrecked by the rigid ideology of the sanctity of debt.
A pragmatic economic principle is at work: a debt that cannot be paid, will not be. What remains an open question is just how these debts will not be paid. Will many be written off? Or will Iceland, Latvia and other debtors be plunged into austerity in an attempt to squeeze out an economic surplus to avoid default?
The latter option may drive debt-laden countries in a new direction. Eva Joly, the French prosecutor brought in to sort out Iceland's banking crisis, warned this month that Iceland would have little left but its natural resources and strategic position: "Russia, for example, might well find it attractive." The post-Soviet countries are already seeing voters shift away from Europe in reaction to the destructive policies the EU supported.
Something has to give. Will rigid ideology give way to economic reality, or the other way round?
I advocate a new approach to the problem, which I call National Equity.
Nations simply issue undated Units of National Equity and these are exchanged by the Issuer for existing debt. If creditors are unwilling to accept them, they are issued anyway, and kept by a custodian until they do, but no other payment against sovereign debt is subsequently made.
These Units carry a reasonable index-linked return - say 1.5% to 2.5% - in an agreed currency, probably dollars, for as long as it is the global reserve currency.
Units are redeemable by the issuer, in that they may be bought back at any time, thereby reducing the dollar payment obligation. In the hands of creditors/ Investors the value of these tradable Units will reflect the confidence of the holder that the Issuer will be able to service the obligation.
The methodology of National Equity turns existing thinking about risk on its head. Everyone has an interest in a country agreeing an affordable dividend, since it will then be more likely that it will be paid, and the Unit will therefore be less risky and more valuable.
So unsustainable obligations to repay sovereign debts are extinguished in a "Debt/ Equity swap" on an international scale.