An Icelandic Remedy?

(By Fisher Investments) Folks at the IMF have a tough job. They're charged with fostering global economic stability, providing financing to needy member-countries and dispending economic policy advice. But of late, they've been especially vocal about their policy advice—some of which has been a tad odd, in our view. The latest example had the IMF prescribing the Icelandic remedy to the eurozone—a remedy, which, in point of fact, they can't follow in full.

In an interview published Monday, the IMF mission chief to Iceland lauded the country's 2008 recovery program decision to push debt losses onto bondholders, safeguard social safety nets and erect capital controls. Proponents of Iceland's recovery program note pushing debt losses onto bondholders of Iceland's three banks protected taxpayers. Likewise, that safeguarding social safety nets boosted private consumption and capital controls prevented investors from fleeing the krona. The IMF estimates Iceland's $13 billion economy will expand 2.4% this year.

But the IMF ignores a key factor to Iceland's recovery. At the very least, this likely means the IMF overstates the case for eurozone nations' heeding Icelandic lessons. For starters, a key driver for Iceland's recovery was the weakening of its currency—down nearly 80% relative to the euro in 2008. The weaker krona devalued Icelandic exports, thereby increasing Iceland's trade competitiveness with the rest of Europe. That increase in net exports contributed positively to Iceland's output. But keep in mind, you can't devalue a currency and expect only positive results. While a weak currency makes exports cheaper, it also makes imports more expensive. That's not just a mere annoyance to consumers—it can impinge on profit margins for firms who rely on importing intermediary or finished goods.

Still, Iceland's economy is highly export dependent. And so, although it's not a consequence-free way to juice economic growth, a devalued currency has no doubt been a positive contributor to Icelandic GDP growth. However, eurozone nations don't have the same ability—monetary policy is strictly controlled by the ECB (and is influenced by the Bundesbank, the largest contributing central bank. Likewise, capital controls preventing foreigners repatriating capital would be extraordinarily difficult to implement—if not impossible—within a currency bloc. While you might be able to prevent capital from leaving the 17-nation zone, they'd probably struggle to prevent Greek bank deposits from heading to Germany, for example.

And perhaps Icelandic politicians now realize their advantage. In talks to join the EU since 2009, members of Iceland's coalition government have recently gotten cold feet, expressing desire to reevaluate their shotgun-marriage commitment to join the EU after 2008's financial crisis. In our view, likely a wise move. Maintaining control of its own monetary policy gives the country another tool in its arsenal to continue fostering economic growth. And, long term, ongoing currency devaluation isn't a sure-fire economic winner. And from the eurozone's perspective, Iceland would, in all likelihood, have to abandon many of the crisis-born protections prior to giving the country serious consideration as a currency partner.

So while Icelandic growth now might be nice, we're not counting our kronas yet. In general, while the IMF's advice is noteworthy, we'd suggest the eurozone isn't devoid of countries demonstrating a more sustainable means of recovery. One even has a name spelled very similar to Iceland, matter of fact.