Greece and Iceland’s recent economic histories offer an interesting case for a comparative study. Highlighting the danger of running a large current account deficit, their experience can also be a guide for the future of the British economy and currency.
After a volatile month of August, financial markets around the world seem to be calming down, giving me the perfect excuse to pause and think back to my last holidays. This summer, my family and I happened to spend some time at two of the extreme corners of Europe. Like every year, we first went to visit my family-in-law in Iceland. Then, crossing 27 degrees of latitude and 45 degrees of longitude, we went to Greece, which simultaneously saw us experiencing a 20-degree increase in temperature. As we landed though, the mood in Greece seemed to be exactly the same as that in Iceland: after several record years, tourism was dropping in both countries, generating some worries with regards to the sustainability of their recently newfound growth.
Tourism is typically perceived as the low-hanging fruit with which to manufacture a recovery.
It is indeed interesting to note that tourism is typically perceived as the low-hanging fruit with which to manufacture a recovery: it only requires, in the first instance, cheap low-skilled labour, small-scale entrepreneurship and, if possible, easy credit conditions. In addition, what is expected from government is generally very limited: some marketing and coordination, a bit of deregulation and possibly the (often controversial) selling off of parts of the commons. By the same token, tourism cannot be the core of a sustainable long-term growth strategy. But who wants to hear spoilsports in a recession? In any event, it occurred to me that however dissimilar they initially appear, Greece and Iceland offered an interesting case for a comparative study.
As the world was hit by the worst financial crisis in a century, these two small but proud seafaring nations at the periphery of Europe saw their economies and banking sectors dramatically collapse. In the same way the tip of a whip “cracks” at supersonic speed following the firm shake of a hand, the Icelandic and Greek economies, alongside others, were brutally hit by the ripples generated at the heart of the global financial system. These nations saw their output decline by a respective 11% and 26% in real terms from peak to trough, versus less than 2% for the world as a whole.
The most overlooked source of fragility for a country: a large and sustained current account deficit.
Arguably, both countries were not merely innocent victims of foreign financiers’ greed and recklessness. They bore some responsibility for their demise when they dismissed warnings about what is probably the most overlooked source of fragility for a country: a large and sustained current account deficit, which, in a world of free capital flows, is not a problem until notoriously-fickle financial markets think it is. Interestingly, the sources of the deficit (excessive public borrowing in the case of Greece, excessive private borrowing in the case of Iceland) did not really play a part in both country’s ability to withstand the shock. European political elites should take note as, unlike their US counterparts, they are more obsessed by fractions of percentage points in public budgets than by large international imbalances. Italy is for example the eurozone’s current “ugly duckling”, but it has actually been running a current account surplus since 2013, and over the last four decades its economic interaction with the rest of the world has been pretty balanced, which means that as a whole Italians are not particularly reckless.
Where the fate of the Greek and Icelandic economies diverged substantially is in the aftermath of their respective crises; whereas Iceland’s real GDP had nearly recovered to its pre-crisis level by 2014, the Greek economy kept on shrinking for many years, and today remains a good 15% below where it was in 2007. At this point, some might be tempted to explain the divergence with dubious cultural arguments, contrasting the resilient Viking spirit of the North Atlantic versus the indulging soul of the Mediterranean. This is at best lazy, at worst racist.
More convincingly, one might look at indicators related to the upholding of the rule of law (using an appropriate proxy, Iceland ranks 14th vs 67th for Greece), economic freedom (11th vs 106th), income inequality (2nd vs 70th) or even gender equality (1st vs 78th). No doubt, all these indicators can partially explain the relative strength of the recoveries, although they are probably better at explaining the overall level of economic output and well-being.
 The rankings are based on respectively to the Corruption Perception Index (2018), the GINI Index (latest available year), the Economic Freedom of the World Index (2019) and the Global Gender Gap Report 2018 of the WEF.
The major variable explaining the divergence in economic recovery: the currency.
However, beyond these, economics 1.0 teaches us that there is one variable which most likely played a major role in explaining the divergence in economic recoveries: the currency. The Icelandic krona collapsed by nearly 50% versus the euro in a matter of months, allowing for an almost immediate and inescapable adjustment of macro-economic imbalances, reducing – not without pain – private consumption and public spending and boosting export-oriented sectors, amongst which was tourism. In addition, the Icelandic government was allowed to default on some of its obligations and could run a large public deficit for several years without external interferences. And so, according to the IMF, in 2018, Iceland was back in the top 5 countries with the highest GDP per capita in the world.
In contrast, Greece could not go through such a “short sharp shock” therapy. As a member of the eurozone, it could not devalue its currency to adjust its terms of trade and reduce its liabilities in such a way as to quickly correct macro-economic imbalances. Furthermore, unlike any other normal debt issuer in capitalistic economies, it was not allowed to default on its debt. Rather, as Yánis Varoufákis rightly puts it, Greece became a debt peon, stuck in some kind of purgatory by rules devised on the basis of archaic bigotry and occasionally bent depending on cultural and political prejudices. Ireland, for example, in principle subjected to the same rules as Greece, ran a much larger public deficit in the aftermath of the crisis without having to face the wrath of the “troika”; but then it is true that Ireland’s problem came from the reckless behaviour of its loosely supervised banks, a small and forgivable error of judgement in our neo-liberal order.
The UK is currently running the largest current account deficit as a proportion of its GDP amongst all OECD countries.
Today, all that is history, but by pure coincidence, the midpoint between Iceland and Greece happens to fall on the United Kingdom, another proud, seafaring nation near the periphery of Europe. Interestingly, it is currently running the largest current account deficit as a proportion of its GDP of all OECD countries. As a matter of fact, even though the UK has not had a current account deficit as large as that of Greece or Iceland in the run-up to the crisis, it has been pretty much in constant deficit for over three decades, and that deficit is deepening. So, how sustainable is this situation, especially given the gradual deterioration of the image of British institutions in the wake of the Brexit referendum? And how would the necessary adjustment take place? Irrespective of the Brexit final outcome, we can assume that the major adjustment variable will be the currency. The weakening of the pound is already ongoing (the British currency is down around 15% against its major counterparts since the 2016 referendum), but it still has a long way to go before the UK’s imbalances get corrected. As for a boost to tourism? Surely enough, soon after the referendum, Theresa May’s government published a new “Tourism Action Plan” in response to the “real opportunities for growth” created by Brexit in the sector. A cheaper pound should eventually support the tourism industry, which would happily satisfy the apparently growing trend for “staycations” and climate-change-related holiday preferences for northern destinations. It will however probably require first an end to the current political crisis, one way or the other.
The information contained herein is provided for discussion purposes only, is not complete and is not, and may not be relied on in any manner as, legal, tax or investment advice or as an offer to sell or a solicitation of an offer to purchase an interest in securities. QUAERO CAPITAL believes the information contained herein to be reliable and has been obtained from sources believed to be reliable, but no representation or warranty is made, expressed or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of the information and opinions.
The estimates, investment strategies, and views expressed herein are based upon current market conditions and/or data and information provided by third parties and are subject to change without notice. There is no obligation to update, modify or amend these materials or to otherwise notify a reader in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
These materials include certain opinions, statements and projections provided by Quaero capital with respect to the anticipated future performance of certain asset classes. Such opinions, statements and projections reflect significant assumptions and subjective judgments by QUAERO CAPITAL’s management concerning anticipated future events. these forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond QUAERO CAPITAL’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The data as presented has not been reviewed or approved by any party other than QUAERO CAPITAL.
Nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument, currency rate or other market or economic measure. Opinions expressed herein may not be shared by all employees of QUAERO CAPITAL and are subject to change without notice.