Iceland’s Bank Revolution

David Karnå|Wikimedia Commons

Iceland considers total nationalization of its banking sector. I consider this essentially socialist dream to be an improvement of the current status quo – which says a lot about today’s quality of money. Schools teach that the private banks operate as an intermediary who channels monetary savings. This is not true. Commercial banks are creators of savings. Up to 84% of the money in the Eurozone was not created by the national central banks, but by the private financial institutions.

The vast majority of loans provided by the banks is money which they create out of nothing. They take the form of electronic money on our current accounts against which – thanks to the blessing of a state guarantee – they hold almost no cash reserves. This causes that the money in the system grows in a dizzying way, when the banks run up in lending with the prospect of profit.

Most people do not know about it and therefore they are not bothered by it. They still believe in fairy tales they learned in school. Icelandic people are tainted by the latest crisis. They paid for their ignorance by the financial crisis, currency depreciation and by carrying the huge costs for cleaning of the damages caused by their incompetent bankers. Now they speculate how to avoid something like that from happening again. The possibility of getting rid of their own Icelandic crown and completely replacing it with the Canadian dollar or some other foreign currency has been already rejected.

The debate continues with a shocking proposal for a monetary reform. According to this proposal, the creation of all money in the economy would be dictated by the state. Commercial banks would continue to provide payment services and service loans and take in deposits. But the assets and liabilities would be on the balance sheet of the central bank. The deposits would have been 100% covered and safe. Not like today, when my current account balance is just a liability of the bank, covered by more or less risky and liquid assets. While now a failed commercial bank takes down with itself also the money it created, in the new system of state money people would simply move their transaction account logged in the central bank from the failed commercial bank to another commercial bank. The banks would provide loans only using money that will be lent for this purpose by the creditors for agreed maturity and interest. Thus, not from the deposits which are payable on demand as today.

The State will get pretty rich by the approval of this proposal. It would receive one-off income in the form of profit from the transfer of the money created by banks to the central bank in the amount of more than half of the current government debt. In addition to this, it would obtain regular income from the creation of new money to ensure inflation.

The State would create and inject into the economy new money to achieve economic growth and agreed objectives of price inflation. The authors of this reform propose to use this plan to reduce state debt, taxes or public spending. It is probably the greatest weakness of the plan. Furthermore, inflation is not necessary for the economic growth at all and it gives in to the hands of politicians’ new resources. In the case of Iceland with 335.631 of inhabitants I am willing to believe that democratic control will safeguard such a miracle and “set the table” for the politicians and their friends. Politicians and their families on the streets of Reykjavik cannot enjoy a pleasant anonymity as those in Brussels or Frankfurt. On the other hand, the absence of fear of the social consequences of robbing their citizens in large democracies, have a damaging effect, so I would be hesitant with such a solution in Slovakia.

Iceland does not have much chance to go wrong. The current system is sufficiently large a disaster to require trying something else. They experienced capital controls, hyperinflation and there are financial crisis on average every 15 years. The currency suffers from chronic degradation. It would be nice to take a chance on an experiment in a country where the changes of a poorly performing financial system cannot be impeded by too powerful bankers and politicians.