How Iceland (or any nation) can adopt real money

The immense failure of Iceland’s largest banks happened for two main reasons: the owners were allowed to create new money through new loans and because the depositors assumed taxpayers, of either Iceland or their own countries, would cover any losses.

Removing the connections between banking and government and taxpayers and treating banks like any other business would prevent future huge bank failures. Mismanagement and fraud will still occur, leading to quick, small bankruptcies, not huge losses.

The people of Iceland can create a stable monetary system that does not have massive currency fluctuations or the booms and busts caused by national paper currencies and arbitrary interest rates set by a central, monopoly bank. This memo recommends steps that can stabilize the economy. None are more radical than staying with the status quo.

It is important to first consider two key monetary points:

1)      A country does not need a national currency. Just as it is not necessary to have a national airline or national grocery company, Iceland does not need a national currency. Individuals in Iceland can decide for themselves what to use as a medium of exchange for trade. People in the American colonies used silver coins printed by various mints. In essence they used silver, coined for convenience, and they chose silver because they valued it in jewelry and other uses. What products do the people of Iceland highly value?

2)      All forms of money fluctuate in value. Regardless of which product someone uses as money, the product will fluctuate in value. Some politicians claim government currencies are more stable, but government currencies also fluctuate in value. The krona declined more than 50 percent between 2007 and 2009. The U.S. dollar’s has declined 95 percent since 1913. Since the value of everything rises and falls, people reduce their risk by using more than one product as money—just as they diversify their retirement accounts. During the recent crisis, many people stored all their wealth in the kronur.

Here are recommendations to stabilize the Icelandic monetary system:

1)      Stop insuring bank deposits.
No other business losses are covered by governments and there’s less fraud as a result. Dry cleaners take possessions of property just like banks but if a dry cleaner ruins a shirt, the government does not pay for a new one. Simply viewing banks like any other business would be the biggest step to logical banking practices.

2)      Do not adopt the euro.
The value of money is partially based on how much is in existence. More money decreases the value of each unit of money, as the rise in orange crops reduces the cost of individual oranges. Brussels can create new euros at any time, with a keystroke, and they do.

3)      Do not start using the U.S. dollar.
Similar to the euro, the supply of dollars can rise dramatically at any time. In 2008, the US dollar stock doubled (http://tinyurl.com/ccg565).

4)      Allow people to use any product (or service) as money. For the reasons stated above and so people could what products they think will store value and be widely accepted in trade. Just as Reykjavik merchants cater to tourists by quoting prices in many currencies, merchants would add prices for possibly gold, silver, dried fish, etc. People will still use charge cards to transfer these money products.

 

5)      Tax only one side of sales transaction. Currently if someone buys a restaurant meal with gold, tax is applied to the cost of the meal and the cost of the gold; a double tax. Instead tax only one side of the transaction, either the meal or the gold.

 

6)      Choose multiple forms of money to accept as tax payments.
To avoid overly influencing the average person’s choice of money, the government could accept more than one form of money, such as gold, silver, or platinum. Accepting only gold, for instance, might overly influence people’s choices, and they will not be able to diversify as much as they would like.

 

7)      Allow the marketplace, not central bank officials, to set interest rates.
Interest rates are a fancy name for the price to rent money. Government officials thankfully don’t set the price to rent cars or homes. Giving the power to set the price of renting money with a person or group of people concentrates too much power. Someone could engineer booms and busts by changing the interest rate – a high interest rates slows commerce, a low interest rates increase commerce. Also high interest rates benefit savers and setting a low interest rate forces savers to subsidize borrowers.

 

8)      Stop using the krona. Exchange existing krona for a product or mineral.
This is the biggest step and there are variations of what could be done. People who hold kronur must be given something of value in exchange. Kronur could be exchanged for any product, thought it’s likely people would prefer gold, silver, or platinum, as they did before government’s mandated paper money. To amass the minerals for the exchange, the Icelandic government will likely need to sell government land and property and buy the minerals.

Here are potential steps for the conversion:

  1. Determine how many kronur are in existence at a specific time.
  2. Decide what product you want to redeem kronur. Let’s assume you choose gold.
  3. Calculate the value of outstanding kronur in different product, such as oil. (Gold will increase in value as you purchase it, making it increasingly more expensive to accumulate. Higher value gold will be worth more oil, meaning less gold will be needed for the exchange as gold increases in value.)
  4. Amass an amount of minerals equal to the value of the oil by selling government assets, such as land and buildings.
  5. Exchange the gold, silver, and platinum for outstanding kronur. (This could be accomplished in person or digitally by using a third party to store the minerals and transfer them to new accounts.)
  6. Stop using the krona, and do not have a national currency.

 

Before embarking on this plan, advise Icelandic citizens that interest rates will rise and prices will fall. Interest rates will rise because banks will not be able to create new paper money and instead will raise interest rates to attract new deposits. Savers will earn more interest on deposits, while borrowers will pay higher rates. Prices will fall because more efficient production methods will drive down costs, and these cost reductions will no longer be overwhelmed by increases in the paper money supply which would normally increase prices.

People in many countries, such as Argentina and Mexico, have suffered through currency devaluations and huge banking failures, but officials in those countries never fundamentally transformed their systems to prevent another crisis. The people of Iceland can do better by allowing people to choose their money and by removing the connections between government and banking and taxpayers.

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By Dave Doctor

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