Professor Michael Hudson has written an excellent article about the current financial condition of Iceland and how the banking elite in Iceland and aboard brought about it’s demise. The destructive power that the “magic of compound interest rates” is given prominence by Prof. Hudson:
The trick is to fool debtors into thinking that “free markets” means paying one’s debts. Creditors can succeed in letting debt leveraging and “the magic of compound interest” empty out economies only by diverting attention from what Adam Smith and other classical economists warned against. For them, a free market was one free of debt – especially foreign debt. In The Wealth of Nations (especially Book V, chapter 3), Smith warned against creditors becoming “free” enough to disable the ability of governments to protect citizens from creditors – especially the Dutch, who were the major investors in British monopolies created to be sold to pay for that nation’s seemingly eternal wars with France. The problem was that creditors sought to extract the wealth of nations for themselves, not to create wealth. Their greed was destructive to society as a whole, because it was easier to simply strip assets than to create real capital.
That is the problem with creditors historically. They tend to care only about how to extract as much as they can, as quickly as possible. “A creditor of the public, considered merely as such,” wrote Smith, “has no interest in the good condition of any particular portion of land, or in the good management of any particular portion of capital stock. As a creditor of the public he has no knowledge of any such particular portion. He has no inspection of it. He can have no care about it. Its ruin may in some cases be unknown to him, and cannot directly affect him.” The problem obviously is worst with absentee creditors.
Smith concluded: “When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about is by bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”
The last line by Adam Smith is one that rings most true. It’s very rare indeed for Nations to fully and completely pay their debts. Prof. Hudson later on explains why this is this case:
Political leaders who fail to recognize the fact that checks and balances are a proper function of government are liable to sacrifice their nation’s hope for economic growth and rising living standards in a vain attempt to pay creditors. Such attempts must be in vain, because “the magic of compound interest” is a cruel myth: In reality every rate of interest implies a doubling time, and no economy’s “real” growth ever has been able to grow exponentially at a fast enough rate to pay the debts that keep accruing interest.
This mis-match in how economies function and how interest rates work means that it’s very rare for national state to pay back such debts. Instead, what will be more likely is either a debt re-adjustment, write-off, or a default as in the case Argentina a while back. Additionally, most nations have been able to reduce their debts through inflating their currency as their debts were in the same denominated form. However, in the case of Iceland this not the case. Most of their debts are from foreign lenders in foreign currency, typically Euros. This makes Iceland’s debt really, really, difficult to pay back.
Interest rates is only part of the story that Prof. Hudson expounds upon. How IMF’s austerity programs can really hurt nations is also discussed just as in Naomi Klein’s book “The Shock Doctrine”. The entire article is considerably long and took me two days to read in it’s entirety, but nevertheless it’s well worth a read.
