 Well, I'm glad that it's a full house and that people actually care about Europe because sometimes I have my doubts so Yeah, okay Well, I'm not gonna show you I'm gonna show you some of the positive things but the euro crisis for those that don't know that was really the the turmoil that started in 2007 2008 and it's the hangover is still persisting today in many countries and I wanted to First of all show you the origins of it and then show you some of the positive things that also came out There was also good policy responses as well as bad ones the good policy responses. I wouldn't really call policy They were more doing nothing, but I want I want to show you the good and the bad of this whole thing and before I start Europe's complicated for many reasons if you didn't know this and The euro crisis is also very complicated because there's several facets to it like there's a you know there's a whole political aspect to it and For my purpose is I just really want to touch on the financial or the economic aspects and push the other ones aside Like for example my my football club Raelle Madrid my soccer club Raelle Madrid Greatest club in the world and they were just fine by FIFA Because they were they were involved in a in a political scandal with the government of Spain because they sold land to the the city of Madrid at below market value and in return though the city of Madrid gave them all this land that was Incredibly valuable as the case may be and so this is you know this set in motion its own little Mini boom bus cycle if anybody knows Madrid has four giant skyscrapers They were at one point that the tallest buildings in all of Europe But they were built on this rail Madrid training ground by the by the city And this is its own little boom bus cycle that was really put in motion for political reasons But I don't really want to touch on those I want to more stick to the to the to the pure economics of it The pure finances of it. So before we start I don't know who's actually been to Europe just out of curiosity. Oh, that's quite a bit actually is the case Maybe who's who's European though? Okay? So about half you have been to Europe let's say and you know one of the things for Europe as there's many ways You can define Europe but Europe for our purposes are the countries who use the euro and the euro is It's a little bit complicated maybe for people to understand because it's it's a group of countries who are separate in the political realm and in the Partly in the economic realm, but they share a currency So when you travel around Europe, there's there's many countries that you don't have to stop at the border and exchange your cash to get something New it's it's quite easy and just to give you a little bit of a timeline of how this came because the the timeline and Understanding everything that happened during these early years is really important and understanding the crisis that started in 2008 like for example in in Murray Rothbard's America's Great Depression One of the greatest Contributions in that book in my mind was that Murray laid out the theory that the depression was not really the problem in and of itself That should be looked at the the seeds were sown in advance and you should really study when the seeds were sown if you want to understand what the depression was all about and That was really influential for me because if you want to understand the euro crisis You don't start at 2007 2008 when everybody was losing their houses You start way back at the origin for it to try to figure out what was what was really going on So in in 1999 the euro was introduced as what we call a virtual currency. This is much less sexy than Bitcoin The virtual currency was that people's bank accounts were redenominated from the national currencies into the new euro currency But the actual physical Euro as a currency didn't come until three years later in 2002 and in January 1st 2002 Effective on that date you would go to the cash point or you would go to your bank and you would you know Withdraw money and you wouldn't get your national currency anymore You could only get euro notes and then along the way and I'll show you a little map here for a geography lesson in a second along The way new countries have been added to it. So we had the you know the original the original 11 countries well plus Greece 12 countries in 2002 that use the the euro have been added to along the way mostly with Eastern European countries and most recently the Baltic states Lithuania joined last year so now we have a fairly formidable currency union which is shaded in blue here and Europe's complicated like I say, so I'll just explain the other colors The colors in blue are countries that use the euro and so you'll travel around these countries and you don't have to worry about the exchange rate Or anything like that little green dots those are the little principalities that just adopted the euro What do we have Andorra, Monaco, Vatican City, and San Marino The yellow or lime green whatever you want to call these countries are in the European Union the political Union But they don't actually use the euro These purple ones are little Balkan states Montenegro and Kosovo who unilaterally adopted the euro So they don't have a say in monetary affairs in Europe, but you go there and you use the euro which is the same as If you go to Ecuador they use the American dollar there they're dollarized we call it But of course nobody in Ecuador has any say over the American dollar what happens for monetary policy and then we've got some strange countries like here in pink is little Denmark and The Danes are are in the EU, but they don't use the euro But they fix the value of the Danish crown to the euro So it's almost like they're in the euro, but they're not they kind of on the border And then I had to change the color on Britain because it's it's neither in nor out of Europe right now I don't really know what the status is with Brexit. It's in right now, and then it'll be out someday But Britain never used the euro anyway, so it doesn't really matter so in in this Not that it doesn't matter, but it doesn't matter for this lecture And so the countries that we're really concerned with here are the ones in blue Or they're the ones that I'm gonna focus on to the extent that those are the ones That use the euro and that some of the imbalances really came from and then at the end I'm gonna give you a little look up here to the North Atlantic a little Iceland Because it had its own little unique interesting crisis in its own way So 1992 is when the seeds are sown for the euro In a little treaty that we call the Maastricht treaty Maastricht after the town in the Netherlands where it was signed and the finance ministers of all the European countries got together and they agreed on and Promised to meet what we call the euro convergence criteria And these are the criteria that a member state had to meet in order to be accepted into the euro zone And then was also expected to meet on an ongoing basis to remain a member of the euro zone So the first criterion that they had was the inflation rate and all the countries got together And they promised that they would get inflation under control and that no country could have an inflation rate greater than One and a half percent above the average of the three least inflationary countries Which is basically Austria Germany and the Netherlands as the case may be And so if you look throughout the 90s, you know in the early 90s I don't show you come in here in the mid 90s But inflation rates were pretty high in a lot of Europe like this. What's this color here purple? This is a Greece as a Greek inflation is 8% which is of course much higher than what the Maastricht criterion calls for And so throughout the 1990s we had this beneficial effect that To meet the criteria to join the euro a lot of these European countries got inflation under control And by the time we get to 1999 here, which is really when the the euro was induced as a as a virtual currency You can see they've got inflation Well by central banker standards under control. I mean 2% this is what their goal is Could have been zero which would have been fantastic But 2% is definitely a heck of a lot better than say 8% for Greece So this is this is quite positive and then the second Twofold criterion that we had in the Maastricht treaty was concerning government finances So all these member states had to pledge to get their deficit under control the public deficit and also debt levels had to remain under 60% of GDP the deficit had to be cut under 3% of GDP and debt under 60 And so if you take a look here deficits in the early 1990s were quite high even by today's standards and then on a positive note throughout the 1990s these euro convergence criteria Caused these member states to get their budget deficits under control and most of them got it by 1992 to about sorry 99 rather to around 2% of GDP You know a strange one in here is actually Germany, which is What do we have this color right here this red color it comes up better on my laptop But this red color is Germany and Germany's got this you know extreme budget deficit Which it had basically throughout the whole of the early 1990s after German reunification and all of their debt expenditures to get To get Eastern Germany up to snuff or the old Eastern Germany up to snuff and then Germany got his deficit under control But even it notably here in the early 2000s was not especially great veering back down to about 4% of GDP so Germany while we think of it as being this You know tight-fisted miserly You know has its government finances all in check was actually quite Quite loose for most of the 90s in the early 2000s the debt levels You know tell much of the same story most countries had fairly reasonable debt to GDP levels public debt to GDP levels The exception was Greece which was slowly creeping up over this time period Italy was always quite high But at least their hearts were in the right place and they were getting it back down in the right direction You know and that was really what mattered because Italy got into the euro in 1999 notwithstanding the fact that in 99 You know they're supposed to be down here at 60 percent government debt to GDP. They're actually up around 90 low 90 percent and But their hearts are in the right place and Italians are nice people and all that kind of stuff So we'll let them in and hopefully this trend will just continue for the next 20 years And maybe after 20 years they'd be down to 60 percent, right? So debt is the debt situation in Europe was looking quite good throughout the 1990s and then there's a couple other criteria Criteria put on here after the fact the exchange rate. Well, of course, we're all going to join into a currency union So we want some exchange rate stability. I'm not going to comment on that too much But one of the big focal points was long-term interest rates ten-year government bond interest rates actually and The Maastricht the final euro convergence criterion was that these long-term government bond interest rates had to be down within two percent of the three lowest inflation countries and You can see that this Actually of all the convergence this one's probably the strongest by 1999 I mean all the countries with the exception of Greece are basically issuing bonds that at identical interest rates and then by 2002 when the euro is actually introduced These ten-year government bonds are all yielding the exact same interest rating including Greece So this was the strongest of all the convergences that we actually saw happen in Europe And this was actually the most important one if I could you know put emphasis on one over the others For economists, this was the most important one Because the European Central Bank which all the countries were going to share was going to enact monetary policy through its open market Operations which was buying and selling government bonds in the states This is quite easy because the only government bond you buy or sell is is US treasuries But in Europe it's a little bit more complicated because the government bonds being bought and sold are all of the member state bonds And so if all of these interest rates were you know all over the place Open market operations would be quite difficult for the European Central Bank But the fact that they managed to converge them all By 2002 in the introduction of the euro simplified the ECB's Monetary policy immensely so most academic economists were really focusing on this and the general perception in the early 2000s was as long as these nominal interest rates remain converged we shouldn't have any imbalances or at least not significant imbalances and to give you an example of an imbalance that you'd get from a Divergence and a nominal interest rate Imagine for a sake of argument that you were in a currency union Well, you are in one of sorts so all the states share the US dollar notwithstanding that the states are more or less independent of each other and imagine that State bonds in Wisconsin were yielding 10% while they were only yielding 2% in Kansas and you would think that all your investment would flow out of Kansas and into Wisconsin and you'd think if anybody wanted to Borrow money they wouldn't do it in Wisconsin. They'd go over to Kansas to borrow money And so you could imagine that with Scott Kansas the low interest rate a state would pile up a lot of debt and Wisconsin the high interest rate country State rather would have a lot of investment and so that I just use as an example to show you how Diverging interest rates could cause cause some imbalances But like I say in Europe this problem was mostly solved as it is within the states as well because state bonds Do by and large yield similar nominal interest rates now of course One problem that didn't get so much attention in the early 2000s was the emphasis on real interest rates and if anybody's taken a Well a finance course for sure, but if anybody's taken an intermediate macro course Which I'm gonna guess I don't know put up your hand if you've taken a finance or intermediate macro like basically three-quarters, let's say of you a Big emphasis in economics is not on nominal rates, but on real interest rates And this is funny that this was not being given too much attention in the early 2000s in in Europe So to just explain the difference to you in a nominal rate This is really the interest rate that you pay or you receive is in money terms and in current money terms And a real interest rate is just adjusting that nominal rate for the rate of inflation and the reason why you would do this is as follows Imagine that I lent you a hundred dollars and you invested it in something that gave you a nominal return of five percent Sorry, I lent you a hundred dollars at an interest rate of five percent So one year from now you're gonna pay me back my hundred dollars plus five dollars worth of interest But imagine that you could have taken that hundred dollars and put it in an investment that returned three percent In which case after one year you'd have a hundred and three dollars You have to pay me back a hundred and five and the real cost for you to borrow that hundred dollars from me was only two or two percent So with real interest rates we factor out the inflation rate from the nominal interest rate and of course lower real interest rates Lead people to go out and borrow more money take on more debt Higher real interest rates are the opposite. They cause people to borrow less They they cause people to save more and it's it's caused by this interplay between the nominal and the inflation rates And again within Europe the situation is pretty straightforward because the nominal rate of return across all the countries is identical But what we saw was that especially starting in the middle of the two thousands there was some serious divergences in inflation rates And here you can see that the higher the inflation rate is The lower will be the real rate of interest and again the lower the rate of interest is the more you'd want to Borrow and go into debt so you can make the causation or the causal statement that higher rates of inflation Are correlated with lower savings rates or higher levels of indebtedness Or you could say well low inflation rates to the extent that they push Real rates higher or at least don't lower them by as much We'll have the opposite effect lower inflation rates will cause people to want to save more money and take on less debt And so with this understanding of the relationship between inflation and real interest rates We start seeing some interesting dynamics happen in Europe Throughout the early 2000s now This is Euro adoption formal Euro adoption Let's say in 2002 until the crisis begins in 2007 2008 And you can see these nominal interest rates. They're more or less. They track each other pretty closely throughout the whole of that So again in that real interest rate calculation. We just looked at there's not too much difference in there being caused by By these nominal rates one exception is Italy early on started having high nominal rates partly because Because it had some deficit problems and Greece was always a little bit higher for various reasons But on the whole most of the countries that I'm looking at and by the way I don't know if you realize that I did this but Europe's quite a complicated place again right now It's 18 countries share the Euro. I'm trying to simplify the problem down a little bit So Germany everybody looks at Germany is the big success story that's got no problems and everything's you know fine And happy financially speaking and then everybody looks at these other Belligerents the pigs. I don't know the term doesn't get used anymore But in the crisis they were called the pigs the PII GS for these countries along the periphery of Europe who seemed to have all of these economic and financial woes And then I just put in in dark blue here the whole of the euro area all the countries Just so you can see what the average is doing But in any case all of these countries here the nominal rates are more or less tracking each other quite closely So investment decisions would not be skewed much by those in other words nominal rates fall in Germany And they're also falling in in Spain or Ireland or Italy or Italy until they're anywhere so on and so forth and Then the crisis hits in 2007 2008 and just to show you how much of a divergence we've had in the year since I mean we've got this nice tight grouping in here in 2008 and then everything goes haywire after the crisis and of course now you open up your newspaper and You read many stories about Greek government bonds yielding 25 percent or now things are a little bit better but still quite high interest rates compared to everybody else and More likely today actually you don't read much about super high interest rates You read about negative interest rates like I made this presentation. I forget when maybe a couple months ago a month and a half ago and Just today Greek government sorry German government bonds here and read while they were yielding mildly positive rates when I did this today I think a 10-year government bond in Germany yields about negative a tenth of a percent mildly negative It's quite a strange situation to be in and the rest of them are mildly positive, but not especially high But this was the real you know the real High years of the crisis in here the the original crisis the housing crisis in 08 And then we had a government debt crisis in 2010 2011 when things got crazy and now things have kind of quieted down a little bit So we need to understand what was happening in the years leading up to 2008 That would have caused some problems notwithstanding the fact that these nominal rates They're all grouped together, and they don't suggest that anything or too much is going wrong And the easiest way to do that is to start looking at real interest rates And of course the real rate is just the nominal less the rate of inflation. So here I've mapped them all out But you know what things are a little bit crazy. It's hard to see what the specific problem would be for any one country So a nicer way to do this Or a nicer way for me to think about it is to ask yourself What inflation rate would be relevant if you were calculating the real rate of interest? like if you're going to your bank and you're going to take out a mortgage and How big a mortgage or whether you're going to take out a mortgage is going to be dependent on two things How much you're going to have to pay your bank and interest the nominal rate and what you think inflation is going to be in The future the the question that you have to ask yourself is what rate of inflation would actually be relevant to you obviously the You know the Brazilian rate of inflation is not relevant to the decision the Spanish rate of inflation is not relevant to you guys But what is relevant is the inflation rate that you personally face not necessarily the one where you borrow But the one where you live and where you face and so I made up this little graph for you because basically what I Have found is is the easiest way to describe the euro crisis is to look at borrowing and the cost of borrowing and lending for the individual countries and for a German They could go down to Spain and they could invest their money in some Spanish investment and earn that nominal rate of return But they don't have to care about inflation in Spain, which was quite high by the way relative to German standards They just live in Germany So they care about what the rate of inflation is for German consumption goods How much their food is going up by their clothing their housing expenses things like that? And when you start adjusting these real rates when you start looking at them not you know on a country by country basis But you start saying well for Germans. What's the real rate of return if they make an investment in all of these countries? The situation is a little bit different and again things look okay in the early 2000s and not too many imbalances were starting in Europe in the early 2000s and then starting in 2005 That's when the divergences within Europe really start happening And that's when we start seeing much higher inflation in the south than the periphery of Europe and very low inflation in Germany And as a result these rates of return one way to look at them is that a German could have invested their money in Germany and earned this red rate of return which is In real terms about one one and a quarter percent, or they could have taken their money over to this is What color is this they're all brown Italy? It could have invested his money in Italy and earned a little under two percent That's a it's a pretty big spread and you think there must be a big incentive for Germans to not want to invest their Money in Germany at these low real rates But to take their money to the periphery so that they can get a little bit of a higher rate of return and just to put this in Perspective maybe the easiest way to illustrate it is to just show the spread Between the real interest rate a German would get by leaving their money in Germany and That of investing in a different country So if the Germans going to earn nothing above the German rate of return by investing in Germany That's this red line here. That's the baseline This is the advantage for for the German to it to invest his funds in all of these other countries example This is Italy right in 2006 a German could have made About three quarters of a percent more by investing in Germany then sorry in Italy than Germany Which is not so insignificant if you think about for you for us. I mean we're probably small-time investors We're probably not chasing Three-quarters of a percent, but if you were a bank with a billion dollars to invest all of a sudden three-quarters of a percent becomes What seven and a half million dollars on a billion? So the the profit margins were quite high if these if these Germans would just take their money to the periphery of Europe and they were getting higher as as periphery European Peripheral European inflation increased while German inflation stayed very low very muted and So throughout the early sorry rather the mid-2000s We start seeing this divergence where a lot of German funds start flowing to the periphery And I'm I'm not doing this to pick on the Germans although I am a little bit but I'm using Germany as the proxy for the core of Europe Austrian funds were also doing this and Dutch funds were also doing this and Danish funds and lots of core European Money was finding its way to the periphery and on the periphery then what do you think was happening? Like you've got all these German savings that flood down into the the outskirts of Europe if you will So what are you going to do if you're in Spain and you're flush with all this German money? Spend it spend it on something and the big Avenue Well, the avenues were different depending on the country in Spain the Avenue was a private commercial real estate Well commercial real estate and private dwellings so a lot of apartments a lot of houses and a lot of a lot of skyscrapers actually as the case may be in Italy it was a lot of government debt is actually where it went into and there was a lot of government expenditure built on these German savings the same in Greece Ireland saw an awful lot of residential Residential investment things like that Portugal as well But the main point is there was a big spending spree that happened in these countries in a big build-up Which was built upon all of these German savings that were coming into the the periphery countries and so we get to the bus stage which is 2008 and You know, there was real reasons why there was Early on in the euro. There was a lot of real reasons why European money core European money was flooding down to the periphery Because the periphery of Europe is really nice Like if you're a German who's German here, don't be don't be embarrassed If you're German and you want to buy a nice vacation home, you don't exactly go to Hamburg although you could you go to the 17th Federal state of Germany, which is Mallorca in Spain a little island in the Mediterranean You buy a vacation home and there was lots of real reasons why Europeans were coming down to the periphery Mostly along the Mediterranean to make their investments to buy new houses vacation homes things like that Of course, that has a real limit, right? I mean, there's only so many Germans who can buy a vacation home in Mallorca There's only so many Dutch who can buy a vacation getaway in Sicily And so as that limit starts getting hit There's fewer and fewer buyers available to to keep the game going and in 2008 we start seeing the game coming to an end now the crush the crash starts happening and I'm gonna phrase this in terms of Germans again Germans start getting scared So they start taking their money out of Spanish banks and financial institutions The one they had invested in originally and they start bringing it back to Germany But if you remember from your lecture with Professor Herbiner about fractional reserve banking yesterday As soon as depositors and investors start bringing in their loans start bringing back their deposits from these banks The banks are really stuck in a in a bind This capital flight leaves them with not enough reserves and not enough assets in order to honor all of the deposits So all of these periphery banks had a big problem as more and more money flowed back to to the core of Europe And of course the banks have to respond in the way like I'm a depositor with with my bank in Spain So I went and I asked for money and they needed to come up with money They didn't have any liquid assets because the Germans had taken all the liquid assets back to Germany But they need to come up with something. So what do they do? They foreclose on some houses or they foreclosed on houses that people couldn't pay their mortgages on any more things like That and to give you a statistic of the scope of the problem in Spain I was there to give you a background. I moved to Spain in in September 2007 so I kind of saw the top tick of Spain's boom and then I I wrote it the whole way down and I'm still there. So it's it's an okay place, but it's pretty good place actually but in Spain at in 2009 or 2010 there was one million Unsold residential units in that country Spain is only about 40 million people to put it in perspective So that's like one unsold apartment for every four people or basically one for every family And to put that in comparison for you in all of America at that same moment in time There was only a million unsold housing units in this whole country So a million for 320 million people in the States versus a million for 40 million people in Spain You can see the size the scope of the problem that periphery you're a pet So we get this capital flight and Germans start calling in their loans And they start getting scared and they bring their money back to to say for banks back in the core of Europe And a lot of these peripheral banks are in in troubles So then the problem becomes well, what do we do with what do you do with a bank that has? Depositors that it doesn't actually have enough capital enough reserves to pay out on like what happens if somebody in Spain goes to their bank And they say hey, I'd like to take out a hundred euros But you only have 80 euros sitting in the vault. What do you what do you do with those banks? We had the same problem in the States and some of the solutions were the same some of them were different There's basically five different types of solutions you could do actually I should have put a six solution on here Which is do nothing just let the banks go bankrupt Which I'll give you an example of where that happened in a moment But the the five active solutions I should have called and their solutions with scare quotes because Their solutions that create a new problem as the case may be is bailout Which was this was primarily the American solution. So you use taxpayer funds to To recapitalize some insolvent financial institutions give money to them That was like AIG in the States for example got a big bailout In Spain and lots of the peripheral European countries We saw quite a few fairly large bailouts and and more commonly we would see the banks become nationalized The governments would just take them over At least for a time period now They're almost all back to being privatized But the government would just take on the bank as a branch of the government and eat the losses To try to save depositors Or from the government's point of view Governments and this was typically a Greek and a Portuguese problem has so much debt Accumulated that they didn't have enough revenue to pay it off and so the solution was to give a haircut to their data haircut is a nice way to just say You're going to give it to your creditors in the sense that Greece would have a million dollar bond owned by somebody else and they couldn't pay it off So the government of Greece would say well now we're going to give you a haircut of 50%. I'm only going to pay you back 500,000 50% haircut and Greece actually did that twice They gave all of their creditors on the government bonds two haircuts at 50% each So somebody would have lent the Greek government a million dollars Let's say in 2006 and then in 2009 they got a 50% haircut So they would have only got 200,000 back instead of a million and then in 2011 they give them another 50% haircut So your initial million euro investment was only going to get paid back 250,000 euros and interestingly enough the sneakiest thing about this was they only did it on the private investors So if you were a government who owned Greek government debt Or or a super government organization like the IMF or the European Central Bank You never had to take a haircut on the debt But if you were you know a small one-time investor you had to suffer this 75% loss because the two haircuts And they also did one in Portugal You know historically Inflation would have been the solution so the government can't pay its debts Let's just fire up the printing press and that'll paper over things and that was in in many ways That was one of the solutions that actually happened in the States Because Congress if you remember early on in the crisis They were kind of debating and taking their time for good reason debating what they were going to do in the crisis But the Fed just stepped in the Bernanke Fed and said well We'll just inflate we'll buy up a lot of this bad debt and we'll we'll pay the banks with cash for it But in Europe you can't do this or it's really hard to do and the reason why is Right now we have 18 different countries that all share one central bank So when central bank policy gets made you have to get 18 different Europeans in a room to agree on it and 18 Europeans in a room to agree on something is is pretty tough So so we don't really see at least early on in the crisis a lot of inflation coming out of the European Central Bank Of course, we do now in in the last couple of years But early on we this was an option that was really not pursued very hard very often or Alternatively we could have created forced creditors this this didn't happen but a forced creditor would have been saying something like hey depositors you have your money in the banks and I know you can come and ask for it on demand like if you got a hundred dollar deposit You can go in at a moment's notice and ask for a hundred dollars But I'm gonna make you a forced creditor, which means you can't ask for your hundred dollars back until five years from now Or ten years from now or something like that You would convert a depositor into a bond holder and that option thankfully didn't get pursued in Europe but what we saw especially after the The the crisis in Cyprus a couple years back is what we call a bail in and the bail in was Within any bank you have depositors who have money Depositors in the bank and then you also have investors who have bought stocks and bonds and things like that in a bank and the bail In the idea was well We're gonna make sure that depositors get back everything that they put into a bank or at least up to the insurable amount Which in Europe is a deposit insurance covers up to two hundred fifty thousand which I think is the same as what you have in the States Right two hundred fifty thousand dollars No, maybe in Europe. It's only a hundred thousand It's a hundred thousand euro. I mean I'm pretty far below this so I don't really These are unimportant. These are such big numbers to me that they don't really concern me But you were gonna be you were gonna be covered through the bail in up to the insurable amount and then Investors bondholders and stockholders They would just lose all of their investment to make sure that depositors are made whole again Which actually is a is a fairly good solution if you could ask me after the the sixth solution Which I didn't put on this which was do nothing and let the banks fail and see what's gonna happen Now to show you what that might look like I want to give you a comparison and a contrast between two countries that are basically spelled the exact same But are pretty different. There was a joke in 2008 there was a joke Iceland was in meltdown extreme meltdown and for various reasons I'll tell you in a minute and Ireland was was getting pretty bad and there was this joke saying what's the difference between Iceland and Ireland? One month in one letter meaning that if Ireland just waited one month It was gonna end up like Iceland and Iceland was an extreme basket case So we got little what are the other similarities? They're both kind of kind of small somebody some Social justice what do they call social justice warrior is gonna say you know the Mercatus projection makes Iceland looks so big and important It's it's 320,000 people and Ireland's about a give or take five million Let's just say and one of the important things is at the beginning of the crisis They both had these massive financial sectors very large banks Very few banks by comparison to the states like in Iceland. Okay 320,000 people. There were three banks But those three banks had total assets equivalent to about 11 times Icelandic GDP To put it in comparison in the states the banks would be about three or four times American GDP so these Icelandic banks are are quite huge relative to the size of these little economies and And they're both European which is the other reason why I want to compare and contrast them But they both got the same problem that when 2008 happens We've got these large very large financial sectors that are in trouble and everybody's looking for solutions So what are the actual solutions and there's three key solutions that happen in the two countries And they were each different depending on where you were So when Iceland they decided to liquidate part of their banking system They implemented what we call a good bank good bank bad bank solution So the idea is we've got a big bank which is kind of bad because it's got a lot of bad assets and you know A lot of debt and things like that so we'll split it up We'll we'll shear off a portion and we'll call it a good bank And we'll put the deposits there and we'll also take the good assets what's available the good assets And we'll put them in that bank so it's fairly sturdy and then we're going to be left with a bad bank which is even worse than the one we Started with but at least it will be contained and that bad bank when losses are suffered They will not be suffered by depositors But they will be suffered by other types of investors shareholders in the bank or bondholders or things like that Iceland when they did it because the Icelandic banks they had they were like Vikings. They invaded Europe and And Everybody gets their just as erds Iceland When they set up the good bad the good bank bad bank system They decided to shear off their British operations and put them in the bad bank and of course for British depositors This is quite a terrible thing. I mean the Icelandic government was looking to secure Icelandic deposits by keeping those in the good bank And there's not very many good assets. So, you know, we can't let everybody in this good bank So everybody else all the other Europeans Icelandic banks mainly had operations and in the UK and in Scandinavia They were in the bad bank and when the British government found out about this they used they enacted an Anti-terrorist legislation that they passed after 9 11 to seize the Icelandic banking assets that they held in the UK So that these British depositors in the Icelandic banks wouldn't be left with nothing and you talk about unintended consequences of some laws and this is you know Surely in 2001 when when British Parliament passed anti-terrorism legislation, they probably didn't have Iceland in mind or When they when they passed it and then in Ireland they took the polar opposite approach They said we got a lot of bankrupt banks or a lot of we've got some very large very shaky financial institutions What are we gonna do with them? Let's nationalize them so the government decided to take them all on nationalize the assets and infuse them with with public money and in in night in sorry in 19 in 2009 the amount of public money necessary to To nationalize this banking system to make it solvent again was equal to about 60% of Irish GDP I mean that would be in the state 60% of American GDP must be like I don't know 12 trillion dollars to put this in perspective and The amount of debt if you were to put it on a per person basis it indebted every single Irish person And that's you know infants up to you know nearly deads to the tuna to the tune of Because before you die you want to get your debts in order and they were they were indebted to the tune of about 25,000 euros per person that's you know a little baby welcome, you know welcome to the world and And that was on top of the existing Irish government debt That was just the new debt they took on to nationalize the banking system and then the second key difference There's two types of depreciations you can do with your money one's called external one's called internal External happens through your exchange rate, so the Icelandic crown takes a tumble About 60% in one year and all of a sudden exports get really cheap Like if you went to vacation if you went on vacation to Iceland in 2005 I feel so sorry for you because it got 60% cheaper if you had to just waited a couple of years That was that was how extreme that the exchange rate depreciation was and in Ireland they took the opposite approach Well, they didn't have much control over this they had what's called an internal depreciation Which is price deflation and the reason they had this not because they wanted it was because with the European Central Bank It's just not easy for them to inflate the money supply again You had to get all the countries in the room together There was 15 euro countries at that moment in time you had to get them all in the room together to agree on monetary policy and Of course the Germans didn't have such a big problem, so they didn't want much inflation plus the Germans don't you know they're not into inflation to begin with and All the periphery had problems, so they wouldn't have minded a little bit of you know Money printing and price inflation that goes along with it, but it didn't happen So in Ireland we saw a good dose of price deflation mostly in asset values house prices really took a tumble Also some consumer goods prices took a tumble restaurant prices for example those types of luxury goods started falling Which was quite beneficial because it started motivating people to come back into Ireland to make investments like You didn't want to buy a vacation home in Ireland I don't know ever I guess if you're smart But you didn't want to buy a vacation home in Ireland in 2007 because it's a little bit expensive at the peak of the boom But give it a couple years and let that house price fall in half And then all of a sudden you motivate people to come and buy those unsold assets in your country This external depreciation in Iceland I'll give you a little funny anecdote that goes along with that So the exchange rate takes a tumble the crown the Icelandic crown like I say it lost about 60 percent visa V the Euro in 2008 2009 and of course this is quite good for Iceland's export industries like if you were You know if you were a fisherman and you were trying to sell me You know cod to Europe okay fantastic now your cods now were 60% less than it was But of course Iceland doesn't really export all that much because you know how many cod do you export? But it imports an awful lot because not much gets made in Iceland like basically every loaf of bread you know is not made with wheat grown in Iceland And there's not too many factories making t-shirts, and there's no automobile industry or anything like that so Basically everything gets imported into Iceland and now it just became 60 percent more expensive because the corona the crown depreciated and so normal Icelanders were going to the grocery store and what was already expensive was now 60 percent more expensive and Normal Icelanders were really having troubles making ends meet and it was it was quite painful for them and Then finally we get to the issue of capital controls Iceland things got really bad and Iceland went looking to its friends for help So its friends are like Scandinavia and the Americans Americans after the war they had a they had bases in in Iceland You know to keep you know to monitor the Russians see where they were sneaking around or the Soviets I guess back then and Iceland went you know looking all his friends banging on everybody's door looking for a little bit of help You know you start calling your friends Can you make us a loan for a couple billion dollars and of course in 2008? Everybody had their own problems So nobody was really looking to pick up the phone from little Iceland So who did Iceland turn to but the international monetary fund so the IMF made them a loan for a couple billion dollars But the IMF they always put you know like any creditor. They're gonna attach some they're gonna attach some Some controls onto this loan So they put on what they call capital controls and capital controls basically block off the island Stop Icelanders from taking their money out of the island But also stop foreigners from bringing their money and investing it in our in Iceland So these capital controls were put in place mostly because the IMF infused the country with cash and to stop that cash from escaping but they also stopped new cash from coming in and so now all of a sudden the poor countries up there and One way to get out of crisis is to get foreigners to come and invest in you But nobody could invest in Iceland if they wanted to nobody can take advantage of this exchange rate Depreciation because the capital controls don't let them take funds into the country and also Icelanders because these capital controls They can't get their money out of the country like for example You know, I feel sorry for the ice the poor Icelander who was on vacation in Bali and You know capital controls go in one day and basically what that means is you can't get your money out of the country anymore So you go to the cash point and put in your card and ask for you know, however many a million Indonesian rupee because because the exchange rate it's like 10 bucks and You know, it says I'm sorry. I'm not able to process this transaction Please call your bank and you'd be stuck there and you can't get your money out And if you wanted to get your money out of Iceland during this time period You had to go to the central bank of Iceland and you had to fill out a form and you had to tell them Why you wanted to get money out of the country, you know, what's your reason? Oh, I'm a student studying in Denmark Okay, that's a reasonably good explanation. We'll let you take out some money. I want to go on vacation to the south of Spain No, I'm sorry. That's that's not a good reason. So we're not going to give you money Which basically means that you can't get yourself out of the country so it was quite a difficult time for For Icelanders themselves in the sense that their lives were being controlled by the fact that they couldn't get their money in or out of the country in Ireland thank God for the European Union Because by right of the fact that Ireland was in the EU it was not possible for them to put on capital or Financial controls, you know, one of the pillars of the European Union right now is the free flow of capital and people across borders And so Ireland thankfully could not put capital controls on its markets to stop Germans from investing in Ireland Or from Irish people getting their money out and bringing it down to Spain or anything like that and as a result as Prices started falling in Ireland It was possible for foreigners to flood into the country to start buying up those assets at lower value houses that were being unsold or Businesses that were being unsold or or things like that And so when we take this when we take this together What's really helpful is you can make a little roadmap from Iceland in Ireland and you can piece together the good and the bad things Well, no, you're gonna piece together the good things that each country did to try to come up with a Set of policies that you could do if the same thing happened again Like in Iceland one of the nice things that they did was they let part of their banking system get liquidated instead of you know artificially nationalizing it and keeping it afloat and the really beneficial part about this in Iceland was Part of the banks failed and that was really painful in the short term But at least investors knew what was good and bad So you looked at the good banks that remained and investors didn't have any they had faith that these were still stable banks While in Ireland you looked around and all the banks got nationalized and you didn't know what was good or bad or in the states when When the troubled asset relief program infused money into banks it it was illegal for the Fed I think to say or Congress to say which banks were recipients of funds I'm pretty sure that was attached to the law So you never knew which bank was unstable to the point that it needed a government bailout and which one was okay on its own Similar in Iceland sorry in Ireland So Iceland did a good thing by letting the banks fail because at least people knew where the rot was and they could avoid it and get On with their lives on the stable part of the banking system Well the same time Ireland did a good job by letting this internal depreciation happen because as asset prices fell People were able to scoop up these assets at the reduced value like in standard econ class If you have a surplus of something You need the price to fall to the market clearing level to get rid of that unsold surplus Well, that's what happened in Ireland you had unsold houses The prices just kept fell falling until people came and buy them and and because capital markets remained open a lot Of those people were foreigners who came in and scooped up these these troubled assets at at depressed prices Which you might not think is the greatest solution But it's something nobody was buying these assets otherwise and nobody was able to buy these assets up in Iceland because the capital controls But at least in Ireland they could and so the last thing I'll show you here is Just a little comparison of of how these two countries did after their own little recession. This is GDP per capita It's in euros. So 50,000 euros, you know back then 2007 a euro was about almost a buck 50. So this is about seventy five thousand dollars now It would only be about fifty five thousand dollars. It's taking quite a tumble So we got GDP per capita and you can see in Iceland here in red It's it's taking quite a tumble and that like I say is because the banking system collapsed Like allowing a sizable portion of your banking system is not without pain However, once that was taken care of and that happened in pretty short order Then we had a pretty strong unrelenting period of steady economic growth and in Ireland They bailed at the banking system and the decline took several years It wasn't until about 2011 that it finally flatlined and then the growth was very anemic afterwards and it's still be anemic until this you know 2005 2015 was a great year For financial markets in Europe because of the ECB not going to go into that but this is you know a little bit of a Artificial boom here going on in Ireland and here. I've just normalized it to give you a better bird's-eye view of things here If you just normalize things back for 2007 GDP per capita in Iceland Fell by about 45 percent. It was an extreme tumble as you could imagine if your financial system collapsed Well, like I say once that system had collapsed and everybody knew what was strong and what wasn't then we started seeing pretty strong pretty steady economic growth as investors come into the country once capital controls were lifted and and making use of the good assets that are there while in Ireland again Retaining these bad assets in the banks and bailing them out by the government just basically saddled the country with You know about eight years of no growth and it was almost very it was only very recently That the that the country actually did see some growth But like I say I don't want to get into it But this is this is more Imagine than real because it has to do with the European Central Bank monetary policy and not to not any real growth going on Thank you