Should Iceland's Next Currency Be the Canadian Loonie or Gold?

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My eyes nearly popped out of my head when I read this headline: "Iceland Considers Adopting Canadian Loonie."

The loonie is otherwise known as the Canadian dollar.

Of course, gold would be a much a better choice as I'll explain later.

But the simple fact that this tiny nation of 330,000 is even thinking about using the Canadian dollar as its currency would have been unheard of just five short years ago.

After all, we live in a world that is literally littered with fiat money. In this world the U.S. dollar has been at the top of the heap.

That the loonie may be Iceland's top choice is just stunning.

But the fallout from the 2008 financial crisis has caused increasing doubt about the long-term health of the greenback.

And with trillions of fresh new Federal Reserve Notes issued since then, it would be hard to call the Fed a friend of the U.S. dollar.

Even the euro has taken its hits. The European banking crisis caused scores of former "euro fans" to bail from that major currency, too.

And it's no wonder.

The massive debt held by the "PIIGS" has compelled the European Central Bank (ECB) and the International Monetary Fund (IMF) to bail out these countries and scores of banks with trillions of euros.

Still, all of this printing is far from over…

Greece vs. Iceland: A Tale of Two Paths

The latest installment in Europe's pathetic financial soap opera was Greece's second bailout (of which there was never really any doubt). This latest rescue totals $170 billion from the European Union, ECB, and the IMF.

The result? Financial repression and riots in Athens that lead to some deaths.
Remember when former Greek Prime Minister George Papandreou announced there'd be a referendum at the eleventh hour?

That would have allowed the citizens of the "birthplace of democracy" to have a say on major issues affecting their future. Heaven forbid.

Papandreou was then summarily ousted, setting the stage for Greece's current path.

I'm convinced that, given the chance to vote, the Greek people would have rejected the proposed austerity plans. And in the process, they'd have – unintentionally at least – forced their government to do the right thing: default and exit the euro.

If that was the case, Greece would have then seen the return of its former currency, the drachma, though severely devalued against the euro.

That would bring serious hardship, but it would also be limited in time and scope, allowing them the chance to regain their competitiveness.

Instead, Greece will suffer under austerity for years, along with a shrinking economy and soaring unemployment. The "bailout" will simply serve to repay the mostly German and French banks that were highly invested in Greek debt.

As is stands, Greece`s unemployment levels have exploded, with nearly one-in-two young Greeks out of work. That's a recipe for plenty more social unrest.

Greece's best case scenario is for its current debt-to-GDP of 160% to fall to 120% within eight years.

With the massive burden of severe austerity and the Greek economy shrinking to the tune of 16% since late 2007, how will Greece ever have the means to repay hundreds of billions in loans?

The truth is she won't.

In the end, the inevitable will be unavoidable: Greece, and probably others, will default and leave Europe.

But it doesn't have to be that way, as Iceland is proving there is a right way to do it.

Iceland Had the Freedom to Choose

You may remember that the 2008 mortgage meltdown was not confined to the United States.

That same year, overextended Icelandic banks also collapsed under the weight of their inflated mortgage "assets." Today, Iceland's financial sector is a mere fifth of its former self.

Thanks to its monetary sovereignty, Iceland was able to default on its bonds and devalue its currency. That's what Icelanders chose to do.

It wasn`t pleasant; unemployment soared and currency controls were put in place. But essentially, the free market was allowed to work.

Paul Rawkins, Senior Director in Fitch's Sovereign Rating Group, recently said:
"Iceland has successfully exited its IMF programme and gained renewed access to international capital markets. A promising economic recovery is underway, financial sector restructuring is well-advanced, while public debt/GDP appears to be close to peaking on the back of a robust fiscal consolidation programme."

In other words, the people of Iceland have not had their future mortgaged in order to bail out a bunch of greedy bankers.

Yes, the nation's financial system has contracted to only 20% of its previously bloated size. That's probably a good thing.

It's even expected that the Nordic country will attain a position of fiscal surplus this year and over the next several.

Just a few short years since Iceland's financial meltdown and default, Fitch ratings has upgraded Iceland to investment grade BBB with a stable outlook. They expect government debt will peak at 100% of GDP.

The Organisation for Economic Co-operation and Development (OECD) sees growth of 2.4% this year, following 2.9% last year. They see unemployment falling from 7% last year to 6.1% this year, and improving even further to 5.3% next year.

The Greeks can only dream of such a rosy outlook. Iceland, however, is not out of the Nordic woods yet.

There are still some legacy issues with the Icesave bank which, if a court ruling should go against Iceland, would push up public debt between 6% and 13%. Also, private debt is at 200% of disposable income and corporate debt is at 210% of GDP.

Still, Iceland is in much better shape than Greece and years ahead of it. But it does have major issues to resolve-namely choosing a direction for its currency.

The Quest for the Canadian Loonie

Before the 2008 financial meltdown, Iceland had been working toward becoming an EU member, with a goal of eventually adopting the euro. That's still the official government line.

But public and business interest in joining a failing political union and its quickly depreciating currency is waning.

I seriously doubt the euro (at least in its current state) will even exist long enough for Iceland to join the EU.

In the meantime, currency controls were imposed after Iceland's 2008 banking collapse, restricting foreign exchange transactions to 350,000 kronur (about $3,000). That limits foreign investors from repatriating profits.

Between 2001 and 2007, the krona rocketed 90%, and then gave it all back, crashing 92% the following year.

As capital controls are removed next year, many Icelanders are weary of a return to those wild currency gyrations.
In their search for a viable solution, Icelanders are favoring the Canadian dollar.

Heidar Gudjonsson of the Research Centre for Social and Economic Studies, the largest think tank in Iceland, summed it up like this:
"The average person looks at it this way: Canada is a younger version of the U.S. Canada has more natural resources than the U.S., it's less developed, has more land, lots of water. And Canada thinks about the Arctic."

Iceland could well take that route. They'd have no influence in Canada's monetary policy, and their small economy (Iceland is the smallest nation with its own currency) would be an afterthought in Canada's currency management.

The shocking part is that Icelanders favor the Canadian dollar over the U.S. dollar, traditionally the most sought after, and certainly the most widely held currency on the planet.

If nations are looking at alternative currencies to adopt, that speaks volumes about the Fed's mismanagement of the dollar.

The Currency End Game

In the end, the Canadian loonie may be a good alternative for Iceland. Its economy is skewed toward the fishing and aluminum sectors, and with its arctic shores, it's likely to become a new frontier for oil and gas.

Canada's dollar has been gaining in strength over the past decade, climbing alongside oil and the commodities complex.

But Canada is no model of fiscal restraint either. Most levels of government carry large debt levels. In the wake of the 2008 financial crisis, the federal government is running a $31 billion annual budget deficit.

Like most developed nations, Canada's central bank is pursuing a zero interest rate policy (ZIRP). That's likely to lead to the same effect it did in the U.S. and elsewhere, unsustainably inflating the insurance, finance, and real estate sectors.

When the next financial crisis hits, it's likely no country will escape.

Nations the world over are waging a lose-lose currency war against each other, devaluing their money to gain a slight and only temporary competitive edge.

Once interest rates rise substantially on even fatter levels of debt, the interest payments alone will become unsustainable.

That could bring about the end of our long running experiment with fiat money.

Gold is Real Money

Ironically, the industrialization of America, which ran into the early 20th century, took place under a gold standard.

It provided tremendous price stability as the money supply; the gold supply in fact, grew at roughly 2% per year.

As a productive nation, American exports were paid for in gold, which increased total gold ownership, allowing it to print more money, which was in turn invested in still more business ventures.

A gold standard means money is backed by a fixed asset-not paper.

This naturally self-regulates and stabilizes the economy, since the amount of gold a country has limits how much the government can print.

With a gold standard, inflation, budget deficits and debt are all but eradicated, since the supply of gold becomes the limiting factor.

Today, fiat money serves its purpose mostly as a medium of exchange.

Its other stated purpose, as a store of value, is failing miserably. It's not so much that the price of gold is rising as it is the value of fiat currencies are falling, dramatically.

Increasingly, the return to a gold standard is an idea that's gaining traction in ever wider circles.

In fact, just last fall, Steve Forbes predicted that within the next five years, America would return to a gold standard. To hear his comments you can click here.

It's not sexy, and it wouldn't be easy. But I submit the probabilities of ending up with a gold standard are multiplying daily.

Iceland could well go the way of the loonie for now.

But as a small, independent nation, why not seize the opportunity to make your mark as a forward-thinking place?

In my view this tiny Nordic nation ought to skip the Canadian dollar altogether and go straight to gold.

Today, Iceland has the chance to truly set a standard: the gold standard.

A move like that would certainly put Iceland back on the map.

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About the Author

Peter Krauth is the Resource Specialist for Money Map Press and has contributed some of the most popular and highly regarded investing articles on Money Morning. Peter is headquartered in resource-rich Canada, but he travels around the world to dig up the very best profit opportunity, whether it's in gold, silver, oil, coal, or even potash.

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  1. Peter | March 9, 2012

    Hi, Peter!

    If Iceland would go for gold and miljons of investors from all over the world would buy their currency as a safe haven, how would that impact their currency and economy?

    asks another Peter

  2. Skúli Sveinsson | March 9, 2012

    Hi, there is an incorrect statement in the article. Iceland has not defaulted on its dept at all and it probably will not any time soon if ever. When the crash happened in 2008 the net foreign debt of Iceland was zero. The Icelandic banks that failed in 2008 however defaulted but the government did not put money into them to try to save them. They were just simply too big to save with balance sheets at around 12 times GDP. Their balance sheets have now been cleaned up and bad dept writen off. This is setting the foundations for growth in the years to come and the economy is already growing.

    On 17 Feb. this year Fitch actually raised its credit rating on Iceland. I don´t remember when that last happened en Europe.

    • nathan | March 9, 2012

      No were in the article does it say iceland defaulted on debt. They defaulted on bonds.

  3. Ron Hemsley | March 9, 2012

    Canada a country of fishing & aluminium & a new frontier for oil & gas??? You obviousdly know nothing about Canada. We have one of the best governments in the world & the best banking sector in the world. The loonie is strong & looks to stay that way for some time. Hopefully when you have an election people will wise up & vote in a government that has some sense.

  4. Dad | March 9, 2012

    I think many Canadians would be taken back by "The average person looks at it this way: Canada is a younger version of the U.S. Canada has more natural resources than the U.S., it's less developed, has more land, lots of water. And Canada thinks about the Arctic." Generally anyone I know in Canada does not see themselves in any way as a younger version of the U.S. Americans believe they are capitalists, individuals have have the right to become wealthly at the expense of their friends or neighbours. Americans can deal with a reality that some people will live under bridges with no health care – that is American capitalism. Although an Icelander made the statement, I do not believe that the average Icelander, European or Canadian would be committed to the American capitalistic ideology.

  5. Jeff Pluim | March 9, 2012

    Canada will be presenting a new budget this month. By 2014 the Canadian government will be operating with a surplus. I am guessing that Canada will see a surplus prior to 2014 because of the drive to build the Northern route oil pipeline to Kitimat, to supply the Chinese with oil. That, and the measures to cut government spending will put Canada in a very strong economical position should the world economy stumble. The only reason that it has taken this long for Canada to balance its budget is that until last year, there was a minority government with Liberals and the even more left wing New Democrats forcing the Conservatives into stimulus spending. Now that there is a majority Conservative government, the Conservatives are pushing a more restrained budget.

  6. topeka | March 9, 2012

    Peter,

    Brilliant piece. Thanks.

    "In other words, the people of Iceland have not had their future mortgaged in order to bail out a bunch of greedy bankers."

    – not necessary for your argument, but I love this line. It's refreshing to read some common sense in a financial letter. ;-)

    Hopefully the Icelanders will choose gold. I fear their recovery will be dashed when the continental or global markets finally meltdown.

    Interesting, though, how many times we can be forced to follow policies invented in small, homogenous, Nordic countries when those policies are nonsensical. But we can't borrow a simple, solid idea? Yeah, I know it's a feature not a bug.

    Thanks for the piece, Peter. Good work.

  7. David | March 9, 2012

    Younger version of Americans? No way.

    We are merely decaffinated Americans.

    No one has mentioned that 80% of our foreign reserves are U.S. dollars. Trade too for that matter. IE – our dollar is backed mostly by USD. Doesn't that give you a warm fuzzy feeling?

  8. eric taylor | March 9, 2012

    The countries with the most in control ideological anarchists seem to have the highest
    debt to GDP! Going to a gold, or a bag of commodities standard would not likely work, without
    budget balancing discipline thrown in. The United States has influenced many countries
    to abandon fiscal discipline, and we may some day be the poster child of bad government.

    A tenable bag of commodities, or gold standard, is still much preferable to doing nothing,
    with Iceland being a small enough country to afford the attempt; Iceland is also relatively
    energy independent, a plus, and could bolster their countries reserves by investing all or
    a part of their pensions privately, as Chile has done. Chile's currency looks safe!

  9. Patricia | March 12, 2012

    Actually, the Canadian dollar is otherwise known as the "loonie"…….not the other way around.

  10. Bill Seaman | March 14, 2012

    ow these people can praise the Harpwr Government is beyond me. They started in 2006 with surpluses fo about $25 Billion a year, paying down debt, and the economy was stating to rcover from years of high deficeits aand growing debt. Their stinlus package along with reduction of 2% in GST (Goods And Services Tax) has resulted in now being $120 Billion futher in debt than we were in 2006 when they took office. In addition, all provinces are now in deficiet and most municipalities, so we now have an estimated $1.5 Trillion total government debt with a population of 33 million.
    They expect to get to balanced budget by 2014, but I don't see it.

    Bill Seaman, Moncton, New Brunswick, Cananda

  11. Shawn | March 16, 2012

    I find it shocking that you're shocked about Canada or its currency.
    For years, the World Economic Forum has rated Canada as having the world's soundest banking system.
    What's shocking is that more nations aren't considering switching.
    Especially in light of what else Canada is:

    "Canada: The Best Advanced Economy in the World"
    Link – http://www.economywatch.com/economy-business-and-finance-news/Canada_the_best_advanced_economy_in_the_world_28-07.html

    "Canada is now the only G7 nation to have recouped its losses from the 2008-2009 recession"
    Link – https://secure.globeadvisor.com/servlet/ArticleNews/story/gam/20110114/RBTICKERBIGRECESSIONATL

    "Canada Trounces U.S. In Best Countries For Business"
    Link – http://www.forbes.com/sites/kurtbadenhausen/2011/10/05/canada-trounces-u-s-in-best-countries-for-business/

    "Canada: Richer than America and more powerful than Europe"
    Link – http://ca.finance.yahoo.com/news/best-place-business-canada-154502953.html

    Some in Iceland and the US may mistakenly think Canada a younger version of the US.
    But Canada – in war, peace and economics – stands on its own merits, as it always has.

  12. eric taylor | March 18, 2012

    If the loonie is backed 80% by U.S. dollars, its time for Canada to try something new. Canada
    should follow China towards a commodity backed reserve currency, or consider adopting Iceland's
    currency. It's a shame that we depreciate our government and private pensions by purposely
    low-balling our government inflation rate. This has been going on for a long time. I just had to
    remind some friends retired to Ceylon that their U.S. pensions are being systematically diluted,
    and to also invest loose money in some of the stronger local currencies, not the U.S. dollar, that
    wont dilute down over the next 10 years. Even Bullwinkle and Rocky the squirrel know better!!!

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