Never underestimate the importance of luck
The financial media is full of stories about some countries are doing the right thing and other are doing the wrong thing. Everybody today agree that it was obvious that the Icelandic financial system was going to collapse and everybody agrees that Greek’s economic problems could have been forecasted easily. I actually think that both cases were pretty obvious examples of accidents waiting to happen and the only reason that they did not play out earlier was investors where betting on some kind of rescue if we would see a collapse. However, it is not always so clear. Why for example has Belgium with very high public debt not been as hard hits by the European debt crisis as for example Italy or Spain? We can surely find explanations, but many of these explanations have to do with pure luck rather than fantastic skills of policy makers. How often have we heard Finance Ministers around the world blame their countries’ bad economic situation on “the international crisis” – “it is out of hands and we can’t do anything”. On the other hand when things are fine policy makers will happily claim that things are fine thanks to their fantastic policies. An example of this is Poland’s rather remarkable escape from recession in 2009. Poland was the only country in Europe to grow in 2009 and Poland’s Finance Minister Jacek Rostowski happily declared that Poland was “immune to the crisis”. The fact, however, is that a key reason for Poland’s relatively strong economic performance was the near halving of the value of the zloty during the first half of 2009. Another example is the Icelandic economic and financial collapse. In 2001-2 the Icelandic banking sector was deregulated, privatized and opened up. That of course coincided with a significant increase in global risk appetite, which made it possible for the Icelandic banks to expand their balance sheets to an unprecedented level of around 10 times Iceland’s GDP (mostly outside of Iceland). So when crisis hit in 2008 the whole thing came crashing down and Iceland is now widely believed to be an “irresponsible” nation like Greece. But the fact is that the things might have been very different had Iceland been a bit luckier as a nation then things would have been very different. Lets imagine that the deregulation and privatization of the Icelandic sector had happened five years later in 2006-7. Then the Icelandic banking sector would likely never have expanded its operations and foreign currency loans would never had become widespread. In that scenario the Icelandic banking sector might have been an example to the world of a prudent and conservative banking sector – a typical Nordic banking sector – and Iceland might not even had entered recession. In Milton Friedman’s wonderful little book “Money Mischief” he tells the story of two countries with “identical policies”, but “opposite outcomes”. Both Israel and Chile introduced fixed exchange rate policies against the dollar. In Chile in 1979 and in Israel in 1985. For Israel it was a massive success, but for Chile it was a disaster. Chile pegged the peso to the dollar at a period, which coincided with a strengthening of a dollar and a collapse in copper prices (Chile’s main export). So Chile was hit by a both a monetary policy shock (the stronger dollar) and a supply shock (the drop in copper prices) just as the peg was introduced. For Israel the opposite happened – the shekel was pegged to the dollar at a time when the dollar was weakening. The differences in the “external environment” had a great impact on how well the experiment with exchange rate policies impacted growth. Chile went into recession, while Israel grew nicely. The stories from Chile and Israel as well as from Poland and Iceland are reminders of what Friedman tells us in “Monetary Mischief” (Chapter 9): “Never underestimate the role of luck in the fate of individuals or of nations”. So next time you celebrate how clever an investor you are or you think of the Greeks as lazy and irresponsible. Remember what Friedman told us – it is often just about luck or the opposite.