#1. Prime Minister Considers 100% Currency Reserves
Recently, the Prime Minister of Iceland commission a study aimed at monetary reform in his country. Frosti Sigurjonsoon[1], an Icelandic member of parliament, conducted this study and is advocating for a 100% reserve for their country’s currency. In other words, abolish fractional reserve banking and don’t allow banks to make new money. But is it a good idea and does it have a chance?
[1] @frostis on twitter
#2. Iceland has suffered terribly from bad monetary policy
Iceland suffered significant monetary instability throughout much of the 20th century. Various government programs like currency controls and inflation preceded the remarkable figure of 83% inflation in 1983 alone! Inflation was so bad, they decided to redenominate the currency by a factor of 100, which is really a fancy term for dividing the numbers on their bills by 100.
#3. Iceland’s economy has trouble on the horizon
Iceland’s economy is tied closely with exports, which means GDP corresponds to how well their export market is doing. This can be a problem if the krona’s value increases against those of foreign currencies. If, for example, Icelandic fish used to cost 10 USD and now because of krona appreciation costs 20 USD, fewer fish will be exported from Iceland to the US.
#4. There Are Almost Zero Good Options
Typically, currencies that don’t have an expanding monetary base, e.g., a 100% reserve, will tend to appreciate against those that do. As countries print more money, their currencies fall in value against those that don’t. So if Iceland adopts 100% reserve banking by law, we can expect other countries to find Icelandic goods more expensive over time. This would hurt the export nation.
#5. Prepare to pay the piper.
If the government can’t rely on monetary policy to create new money, it stands to reason that they’ll use fiscal policy (taxes) to do so. Tyler Cowen asks the questions[2], “How powerful does the statement become? On what do they spend the money?”