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Iceland's depreciation a miracle cure? Only in Oz.

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Fredrik Sandberg/Scanpix Sweden/Reuters

(Read caption) Singer and songwriter Bjork Gudmundsdottir of Iceland attends the Polar Music Prize news conference in Stockholm Aug. 30. While some economists say Iceland is better off than troubled nations because it has its own currency, which it can depreciate, its economic contraction is accelerating.

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We keep hearing from various pro-inflation pundits like Paul Krugman and Ambrose Evans-Pritchard how the problems in various countries with the euro or with a currency pegged to the euro, like Ireland or Latvia, would have been eliminated or at least significantly reduced if only they could have and would have devalued.

As a role model, Iceland is often used. While they concede that Iceland has big problems, the problems are less severe than in allegedly comparable countries like Ireland and Latvia, something which they claim is due to its massive currency depreciation in 2008.

I have already discussed why the relative performance of Iceland is less favorable than some claim, and why it is not fully comparable due to the fact that Ireland and Latvia had bigger booms before the bust.

New numbers released this week now make the Icelandic example look even more like a horror example. First of all, the 2009 growth number was revised down further (or perhaps more accurately the rate of contraction was revised up).

Perhaps even more significantly, the second quarter GDP number shows that the contraction continues-and continues at a faster pace.

Compared to the previous quarter, GDP fell by 3.1% (11.8% at an annualized rate) compared to the previous quarter and by 8.4% compared to the second quarter of 2009.

That is what Krugman calls "post-crisis miracle" and what Evans-Pritchard calls "magic wand" [that works] its "magic cure".

While the sharp drop in the Icelandic krona has boosted net exports, it has also reduced domestic purchasing power dramatically.

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