Iceland Proves That in a Financial Crisis, Breaking Glass and Trashing Currency is a Good Remedy

The headline exaggerates, but not by much. Back in April, a Vanity Fair story about Iceland’s remarkable financial blow up was grist for a Vanity Fair story by Michael Lewis, “Wall Street on the Tundra“. The quick version is that Icelandic men were not merely reckless, that is such a common male pathology as to barely warrant mention, but were possessed of a particular fondness for physical aggression and bullheadedness that helped made Iceland ground zero for the most spectacular banking industry boom and bust in the history of man. Iceland managed to go on a debt party that saw its obligations soar to 850% of GDP, leaving America at a mere 350% firmly in the dust.

So how is Iceland faring now? One would assume still broke and chastened. One would be dead wrong.

The krona is down 50% from its peak, and it seems to have sparked a speedy revival. I remarked when Iceland fell apart that someone should swoop in and buy a business that sold strictly in international markets (I had thought fish oil would be a good candidate). But that takes time, legwork, and walking around money.

This is the same remedy that the Nordic countries used in their banking crises, save they nationalized the banks, put in new management, cleaned them up, and reprivatized them, But they also devalued their currencies versus the ECU.

But Iceland and the Nordic countries can make move like that without precipitating competitive devaluations. What works individually does not work collectively.

The EU bashing is a bit heavy handed, but the general comments are nevertheless useful

BTW, reader Richard Kiine is in Iceland now, perhaps he can give a report when he returns.

From Ambrose Evans-Pritchard at the Telegraph:

The krona has fallen by half against the euro since the `New Viking’ trio of Landsbanki, Glitnir, and Kaupthing strayed out of their depth and brought down Iceland’s financial system.

Nothing is cheap, but prices have come within reach. Reykjavik’s cafés are packed with euro-youth, at last able to afford a taste of all-night dancing at this Arctic Ibiza…

Out in Iceland’s Eastern fjords, Alcoa has raised aluminium production to record levels – and metal matters as much as fish for exports.

“The smelters are running full speed,” said the new-broom finance minister, Steingrimur Sigfusson. So is Mr Sigfusson himself. Last week he launched three new banks on the ruins of the old. Normality is returning. “We are going to get through this better than feared. We’re feeling real activity in the economy, and much of this comes from a favourable exchange rate,” said Mr Sigfusson.

Iceland’s great lurch towards casino capitalism over the last decade has a cultural logic. “We are a fishing culture: when the herring is there, we take it,” said Andri Snaer Magnason, author of `Dreamland: A Self-Help Manual for a Frightened Nation’.
There was no easier catch on offer than the Greenspan bubble and the global “carry trade”. How could fishermen resist?
In one sense it was a terrifying shock for the 310,000 inhabitants of this Norse-Celtic outpost of lava rock to see their currency, banks, and global image crash in a single week last autumn. Yet nothing has really changed.

“Everything still feels normal. The services of the state are intact. The swimming pool is open. You can still have a decent heart attack in Iceland,” said Mr Magnason.

“Friends who lost jobs in banking have already found new work, and you could say the krona has worked as a buffer for us. We all went down together, and that has led to healthier recession without mass unemployment.”

The jobless rate has risen to 9.1pc. This is below the eurozone average of 9.5pc, and is stabilising much earlier.

Those who point to Iceland as a scarecrow exhibit of what happens to a small country caught in a financial storm without the shield of euro membership have the matter backwards, as will become ever clearer over the next two years.

The OECD expects Iceland’s economy to shrink 7pc this year. This is much better than Ireland at minus 9.8pc, and recovery will come sooner. So next time you hear the Sacra Congregatio of the euro faith incant yet again that EMU saved Ireland from a terrible fate, know that they deceive only themselves.

You take your punishment early with devaluation, as Britain did on leaving Gold in 1931, or ending the D-mark torture in 1992, or now. You look a sorry sight at first, but sweet vindication comes later.

It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Greece, and rising.

At Iceland’s central bank – mercifully, no longer listed beside al Qaeda as a terrorist body by UK authorities – Governor Svein Harald Oygard says currency therapy is working as it should. “If you lean back and look you can see that fall of the krona accentuated the shock at first, but it is also now working as a turbocharger for recovery.

“We’ve seen a strong hit on wealth and asset values, but the story for real economy is very different.”

Devaluation is always double-edged. Some 13pc of households in Iceland hold mortgages in euros, Swiss francs, or God forbid, yen. Their debt levels doubled overnight.

Some 70pc of corporate loans are in foreign currencies. Exporters are hedged. Those that earn in krona are not, and a “large number” are now in dire straits.

The Governor is a Norwegian who cut his teeth in the Oslo banking crisis of the early 1990s. He was brought in as a troubleshooter after the last crew was literally banged out of the Sedlabanki by the Saucepan Revolution in February.
With justifiable pride, he showed me the latest trade figures. Iceland has defied the global shipping crash to eke out an 11pc rise in exports over the last year. Even China has seen a fall of 21pc.

Iceland will be back in surplus by next year, from a peak deficit of 25pc of GDP. You could say the same about Latvia, which has stuck to its euro peg under orders from Brussels. But there is a big difference.

Latvia is balancing its books by crushing demand. Exports are down 28pc, but imports are down even more. The result of this Stone Age policy is economic contraction of 18pc this year, and 4pc in 2010 (state data).

Icelanders have taken a hit, of course. Unions have accepted ‘real’ wage cuts of 10pc. Health care and welfare is being cut 5pc, education 7pc, and the rest 10pc. This is comparable to what is happening in Ireland, but again there is a difference. Dublin faces a Sysphean task as collapsing tax revenues force ever deeper austerity: Reykjavik is over the worst.

It baffles me why rating agencies still talk of downgrading Iceland’s debt to junk. The country should emerge with public debt of 80pc to 100pc of GDP – much like Britain. Yet Iceland also has the world’s best-funded pension system at 120pc of GDP. It is the two together that counts.

In their angst, Icelanders look wistfully at the apparent safe port of EU membership. The Althingi has voted to start entry talks. But the storm will have blown over well before an EU referendum is held in two or three years. By then the delayed cluster bomb of Europe’s unemployment will have detonated. Try selling EU protection then.

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  1. Anonymous

    It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Greece, and rising.

    And in Japan where the currency has actually appreciated during the crisis, the unemployment rate is… 5%.

    You are seeing what you want to see.

    Working people may be able to survive a trashing of the currency. But how does an elderly person survive after their life savings are destroyed?

  2. Diego

    It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Greece, and rising."

    Since students are counted as unemployed and there is no need to work while at university (unlike in the US), and registering as a young unemployed, even while working in the informal sector, means increased education opportunities… those stats on young unemployed are absolutely meaningless.

  3. Views By a

    Evans-Pritchard is so anti-EU that you just can't take anything he says about the subject seriously.

    Iceland has handed in its EU membership application. An unbiased observor might think it possible that the prospect of EU membership is helping to provide Iceland with some stability now.


  4. biofuel

    They went from cruising the seas with the sails of a strong currency to being imprisoned on their own island by a weak currency in less than a year. Last winter in Jamaica, locals were asking what happened to Icelanders, why none were coming when in the previous years there were many. I told them Icelandic currency blew up. From vacationing in Jamaica to being a Jamaica in the North: tourism and bauxite is exactly what Jamaica exports. Good luck with that…

  5. Anonymous

    Devaluation works when a country (1) is a net exporter of goods AND (2) the cost of producing said goods is in local currency. In other words, devluation will not work in Latvia or Bulgaria. When you import all/most of your raw materials, fuel and capital goods, how the **** is devaluation going to do any good? FYI, in Bulgaria labour costs are like 10% of all costs. Say you are a major producer/exporter. In a devaluation your labour cost will go down, but your gas bill will crush you in an instant.

    The debt in foreign currency goes without mention. Or does it? When you have a fixed exchange rate, consumers and businesses borrow in Euro, because they trust the currency board. When the rate is floating, people would think twice before borrowing in foreign currency. In short, devaluing from a fixed exchange system will do muc more harm than devaluation if you had a floating rate to begin with.

  6. Sergei

    The comparison between Iceland and Ireland seem a tad unfair. the three Icelandic banks have defaulted on their debts, while Irish banks haven't, and have been backstopped by the government. The Irish would have a much easier time managing their economy if they could simply allow their banks to renege on foreign borrowings…

  7. kpl

    appears Iceland defaulting has done wonders for the economy!

    shows that defaulting on your debt is the way out of a debt trap and get the economy going .. will others bite the bullet???

  8. Anonymous

    "We all went down together, and that has led to healthier recession without mass unemployment."

    All for one and one for all, eh? As Yves points out, this is not true. If you're old or reliant on krona-based income, you're worse off, as almost everything in Iceland must be imported.

    Evans-Pritchard acts as if this is a great accomplishment, but "feeling the same" as before is not the same as being the same.

    Icelanders are now having a sale, selling their labor and goods for 50% off. Sure you get takers, but are you better off than you were before the crisis?

  9. Anonymous

    I would like to know who are the foreigners that held Iceland's debt. I mean, defaulting works when you are a tiny island in the middle of nowhere. It doesn't work so well when you are EU with 1/5 of the world's GDP

  10. Anonymous

    Wasn't there a bunch of agreements that are pending before the Athling about assuming the huge debt burdens of the failed bank obligations towards EU citizens? I thought the size of the repayment is going to exceed what the Weimar republic faced after WWI. I don't know how anyone can say things are going well for Iceland — more likely that those clueless fisherman (and Pritchard) still don't understand the trouble they're in.


  11. Anonymous Jones

    As Anon 4:37am implies, this must be a bitter pill for the labor force, working for less to pay off the debts that almost certainly never could have been generated with such magnitude if Iceland had been on the Euro rather than the krona. Seems not just a little disingenuous of AEP to not even mention that having the separate currency allowed them to get into this mess in the first place. So by trashing it now, they get back to the 100% public debt to GDP ratio of everyone else, so what? [And if anyone cares, I'll believe AEP's claim about the debt ratio when I see it, not to mention that it is really the full private and public debt ratio that is more important, especially here because as AEP pointed out himself, a number of Icelanders have debts in foreign currencies].

  12. Gerter

    It seems that there's a new worldwide regulation that requires everything written about Iceland to be superficial. Lewis's article was a complete joke and comments by (somewhat) respected commentators such as Paul Krugman have been uninformed but listened to due to the author's accomplishments elsewhere.

    As for seeing a 50% currency fall as a positive thing, it's probably wrong in all cases and certainly wrong in Iceland's case. Evans-Pritchard sees it as he wants to see it, as usual, and just finds the anti-EU angle to the story.

    Not only does an unusually large percentage of GDP come from foreign trade, meaning imports have almost stopped, but a bulk of the nation took out FX loans for both mortgages and new Audi jeeps. This means that at any plausible level of the ISK a sizable amount of consumers are insolvent, and companies even more so.

    As with all currency restrictions, the ones in Iceland are leaking heavily with FX desks at Heathrow advertising "ISK for sale here!" and many of those allowed to sell the ISK at the inflated central bank rate arbitraging easily at such desks. There is still a very large amount of foreign investors stuck in the ISK, meaning it is sure to fall heavily again when they finally get out.

    In addition to that, separation between the "old" bankrupt banks and the "new" state-owned banks has taken over 9 months and the new banks don't even have balance sheets yet. Foreign (and domestic of course) investors have lost most of their capital but nobody knows exactly what will happen.

    The main talking point now revolves around the so called Icesave deposits that one of the Icelandic banks took in England and the Netherlands which have to be paid back under the EU deposit insurance scheme. Although the banks assets should go some way to covering this amount, the extent to which the taxpayers have to pay is unknown and will be for many years.

    The Icesave obligations will be added to the bailout of the Central Bank (nb. the Central Bank being the recipient of a bailout, not provider) where the government had to pump several hundred billion ISK (for comparison, GDP 2008 = 1,465bn) after the Central Bank provided financing to the banks without collateral weeks before the crash.

    Oh, don't forget the other several hundred billion ISK that were pumped into money market funds in the days after the crash to subsidize savers loss when the outrage was breaking out and the government was freaking out.

    These are just a few of the issues dawning on Iceland at the moment and anyone with a hint of insight would agree that saying "Reykjavik is over the worst." is highly delusional.

  13. Anonymous

    Recklessness is not a male pathology. It is an evolutionary adaptation that allows the species as a whole to make new discoveries and do new stuff.

    I could just as easily say that passive-aggressiveness in social situations is a female pathology and I would be just as incorrect.

    What is with the male bashing on NC today? First the story about women making better managers than men (talk about imposing a dehumanizing stereotype on a group of humans to degrade and ridicule), and now this.

  14. VG Chicago

    It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Greece, and rising.

    The Euro has been bad news for every country where it was introduced, especially in Southern Europe. The next target of the ECB is Eastern Europe.

    Makes one wonder how much longer until pitchfork-armed Spanish peasants and machine-gun-armed Italian mobsters start heading toward Brussels…

    Vinny Gold

  15. Dan Duncan

    Yves writes: "The quick version is that Icelandic men were not merely reckless, that is such a common male pathology as to barely warrant mention…"

    Hey Yves, you should put that gem on your book cover.

    So how does that work: Do we correlate the severity of all financial blowups to testosterone…or just this one?

    Damn China, I couldn't help but notice you weren't particularly hard hit by the mortgage crisis…what, are you guys a bunch of flaccid wimps? C'mon, start acting like MEN!

    Hell, I shouldn't be so sarcastic.

    In all seriousness, though…as to the Iceland situation…it really is a compelling theory. But the one key point you and Lewis missed is the following:

    Yes, the Icelander men were waayyy too aggressive and reckless. But the thing about that recklessness is another unreported consideration: The Icelander women just were never satisfied with the gains enjoyed by their male Icelander counterparts. These demanding Icelander women would constantly harp on their boyfriends or husbands to make more….so much so that they would threaten to leave their significant other and sleep with a more successful neighbor. The pressure on Icelander men was unbearable! They had to do more…even if aggression turned into recklessness—they would have to live with the risk.

    "Bjorn, our house is too small. Buy me a bigger house. And a bigger car too!"

    "Don't worry Babushga! I just secured a BIG finance deal with some Nigerian-Russian investors I met online. Lots of Kronas!"

  16. Yves Smith


    I have no view on Icelandic men or women, If you reread the post, I am summarizing Lewis' article, and if you were to have read that, he does make quite a few snarky comments on Icelandic male aggression as a cultural trait and relates it to fishing and the crisis.

  17. Dan Duncan

    Yves, please:

    You wrote the following, not Lewis:

    "[recklessness]…that is such a common male pathology as to barely warrant mention…"

    It's a ridiculous oversimplified generalization.

  18. RockyR

    This blog is on fire…

    …as in going down in flames.


    "The quick version is that Icelandic men were not merely reckless, that is such a common male pathology as to barely warrant mention, but were possessed of a particular fondness for physical aggression and bullheadedness that helped made Iceland ground zero for the most spectacular banking industry boom and bust in the history of man."

  19. Yves Smith

    Rocky R and Dan,

    With all due respect, you did not read what I read, I point out that Michael Lewis wrote an article on the Icleandic meltdown. The very next sentence starts "The quick version…." it is quite clear I am referring to Lewis' account.

    In fact, if you go to the Links page where I point to Lewis's article, I say it was mean spirited. The article is over the top and I signal that.

    I suggest you look at context. You both got upset b a colorful characterization of the Lewis article, which frankly is MORE offensive to Icelandic men than what I wrote. Go attack the right party on this one, Your ire is badly misdirected.

  20. Anonymous

    The article is mean spirited (and lotsa fun), but I suspect that the superficial stereotype may be true. I mean, these guys got into debt that was 850% of GDP. How do you explain that without bullheadedness?

  21. skippy

    Concur with above, a country or region is precluded to certain psychological norms. To engage in any type of activity with out forethought to these conditions can leave one banged up abroad, financially or physically.

    Skippy…Dan Duncan going PC shudder the thought…hay Dan work on a construction site for a bit, the bigger the better. Then get back to me k.

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