Wednesday, December 9, 2009

Aftermath of Iceland Economic Crisis

What happens when your financial sector and economy collapses?Iceland will provide an interesting case study for future economists

To recap:
  • Iceland's banking sector expanded rapidly as they lent money to financial institutions around the world.
  • The foreign exposure of Icelandic banks were enormous, their loans and other assets totalled more than 10 times the country's GDP
  • In 2007/08, the subprime mortgage crisis led to a spate of loan defaults in the US, but, this spread around the world. Icelandic banks had exposure to these toxic loans and soon there losses mounted. Given extent of banking loans, Icelandic banks suddenly looked very vulnerable.
  • Despite government attempts the banks went bankrupt and they were forced to borrow $10bn from the IMF.
The main implications of this Financial Crisis are:
  • Rapid depreciation in the Currency.
  • This reduces living standards and increases price of imports
  • McDonalds recently left Iceland because a Big Mac would be too expensive after importing raw materials
  • Unemployment has increased from 1% to 10%
  • GDP has fallen 7%
  • Inflation has increased to 11%
Yet, despite these dire economic statistics it is not quite the end of the world. The rise in unemployment could have been worse and there is a prospect of returning to 0% growth in 2010.

The initial anger of Icelanders at their bankers, their government, the British government, foreign bankers e.t.c has somewhat melted away and people have started to view their lifestyle in a new light. I have a few friends who run a cafe in Reykavik, they tell me the initial fears of the crisis proved to be less dangerous than they first feared. Business has held up reasonably well, what they really notice is how expensive foreign travel has become. They also suggest, the fashion for expensive luxuries and SUVs are fading are being replaces by a more frugal, simplistic, "back to our Viking routes" kind of lifestyle. It's no longer so fashionable to pose in Dolce & Gabanna imports, it is more fashionable to be making homemade hair dye, from an old Viking recipe. (See also: Frugality and the economy, we looked at how frugality was becoming popular in US)

Yet, the economy remains vulnerable. The collapse of the financial sector means they are still reliant on fishing for over 40% of export revenues. This makes the economy vulnerable to depletion of stocks or fluctuations in the price of fish. There is a need to diversify and develop the economy, but, not the diversification of buying toxic subprime mortgage debts the Icelandic banks tried to their cost.... (By, the way, in 2009, the Icelandic banks were awarded the reverse IGnoble Nobel Prize for economics by Harvard University. That is pretty impressive since one ig prize was awarded for the bra which could easily be converted into two gas masks.... Ignoble Prizes list)

Many now see the EU has offering salvation for the economy. But, joining the EURO does not solve your underyling problem as Greece, Spain and Ireland are learning to their cost.

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