Thursday, 8 October 2009

Iceland is in hot water

Here in the UK we don’t generally appreciate how much hardball our government is playing with Iceland. Not since the “cod wars” of the 1970s when the Royal Navy was used to force access for British fishing boats into Iceland’s 200 mile territorial limit have relations been so bad. The Icelanders deeply resent us for the actions of our government – and yet most British citizens are oblivious to the situation.

Let us remind ourselves of some recent history. In the Autumn of last year Iceland’s three largest banks, Glitnir, Kaupthing and Landsbanki collapsed, seemingly as a result of some of their major shareholders deciding the game was up and emptying the vaults by making large loans to themselves. The Icelandic government took control of the banks and pledged to underwrite their liabilities, a sum of about 40 billion euros, this being nearly five times Iceland’s GDP. If government hadn’t done this Iceland would have been reduced to anarchy.

The Icelandic currency, the krona (ISK) fell by thirty-five percent; the stock market fell by ninety percent and was shut for two days.

In the UK hundreds of thousands of savers with “Icesave”, a brand name of Landsbanki, who had been attracted by several years of higher-than-normal interest rates, were unable to access their money. The website was down. To stop panic spreading into the rest of the British banking system the chancellor, Alistair Darling, said the British government would give individual savers all their money back. (Institutional savers such as local authorities, police forces and fire departments were left high and dry and are still out of pocket.) To recoup some of the money to do this he froze the remaining Landsbanki assets using anti-terrorist legislation, in a move which may not have been legal – but nobody in the UK is complaining.

Meanwhile in Iceland the government bailed out its own citizens 100% using funds that strictly speaking should have gone to British savers.

The current situation is that Iceland is in a deep recession, possibly its GDP will fall ten percent this year and inflation may reach 75%. Draconian foreign currency restrictions have been imposed. Citizens cannot hold foreign currency at all and must surrender any foreign cash that comes into their possession. All foreign currency is earmarked for food, medicine or oil.

Several foreign countries are chasing Iceland to pay its debts – 50bn euros in total, which Iceland simply cannot afford. And the UK government wants 5.5% interest until Iceland pays up, despite the UK base rate being 0.5% at the moment.

The British government is putting pressure on the IMF to put pressure on Iceland to start paying. The IMF’s leverage comes from the fact that it is supporting Iceland’s currency which is vital to Iceland because most big debts in Iceland, eg people’s mortgages, are denominated in other currencies, mainly the euro, and if the krona falls their repayments will become unaffordable. If the IMF withdrew its currency support just about every Icelandic citizen could suffer personal bankruptcy, either due to direct costs or knock-on effects.

The British government is also blocking Iceland’s application to join the European Union. (That said, the Icelanders no-longer have a majority in favour of joining the EU.)

The Icelandic government is trying to negotiate payment terms for its debt. It has offered to pay the UK 4% of all GDP growth until its debt is repaid (and 2% to the Netherlands, another big creditor nation due to Landsbanki having been very active there.) Linking debt repayment to GDP growth is quite a smart move for Iceland as it would give foreign governments a strong incentive not to impose economic sanctions while at the same time postponing the pain for Icelandic citizens. The British government, however, does not accept these terms. It wants repayment to start immediately.

Meanwhile Icelanders are voting with their feet. Each Icelandic taxpayer has a notional debt of a quarter of a million euros, which implies a lifetime, or even many generations, of debt servicing. The obvious solution for any Icelander, especially a young one with no krona-denominated assets such as a house, is to leave the country and seek their fortune elsewhere. Emigration is endemic – there is a real risk of Iceland becoming depopulated – leaving behind only non-tax-paying old retired people.

Meanwhile, over in Latvia the situation is worse.


Dex said...

Is Europe likely to head into financial melt down soon? I also read something about the Chinese talking about replacing the dollar as the currency to hold reserves in. What are the implications of that?

I hope it all goes tits up, and soon. Then we can start winning over the people.

Anonymous said...

Latvia - do tell - they used to be doing so well :-)

Nationalist said...

Europe isn't likely to go into financial meltdown in its entirety. The PIIGS are in trouble (Portugal, Ireland, Italy, Greece, Spain) but the larger Western European countries such as France and Germany are in better positions - they don't have massive personal debt levels and their public debt isn't on the same growth curve as ours. I picked Iceland out as an example of what happens when it all goes completely wrong.

I'll cover Latvia in a future post. Surfice to say the Lat is falling and their mortgages are in Euros.