One of the world's richest nations is trying to beat economic ruin, writes Derek Scallyin Reykjavik
ICELAND'S LAKES and rivers began to freeze over this week, some two weeks after the economy did. And with a long winter looming, literally and figuratively, it's a good time to be in the vodka business.
"My vodka factory has not been operating much over last years, but I'm calling all my experts together to increase production," said Orri Vigfússon.
He made his fortune by selling the premium-brand Icy vodka in the US and Russia, but he is best known around Europe for his campaign to save wild salmon through his North Atlantic Salmon Fund.
Like all Icelanders, he watched, first in mild concern then in sheer disbelief as, in a matter of weeks, his country slid into near-bankruptcy.
Is this the same Iceland that, based on per capita gross domestic product (GDP), was ranked one of the richest nations in the world?
Wasn't it just last year that Iceland was considered the place with the world's highest standard of living, ahead of Sweden and Norway? And now?
Icelanders are coming to the painful realisation that much of that praise, like much of their country's wealth, was built on air - and that their hopelessly overextended country will be living with the consequences for years to come.
"At the moment, we are in this limbo," said Mr Vigfússon. "We do not know what is the value of our currency, and the real impact will only begin to be felt in the coming weeks when people start losing their jobs. That's what hits really hard."
Iceland's fall has been a financial stripshow of increasingly painful revelations. For a decade, growth in the North Atlantic island nation averaged nearly 4 per cent.
Despite a population of just 300,000, the economy powered ahead past more populous neighbours, thanks to deregulated banks steered by modern-day Vikings riding the seemingly limitless waves of international finance.
In the middle of this, in 2001, the central bank reacted to a banking regulation change by making the fight against inflation its main underlying goal. That decision had two consequences.
First, raising interest rates to beat inflation brought a huge inward flow of foreign capital attracted by the high rates on offer. Iceland became an Eldorado for so-called "carry traders" out to make fast money.
The second effect was on would-be homeowners, faced with the highly unattractive prospect of a high-interest, kronar-based indexed mortgage. Such a mortgage, in times of increasing interest and inflation rates, would give them the Sisyphus-like burden of making payments on an ever-increasing lump sum.
Small wonder then that they shopped around, taking out lower-interest foreign mortgages partly or wholly in euro, yen or dollars.
Their calculation was that even a 20 per cent drop in the kronar's value would still be better value than a domestic home loan.
In the new party mood, everyone seemed to have enough cash to go round. Icelandic companies snapped up House of Fraser, Hamley's and dozens of other retail icons around Europe, often selling to their own cash-rich countrymen, who headed to mainland Europe several times a year on their own shopping sprees.
But when the credit crunch hit, Iceland's "carry trader" capital began to drain away and the kronar, already weakened by hedge-fund betting, began to plunge on foreign exchange markets. The foreign currency loans that had such disastrous results in the Finnish crisis of 1991 struck again in Iceland this month with full force.
Thousands of ordinary Icelanders are now unable to pay back what was sold to them. The innocuous-sounding "breadbasket" private loans had pushed domestic credit in Iceland's banking system quadruple as a share of GDP in the last seven years.
As temperatures dropped below zero in Reykjavik this week, the veneer of normality was beginning to crack. The bars and restaurants are busy, though less so than last month. The doors of the three main banks, with 90 per cent of the market, are still open but are now in state ownership. The Icelandic kronar still pops out of ATMs, but it is a condemned currency.
In the blink of an eye, Iceland has gone from a free-market party to a centrally-managed economy, with the central bank prioritising the use of the limited foreign exchange available. That policy will become visible in stores as stocks run down: food, clothing and fuel will come first to be replenished; plasma screen televisions don't even figure.
As the first shock begins to wear off, the hunt for scapegoats has begun. The government has come in for huge criticism for letting the regulation of banks slip to the point where a generation of young, brash bankers could run up liabilities over 12 times Iceland's GDP.
There have been harsh words, too, for the governor of the central bank, a political appointee seen as completely out of his depth in a financial crisis. But there is little time for blame as the government tries to end the short-term crisis with an IMF-headed loan, expected to top €6 billion.
The next stage, Iceland's medium-term financial stability, is more daunting. As well as hundreds of millions in IMF loan interest, the government can no longer count on huge tax revenues from nationalised banks. That nationalisation process has left almost deficit-free Iceland, overnight, with a national debt of more than 100 per cent of GDP.
After the shock of the collapse comes the awe: not quite knowing what's next, how long this will last, or to whom Iceland can turn for support.
"It's clear Iceland and its name are toxic waste - no one wants to touch us," says Gunnar Haraldson, economics professor at the University of Iceland. "There's a popular myth that no one was yelling warnings. Many economists were, but people had too much confidence in the central bank and could not believe it would lose control like this."
The real shock is likely to hit after Christmas when people begin to lose their jobs, first in banks and construction, then in services and retail. Experts estimate that the unemployment rate of less than 2 per cent could climb to between 6 and 8 per cent by the spring. Before then, Iceland has to decide what to do with its currency.
In private and in public, businessmen and politicians agree that the kronar is finished. Once the emergency measures are in place, the government faces a difficult decision: to try pegging it to another currency, or to begin negotiations to join the euro zone.
That leads to the next question: after years of ploughing its own furrow, will this be the crisis that brings Iceland into the European Union?
It's too soon to say. Polls show 60 to 70 per cent support for joining, not exactly an overwhelming majority in the middle of a crisis. EU critics suggest that Iceland's traditional opposition will return when the situation stabilises. The pro-EU camp is sure that Icelanders have been shocked into joining.
"I think there is an overwhelming support for membership of the union when the situation stabilises," said Vilhjalmur Egilsson of the Icelandic Employers' Federation (SA). "Members of our federation will start to advocate membership of the EU more strongly than before."
It predicted this week that Iceland's GDP may drop by as much as 10 per cent next year, perhaps concentrating minds on the perceived safety of EU membership.
But with the ruling right-wing Independence Party still divided on EU membership, observers predict that it will take a rebellion against the current leadership to break the party's internal EU deadlock.
Like the kronar, there is little dispute that Iceland's banking sector is dead in the water. Now the search has begun for industries to take its place. Many in industry predict that Iceland's saviour will be energy-intensive industry and services. It has already harnessed they volcanic country's geothermal energy to make inroads into the aluminium industry, which produces 800,000 tonnes annually and is on track to produce 1.5 million by 2014, almost 10 per cent of world production.
Other energy-intensive companies that have expressed interest in locating in Iceland include several internet companies. They need huge amounts of cheap electricity to power its servers and the air conditioning that keeps them cool. Icelandic data centres would dovetail nicely with the huge data connections being built between the US and Europe, with Iceland as the interconnector.
"The long-term base and wealth of Iceland is energy because, without any doubt, energy prices for the long haul are on the rise, no matter what is happening these days with oil prices," said Viglundur Thorsteinsson, president of cement company BM Valla.
Until that takes off, however, Iceland's saviour might be what has kept the country going for centuries: its plentiful North Atlantic fishing stocks.
With exports worth €1.5 billion annually, fish is one natural resource regularly mentioned as a life raft for the economy. Sales will bring in much-needed foreign exchange, but analysts say the industry is already so efficient that it's hard to see how to squeeze out extra revenue in this time of need.
Many are banking on an increased export of Icelandic know-how from companies like Stofnfiskur, a leading producer of salmon eggs from farming operations, exporting from Chile to Ireland. "It's a good time to be in the export business in Iceland," says Stofnfiskur's managing director Jonas Jonasson. "It's also always the same over the years, people don't ever stop eating fish. On the contrary, when things go bad, people eat more. Dried fish here, fish and chips in England."
Renewed talk of the EU membership this week has kicked off a new round of hand-wringing over the dangers of Spanish fishermen to Iceland's fish stocks.
The leading Morgunbladid newspaper suggests that the fear over fish stocks is a proverbial red herring. EU fishing quotas are based on historical fishing patterns, it says, and with no history of foreign vessels in its waters, Iceland has nothing to fear.
"The obvious competitive advantages for the country have to be weighed against the disadvantages for the fishing industry," said Mr Egilsson. "We will need a compromise that is acceptable for fishermen without forgetting that they are hurting in this situation as well."
Iceland always explained its resistance to join the EU with war: after a war of independence from the Danes and the Cod Wars with the British from the 1950s to the 1970s, Icelanders were loath to sit at a table and negotiate fish quotas with British and Danish ministers.
Today, feelings towards London are at a new low after the stand-off over British banks' deposits in Icelandic banks. But there is a bitter irony in Iceland's present situation. The very resource it stayed out of the EU to defend may now come to the country's rescue after a crisis which, Icelanders increasingly acknowledge, might never have happened if Iceland had been in the union in the first place.
