There is a world of difference between a tiny island nation of 300,000 souls and the world’s largest economy and reserve currency.
But the precise conditions being experienced by Iceland right now are definitely within the realm of possibility for the US. Therefore this next story is highly instructive as a possible, if remote, road map for the US and other overleveraged countries.
REYKJAVIK, Iceland — The collapse came so fast it seemed unreal, impossible. One woman here compared it to being hit by a train. Another said she felt as if she were watching it through a window. Another said, “It feels like you’ve been put in a prison, and you don’t know what you did wrong.”
This country, as modern and sophisticated as it is geographically isolated, still seems to be in shock. But if the events of last month — the failure of Iceland’s banks; the plummeting of its currency; the first wave of layoffs; the loss of reputation abroad — felt like a bad dream, Iceland has now awakened to find that it is all coming true.
The first thing I take away from this is how fast these crises can develop. It can certainly happen at a pace that can overwhelm the ability of key political, financial, and social institutions to adapt. This leads to hardship and disruptions for the citizens.
These next two paragraphs capture the dynamic of a currency crisis perfectly:
Overnight, people lost their savings. Prices are soaring. Once-crowded restaurants are almost empty. Banks are rationing foreign currency, and companies are finding it dauntingly difficult to do business abroad. Inflation is at 16 percent and rising. People have stopped traveling overseas. The local currency, the krona, was 65 to the dollar a year ago; now it is 130. Companies are slashing salaries, reducing workers’ hours and, in some instances, embarking on mass layoffs.
“No country has ever crashed as quickly and as badly in peacetime,” said Jon Danielsson, an economist with the London School of Economics.
These are the same effects that I would anticipate, should the US dollar suffer a similar loss of international confidence. You might retort, "Yes, but Iceland had an enormous amount of capital outstanding for such a small country," but I would reply that the US is similarly overleveraged after more than 30 years of abuse of its reserve currency position.
It is this precise suite of effects – "overnight" loss of savings, soaring prices, currency rationing, and massive layoffs – that I hold as a distinct possibility for the US at some point over the next couple of years. This is a "Horizon I" concern of mine.
While I think the chances are low, I also think the impacts are catastrophic, so it is something that I have prepared for.
In part, this happened for the same reason that every bubble and collapse happens: People readily succumb to the notion that wealth accumulates all on its own, without any hard work on their part. In short, they believe that, when it comes to everlasting prosperity, "this time it’s different."
Emboldened by the strong krona, once-frugal Icelanders took regular shopping weekends in Europe, bought fancy cars and built bigger houses paid for with low-interest loans in foreign currencies.
But no story of an addictive run to the heights followed by a trip to the rehab center is complete without an enabler:
Like the Vikings of old, Icelandic bankers were roaming the world and aggressively seizing business, pumping debt into a soufflé of a system. The banks are the ones that cannot repay tens of billions of dollars in foreign debt, and “they’re the ones who ruined our reputation,” said Adalheidur Hedinsdottir, who runs a small chain of coffee shops called Kaffitar and sells coffee wholesale to stores.
People all over the world are right to wonder, and perhaps become angry, about why the very institutions that created this mess are the primary (and majority) recipients of public money. In every country that I’ve looked at so far, the people fashioning the "cures" are the very people who created the illness.
Think of Hank Paulson, a consummate Wall Street insider steeped in the ways and means of "high finance," running the bailout machinery. All he can think to do is prop up the big institutions, because that’s all he knows.
Because of this narrow focus, are mistakes being made?
You bet.
by davos