Burning Ice

We all have heard the ancient saying that goes like, "Every dog has his day." What it basically means is that every individual will be successful or lucky at some point in their life. You all might be thinking about that one day that changed your life, for better or for the worse. Likewise, I believe that every country has their own day or a year that changes their destiny. Personally, I believe that the year that changed the world economy was the year 2008. The aftereffects of the crisis were so abysmal that some countries are still trying to recover. It didn't just give economic trauma to the world, but it also gave emotional and psychological traumas, which is the reason why emerging market countries have such low stock market participants. Of 198 countries compared on the percentage change in GDP between 2007-2009, the most impacted countries were predominantly the Eastern and Northern European countries. 

 Out of those 198 countries, I personally believe that Iceland was the most affected. Icelands health was as bad as Popeye when he becomes spinach starved. Mass unemployment, soaring inflation, depreciating currency, rising criminal activities, and trembling stock markets. What Japan experienced physically after the nuclear bombing, Iceland faced it economically and are still suffering. So, ladies and gentlemen, sit tight. Glue yourself to this screen because what I am going to narrate today are the effects of greed and envy and how rationality will always keep you one step ahead of the crowd. Let's begin. 

Iceland, a country with a population of 320000, had traditionally relied on the fishing, aluminum, and energy industries for economic growth. That began to change in 2001, when the banking industry was liberalized. Three banks dominated the Iceland's banking industry: Glitnir, Kaupthing, and Landsbanki. Given Iceland's small population, these banks sought growth by offering short-term, interned-based deposit accounts to foreign investors. These accounts offered attractive interest rates and were denominated in foreign currencies. In particular, many of the depositors were British, Dutch, and other European citizens who held deposit accounts denominated in Pounds and Euros. 

With government guarantees on their deposit accounts, the banking industry grew rapidly. The largest bank, Kaupthing, experienced asset growth of 30 times between 2003 and 2008. The three banks increased lending rapidly, with many of their loans being long term, resulting in a maturity mismatch of assets and liabilities. The bank's assets were more than 14 times the country's GDP, while foreign debt was 5 times the GDP. The three banks constituted more than 70% of the national stock market capitalization. 

The economy expanded at a real growth rate above 20% annually between 2002 and 2005, and many Icelanders left traditional industries to work in the banks. Iceland earned the nickname "Nordic Tiger" as per capita GDP approached USD 70,000 in 2007. The Icelandic Krona increased in value against the US dollar by 40% between 2001 and 2007. By 2007, the unemployment rate was less than 1%. Icelanders went on a shopping spree for consumer goods, in part by using loans tied to the value of foreign currencies, motivated by lower interest rates abroad. A 2002 trade surplus turned into a trade deficit in the year 2007. Iceland's external debt in 2008 was more than 7 times its GDP and 14 times its export revenue. Broad-based monetary aggregates grew at a rate of 14-35% annually from 2002 to 2007. By the fall of 2008, inflation had reached 14%. 

As the global financial crisis unfolded in 2008, interbank lending declined, and Icelandic banks were unable to roll over their short-term debt. Anxious foreign depositors began withdrawing their funds. In the first half of 2008, the Krona depreciated by more than 40% against the Euro. As the Icelandic currency declined in value, it became more difficult for the banks to meet the depositor's liquidity demands, while at the same time the bank's depreciating Krona-denominated assets could not be used for collateral financing. The three banks collapsed in 2008. Unfortunately for foreign depositors, because of the relative size of the banks, the government guaranteed only domestic deposits. Iceland's central bank became technically insolvent, as it's EUR 2 billion in assets was dwarfed by Iceland's debt to foreign banks of EUR 50 billion. Trading in stock market was suspended in October 2008. When it reopened several days later, the Icelandic stock market fell by more than 77% as a result of the elimination of the three bank's equity value. 

The government attempted to peg the Krona to the Euro in October 2008 but abandoned the ped one day later. When trading in the currency was resumed later that month, the currency value fell by more than 60% and trading was eventually suspended for days. Iceland increased interest rates to 18% to stem outflows of Krona and imposed capital control on selling of Krona for foreign currency. The Icelandic economy contracted, and per capita GDP fell 9.2% in 2009. By the spring of 2009, unemployment was 9%. The country subsequently required a bailout from the IMF and its neighbors of USD 4.6 billion. 

Beneath the surface, problems with Iceland's economy were always brewing. The foundation of the Icelandic economy was far from solid. The banking sector was living on borrowed time, quite literally. It had amassed enormous debts from foreign banks. The Krona, in its arrogance, had become overvalued, making Icelandic exports less competitive and everyday imports more expensive. It is always favorable for an emerging country to have a depreciating currency, in order to remain competitive. To top it off, the country had a substantial current account deficit, essentially spending more money than it was earning. It was a recipe for disaster. Levered banking system, overvalued Krona, growing current account deficit, arrogance of not accepting the fact that their economy was falling, and greed were some of the prominent reasons why I believe Iceland had a fatal fall.

As always, the government felt the heat, but it was too late. Prime Minister Geir H. Harrde had to step down due to "health reasons", and a new government was formed. The new leadership promised to hold the bankers accountable for their actions and reform the financial system. They sought the bailout from the IMF, but Icelanders found the terms to be very harsh. Instead, they turned to their Nordic Neighbours for help. The new government created a new financial watchdog. New laws were passed to prevent the banks from taking excessive risks. A deposit insurance system was introduced to protect depositors in case of bank failure, and the tax system was reformed to make it more equitable.

The Icelandic financial crisis of 2008 was a cautionary tale of the perils of unchecked financial exuberance. It serves as a reminder that even in small remote country like Iceland, a global financial crisis can wreak havoc. The government's response, market by accountability and reforms, was commendable, but the full impact of the crisis is a story yet to be fully written. As the economic snow began to melt, Iceland learned that with resilience, reforms, and responsibility, even the iciest financial crisis can eventually thaw, bringing hope and prosperity back to the land of fire and ice. 

The average inflation rate in Iceland is falling. Even though it has not reached the pre-crisis levels, it has come under significant control. Unemployment is rising. From a high of 60 Krona's per US dollar, the Krona has depreciated to an average of 139 Krona's per dollar.

" There is no calamity greater than lavish desires. There is no greater guilt than discontentment. And there is no greater disaster than greed." - Lao Tzu. 

Happy Investing.