Out of Iceland’s ashes

Published in Business Spectator (Melbourne), 14 April 2011

Icelanders are a tough people. No one turns catastrophes into opportunities as well as the Viking descendants. Instead of seeking foreign help with their country’s financial disaster, Icelanders are turning their backs on the EU.

This was the real message the Icelandic people sent out last weekend when they rejected an international deal over the collapsed Icesave online bank. Effectively abandoning their chances of being admitted into the EU, almost two thirds of Icelandic voters refused to pay the Dutch and British government, who had compensated their national savers.

You have to be impressed by such determination but it is only typical of the Nordic islanders. Remember Eyjafjallajökull? If you were stuck at a European airport when the unpronounceable volcano erupted, you probably will. What troubled travellers last year is now becoming a profitable business for Iceland.

Ólafur Eggertsson, whose farm had to be evacuated during the disaster, just opened the first Eyjafjallajökull museum in which he sells original volcanic ash and other memorabilia. Fashion designer Sigrún Lilja Gudjónsdóttir also wants to profit from the eruption. She added the perfume ‘EFJ’ to her range – made from volcanic ice and water, decorated with a lava stone and selling for an eruptive $US105. Icelandic tourism is also booming, reporting a 5 per cent increase in foreign visitors in February, and hoping to attract still more volcano enthusiasts.

That tourism is booming so much does not only have to do with volcanoes but also with exchange rates. After the collapse of its three major banks Kaupþing, Glitnir andLandsbanki, the Icelandic krónafell dramatically. Almost overnight, Iceland turned from one of the world’s most expensive tourist destinations into a more affordable place.

A coach trip from the capital to the famous Blue Lagoon and on to the airport used to cost $65 only three years ago. Now it’s down to $53. Reykjavík hotels used to have tiny rooms and big prices. The rooms are still small, but you can now find decent tourist hotels for under $100 a night.

The fall in its exchange rate was certainly tough for Icelanders, who were used to having one of the strongest currencies in the world. However, the devaluation was just the medicine Iceland needed. It certainly helped to avert the economic Armageddon that was on the cards in September 2008. Iceland would be left impoverished, lose much of its population through emigration and see unemployment soar to high double digits, were some of the forecasts.

Reality was much better. Though there was some net emigration, the Icelandic population continued to grow. Economic decline remained modest at -3.5 per cent last year, leaving GDP per capita at a $US39,668 – still higher than in countries such as Britain or New Zealand. Inflation, which had peaked at 18 per cent, is once again below the Central Bank of Iceland’s 2.5 per cent inflation target. In 2009, Iceland’s trade deficit had turned into a substantial trade surplus for the first time since 2002. Devaluation was doing precisely what it was supposed to achieve. Lucky the country that still has its own national currency.

As Icelanders were making quick progress turning their country around, the fallout from its collapsed banking sector remained. Between 2006 and 2008, Dutch and British savers had been attracted by Icesave’s high interest online savings accounts. Compared to ordinary high street banks, Icesave had offered interest rates about 2 percentage points higher. The difference was tempting savers who probably did not know much about Iceland. And had they known more about this tiny economy, whose main export is fish, they should have had more questions about Icesave’s business model.

Icesave’s customers had wilfully chosen to ignore the iron rule of finance that you cannot divorce high interest rates from high risks. However, when the bank went under they cried loud enough until their national governments paid them out.

To be clear, it was sheer populism on behalf of the Dutch and British governments because there had never been an obligation to compensate anyone. But as soon as Dutch and British politicians had finished with their populist activism, they were then demanding the money back from the Icelandic government. The British even took their aggression towards Iceland a step further and froze Icelandic assets under anti-terror laws – as if Bin Laden resided in Vatnajökull National Park.

As Iceland sought help from other countries at the beginning of its financial crisis, it soon learned how the EU defined solidarity. Under the EU’s approach, it meant that Iceland had to submit itself to all EU rules, give up its fishing grounds, introduce the euro – and of course first compensate the British and the Dutch for their very own populism.

When the Icelanders overwhelmingly rejected this demand in a first referendum last year, they also found out what democracy means to Europe’s political elites. It is an old habit for EU politicians to repeat referenda that do not produce the desired outcome. It happened after Denmark’s initial ‘no’ vote on the Maastricht Treaty in 1992, and it happened again when Ireland had to vote twice to approve the Lisbon Treaty.

So Iceland was asked to vote a second time on the compensation deal for Britain and the Netherlands. However, the Europeans underestimated the islanders’ stubbornness. Or maybe it was just asked too much for each man, woman and child to bear a debt burden of $16,400 in order to repay some other governments so that they may compensate savers for their foolishness? And the prospect of having to continue repayments until 2046 wasn’t all too enticing either. It was like war reparations without a war. For the usually peaceful Icelanders, this was just more than they were willing to take.

Icelanders have now decided that all the pain of dealing with their European ‘friends’ was simply not worth it. Why burden yourself with debt, give up your fishing grounds, and subjugate your national parliament to regulations from Brussels when all you gain in return is membership in a fragile monetary union with countries like Portugal and Greece? To all of that, Iceland on Saturday said ‘Nei takk!’ (‘No thanks!’).

Icelanders are great at turning crises into opportunities. The Eyjafjallajökull disaster provided a much needed impetus to Icelandic tourism; and Iceland’s banking crisis has now finally alerted Iceland to the importance of independence from the EU.

Lucky Iceland. Now they can leave the Eurocrats behind and just go fishing.