In 2008 Iceland suffered a catastrophic banking meltdown related to the collapse of an overheated real estate market.
“Iceland, like the rest of Europe, was faced with an almost unprecedented economic situation in 2008. Iceland’s central bank tried to rescue some of the country’s largest banks, bankrupting itself in the process. Iceland’s largest banks held almost 10 percent of Iceland's GDP in assets (much of it foreign) in 2008. The central bank was forced to attempt the rescue after agreeing to guarantee future bailouts in 2001. With the central bank out of commission and a crippled financial sector, Iceland’s GDP took a nosedive.”
“Iceland’s GDP per capita (in current U.S. dollars) was a little over $65,500 in 2007; in 2009 it was almost $38,000.”
But Iceland had one thing going for it that the United States and EU countries like Greece did not: It was too small and unimportant to be bailed out. As a result,
“Icelanders will do better than Greeks precisely because financial institutions collapsed in Iceland, ironically in part because of mechanisms in place requiring bailouts from the Icelandic Central Bank. Economic collapse allowed for proper refinancing. Greece has suffered from too much attention, and because of all of that attention, the actual size of the Greek economy has been forgotten.”
“This international neglect turned out to be Iceland’s saving grace. The crisis ended almost as quickly as it had begun. The Organization for Economic Co-operation and Development expects Iceland’s economy to grow by 2 percent this year and next. That’s not enough to replace the post-2007 loss, but it’s more than enough to return to the pre-boom trend line, and it’s much stronger than the performance of Portugal, Italy, Ireland, Greece, and Spain, affectionately known as the PIIGS economies. Iceland’s long-term interest rate, a not-inconsiderable 8 percent, compares well with a rate of over 13 percent for Greece, which is astounding when you consider that Iceland endured a default that Greece, in name at least, has so far avoided. The difference in unemployment—5.8 percent for Iceland against 16 percent for Greece—is even more striking. Iceland expects to have a balanced budget in 2013.”
“So what’s causing the recovery? The plain-sight answer is the one nobody will consider. Iceland is coming back specifically because its banks went out of business. That happened in spite of strenuous public efforts, but the removal of the tiny nation’s colossally bloated financial sector turns out not to have eliminated all that much value.
It bears repeating that banks are not creators of wealth. They are places where you store the surplus value generated by productive enterprise. In very narrow circumstances that surplus value can be loaned out at a profit, but a financial sector is the icing, not the cake. This should be common sense, but apparently it is wisdom so rare it can only be learned in countries small and remote enough to avoid the deadly medicine of the global financial markets. “
Though it sounds counterintuitive, bankruptcy is a necessary part of a free market’s healing process. Only when the bad debt has been purged, can the economic healing begin. When this isn’t allowed to happen because of artificial means such as bailouts and stimulus spending, the market can’t reach the bottom and zombie companies and banks remain alive to drag down the economy. The result are things like the protracted and painful ‘Obama recovery’ in the US, the endless cycle of bank bailouts in the Eurozone, and Japan’s lost decade(s). Thanks to bailouts and Keynesian stimulus, Japan has a debt to GDP ratio of 200% (the highest in the world, except for Zimbabwe) and has not yet recovered from the stock market crash of 1990!