What happens when you create an economy based on the shaky foundation of foreign debt? While this sounds like a question about the U.S. economy, it is actually something that has been asked recently about Iceland. While the U.S economy has been built on foreign borrowing for about 25 years, Iceland only pursued this course of action after the mid-1990s and it is already experiencing a financial meltdown. Things are so bad that the country itself risks bankruptcy. In response to the crisis, draconian emergency powers, which would be the envy of any totalitarian state, have been granted to the authorities. The currency no longer floats, some stock trading has been suspended and banks are closed. Want to get access to your money or get it out of the country? Lot's of luck.
The rot in Iceland's financial system that has built up over the years was hardly a secret. The top four banks in Iceland have liabilities greater than $100 billion, while the entire GDP is only $14 billion. However, unlike much of the rest of Europe and the United States, Iceland banks do not own toxic mortgage securities. The problem instead is simply one of too much leverage (the U.S. also has this problem). Heavily exposed banks are collapsing under the weight of debts incurred during the 2000's lending boom, which artificially increased the average citizens wealth 45% in only five years. While all highly leveraged enterprises will inevitably fail, the Icelandic government still refuses to admit this is the cause of the country's problems. The prime minister has claimed that the "banks were victims of external circumstances". Governments throughout history have of course always blamed external (and frequently internal) forces for economic calamities and never their own policy failures and mistakes. Iceland is no different, nor is the U.S.
While the financial bubble developed over many years in Iceland, the final decline has been sudden. The surprise nationalization of Glitnir, the nation's third largest bank, a week ago precipitated a large drop in stocks prices and a plummeting currency. It order to stabilize the krona, the government stopped its convertibility and fixed the exchange rate to 175 per dollar. Stock trading was also suspended. To avoid capital flight, banks were closed down. Emergency powers were given to the government that allows it to take over any company, limit the authority of boards of directors, and to call shareholder meetings at will. If this sounds like communism, that's because it is. And all this is happening in a country with a democratic history going back to 930 when the national parliament, the Althing, was established.
Any American that thinks that similar things can't happen in the United States is being naive. In desperate times, governments take desperate actions. The U.S. government after all confiscated gold and closed down all the banks in the 1930s to help stabilize the economy. This time around, AIG Fannie Mae, and Freddie Mac have already been nationalized by the formerly capitalist U.S. government. Treasury Secretary Paulson stated only yesterday that partial nationalization of banks was an option under the Wall Street bailout bill. Just like in Iceland, governments shut banks, stock trading is suspended, and currency is frozen during a financial crisis. Democratic states can become totalitarian and capitalism can transform overnight to socialism. If you haven't prepared for these developments beforehand, it will be too late to do so once they actually occur.
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