Iceland's deep freeze

From the blog at the Economist:
Iceland’s entire banking system is ruined. In addition to the usual domestic credit shock, this financial sector collapse is causing havoc to the import and export sectors, which are crucial to this small open economy. International bank transfers are difficult. Capital controls are in place; a multiple exchange-rate system is operating. Many companies are facing bankruptcy. Others are thinking of moving abroad. Polls show that a third of the population is considering emigration.

The International Monetary Fund has promised aid, but the Dutch and British governments are demanding compensation for citizens that deposited billions in an Icelandic bank’s high-interest saving accounts. Since Iceland’s GDP is down 65% in euro terms, repayment is unlikely—especially if the nation’s best and brightest move abroad to escape the shock and growing tax burdens. This has happened before. The Great Irish Famine triggered a mass emigration shock which tipped the nation into a downward spiral; population fell in most counties from 1840 to 1961, according to O’Grada and O'Rourke (1997).

I learned all this from a fascinating Vox column posted 12 November by Jon Danielsson, who is a Reader (professor, in American English) of finance at the LSE. Here’s the most sobering bit:

In this crisis, the strength of a bank’s balance sheet is of little consequence. What matters is the explicit or implicit guarantee provided by the state to the banks to back up their assets and provide liquidity. Therefore, the size of the state relative to the size of the banks becomes the crucial factor. If the banks become too big to save, their failure becomes a self-fulfilling prophecy.

That’s worth paraphrasing: If banks are too big to save, failure is a self-fulfilling prophecy. There are several European nations with banks their taxpayers could not save.