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At one end of Laugavegur, Reykjavik’s main shopping (and partying) street, Icelanders jostle in the aisles of a Bonus discount grocery to fill their baskets with ham, dried codfish, and other staples. A mile or so up the road, on the ground floor of a shiny new office tower that also houses the stock market, sits an Apple [AAPL
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] store that is perhaps the only one of its kind: Save a salesman, it is completely empty.
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This neatly illustrates the state of play in Iceland eight months after it essentially went bust. No country embraced the excesses of the credit bubble as zealously as this north Atlantic island nation of about 310,000 people. As a result, it’s hard to find a place that’s suffering the deprivations of the crunch to the same degree. It’s not just that iPods are off the shopping list in favor of processed pork. The nation is massively indebted, consumer spending is in free fall, its big banks have been taken over by the state, and capital controls restrict the flow of money outside the country.
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But as hard as Icelanders will need to toil to fulfill the demands of their financial rescuers—including $5 billion from the International Monetary Fund, a phalanx of Nordic neighbors, and even the Faroe Islands—don’t cry for them. Iceland, unlike many of the other nations that went mad for credit, has lots of things going for it: an average age of 37, a highly educated work force, a nearly positive birthrate, overfunded pension schemes, and abundant natural resources. With a little extra creativity, the place should emerge stronger from its recent fall from grace.
“Yes, Icelanders have to work hard, but they have a natural inclination to do so,” says Svein Harald Øygard, a Norwegian McKinsey consultant who was parachuted in earlier this year as interim governor of the Central Bank of Iceland. “Given how small a country Iceland is, it has a surprisingly high degree of self-reliance; remarkably strong sectors like the fisheries and renewable energy-based industries; and a productive, highly confident, and well-educated work force.”
Statistics paint the remarkable fiscal challenge Iceland’s people face. The central bank estimates that about 40,000 of the country’s 100,000 households took out loans to buy automobiles denominated in foreign currencies, chiefly the Japanese yen and Swiss franc. Similarly, about 80,000 Icelandic households have mortgages—all of them with payments either directly linked to inflation or, like those car loans, denominated in foreign currencies. When the krona was soaring, taking out forex loans for new Land Cruisers and condos overlooking the harbor might have seemed rational. From about 2002, the soaring currency—buoyed by artificially high official interest rates—allowed hot money to flow over Iceland like the Gulf Stream that keeps the country temperate. Everyone from American hedge fund managers to Austrian dentists found it easy to borrow cheaply at home, or in low-rate currencies like the yen, and buy higher-yielding Icelandic securities.
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Ingenious bankers even came up with securities to capture this trade, selling 500 billion krona ($4 billion) of “glacier bonds” to retail investors. When this vast carry trade ended, though, the currency crashed and, all of a sudden, the cost of servicing all those liabilities priced in foreign currencies spiked. So did the prices of imported goods, which led to inflation that jacked up the three-quarters of Icelandic home mortgages that are linked to inflation. The central bank estimates one in six households now face mortgage payments equal to a crushing 60 percent or more of their take-home pay.
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