In 2008, Iceland was in meltdown after its banking sector, which had run up debts worth several times the country’s GDP, collapsed and defaulted on its foreign debt.
Now, only four years later, the economy has bounced back, with growth of 3% last year, and Icelandic debt has been upgraded to BBB by credit-rating agency Fitch. That means it is no longer ‘junk’, but ‘investment grade’.
This testifies to the regenerative power of “default therapy”, says Eric Fry on Dailyreckoning.com. “Economies function best when failure [clears] the way for new successes.” Endlessly “rescuing and meddling”, as we have seen in Japan and Greece, prevents “creative destruction”.
Iceland’s refusal to prop up its banks meant that the state could keep a lid on its debts, while Fitch notes that “financial sector restructuring is well advanced”. But a key reason the default worked was that it sent the Icelandic krona though the floor. It fell by 80% against the euro and the dollar, giving exports a fillip and quickly shrinking the current-account deficit.
“The outcome is a vindication of sovereign currencies,” says Ambrose Evans-Pritchard on Telegraph.co.uk. Flexible labour and product markets have also helped. “The contrast with the unemployment catastrophe and debt-deflation spirals” in Europe is “crystal clear”.