UK could experience a crash similar to Iceland

Date: Wednesday, February 18, 2009
Author: Hedgeweek.com

The global financial crisis could be entering a 'new and more treacherous phase', which could push international countries to the brink of failure and further hinder the global economic recovery, according to Hennessee Group.

Charles Gradante, co-founder of the Hennessee Group, points out that Iceland had one of the highest standards of living in the world just a few months ago, but after experiencing the fastest economic collapse in history, it is suffering from soaring unemployment as well as double digit interest rates and inflation.

Hennessee Group says there are other countries that share some of the same characteristics as Iceland, particularly with regards to its debt to economic output, and could be vulnerable to the same devastating effects of the financial crisis. 

It believes it is imperative that world leaders pursue the appropriate policies to stimulate trade and promote worldwide growth so it does not enter a global economic crisis similar to that of the 1930's.

After privatising the banking sector in 2000, Iceland's banks went from being largely domestic lenders to major international financial intermediaries with foreign assets worth nearly ten times the country's GDP. 

As the banks dramatically expanded overseas and foreign money poured into the country, the Icelandic economy experienced exceptional growth and prosperity. 

Iceland was considered in 2007 to be one of the richest per capita countries in the world. However, as the global financial crisis picked up steam, it exposed the weakness and dependence of Iceland's economy on the banking sector, as well as its vulnerability to a staggering economic collapse.

Hennessee Group Research believes a primary contributor to the rise and fall of Iceland's economy was the vast size the country's financial sector grew relative to its GDP and fiscal capacity. 

Gradante says: 'Iceland's three main banks (Kaupthing, Landsbanki and Glitnir) built total liabilities of approximately ten times the size of their GDP, up from about two times in 2003. In addition, approximately 80 per cent of the liabilities were in foreign currencies leaving them at risk of a currency collapse.' 

As the markets seized up, Iceland's banks started to collapse under the heap of foreign debt they took on over the years. As concerns mounted about the stability of Iceland's banks, foreign investors fled the country, prompting the value of its currency to drop nearly -50 per cent in just one week. 

The collapse of the currency left banks and citizens with loans originated in foreign currencies in a very tenuous situation; the weakening currency led to their debt obligations nearly doubling. As the nation's economic crisis deepened, unemployment rose from one per cent to ten per cent, inflation soared to nearly 18 per cent and the stock market lost approximately -90 per cent of its value. 

Hennessee Group Research believes that while Iceland's circumstances were unique in many ways, there are countries suffering from similar risks which could leave them just as vulnerable in the current crisis. 

One particular statistic of concern is the large amounts of external debt certain countries are currently carrying relative to the size of their economy (GDP) and will continue to build as they battle the economic slowdown.

While the there has been a lot of discussion regarding the mounting debt of the US due to recently implemented bailout programs and stimulus packages, Hennessee Group Research believes the US appears relatively stable in comparison to their international counterparts. 

Currently, the US debt to GDP ratio is approximately 100 per cent with the bulk of its external debt mostly in dollars. 

The Netherlands currently has a ratio of approximately 328 per cent, while Ireland has built a debt to GDP ratio of 900 per cent.

However, the two countries that appear most susceptible to an economic collapse are the UK and Switzerland. The UK's debt to GDP ratio is currently 456 per cent while Switzerland's is 433 per cent. 

Gradante says: 'While these countries are much bigger than Iceland, they do share certain characteristics that make them vulnerable to further economic hardship. Both countries have developed into major financial intermediaries over time, and have grown sizeable external debts that are denominated in foreign currencies.'

The Hennessee Group believes if either country were to experience a crisis of confidence whereby investors flee the country for safer havens, their currencies could experience a crash similar to that of Iceland's and leaving them potentially insolvent.