DEEP FREEZE

International Trade Assignment Case Study of Iceland FinancIal Collapse MBA in Marketing&Communication

“The most spectacular bankruptcy of the 2008 financial crisis was the collapse of Iceland's financial system. This collapse is especially intriguing as Iceland is not an underdeveloped country!” ---EHMAN BROTHERS

Introduction
Iceland is an independent Nordic European island country situated at the confluence of the North Atlantic and Arctic Oceans, on the Mid-Atlantic Ridge. Its traditional industries are fishing, processing of fish, aluminum, and strong energy industry. During several years of economic boom, the Icelandic financial system expanded considerably. A nation with a slight population erected a banking system whose total assets were 10 times the size of the country's GDP. Greedy bankers, inexperienced upstairs, corrupt political elite, the deregulation of the financial system, make the banking sector grew faster than any other sector of the Icelandic economy. Following the global financial crisis in 2008, Iceland became the most dramatic economic meltdown. The key problem with the banks essentially owning all the bankrupt highly leveraged business (that were and are essentially good ocean harvesting fishing business) and the downgrade in sovereign debt rating led to capital flight. With the collapse of exchange rate of Krona, 3 main banks (Landsbanki, Kaupthing and Glitnir) are nationalized because of the serious liquidity problems of banks. By the end of 2008 rate of price inflation reached 18 percent. The government instituted the exchange rate regulations and controls to limit the use of foreign exchange rate regulations. The limitation of purchase of precious imports as food, drugs and oils are limited made the situation worse than ever. In order to deal with the crisis, the Iceland would adopt several solutions such as appeal to IMF for help, receiving the helps from Northern European neighbors and application for joining European Union. But there's no such thing as a free lunch! The strings attached include fiscal tightening and some cutbacks in welfare spending. Negotiating the payback to British and Dutch government for a guarantee is also a contingency. With the development of crisis and recommendations of IMF, the economic collapse became a political issue. Even as the member of EFTA and EEA, Iceland has still many complex issues to trade off, such as the Icelandic fishing territory, and the right to exploration for oil in the Atlantic Ocean.

1.Is there a link between the US sub-prime crisis and the Icelandic financial crisis?
Yes, there is the link between them. As US is the leader of world economy, it led to the late 2000 global financial crisis. We can say that, the US sub-prime is an incentive of the Icelandic financial crisis. A fatally over-leveraged banking sector, the banks were dependent on borrowing aggressively in international capital markets and attracted the foreign funds with Iceland’s high interest rates and strong sovereign rating. They grew, to begin with, mostly in foreign markets; via buying financial companies and institutions, opening branches and by increasing their international trade. So Iceland was deeply influence by the US sub-prime crisis.

The U.S. dollar is the currency most used in international transactions and is one of the world's dominant reserve currencies. So the depreciation of U.S. dollar affected the whole global economy and increased the prices of global energies and raw materials. As that Iceland’s agriculture and manufacture is limited and most consumer goods are imported, Apparently, Iceland will be negatively influenced. The depreciation of U.S. dollar also put inflation pressure on Iceland. The Icelandic Krona is weaken by 35% in the six month prior against us dollars cause by the capital flight, the result of downgrade in sovereign debt rating. Lehman Brother ́s fall down led to widespread crisis of confidence. According to Ingimundur Friðriksson, former Icelandic Central Bank ́s director; it can even be stated that the Lehman Brother ́s melt down is partly related to the collapse of the Icelandic Banks. The Icelandic financial crisis and the US sub-prime crisis are both bubble economic: can’t pay the high debt--->bubble burst--->bankrupt. Both of them have three folded. “First there is a presence of an extreme use of credit; second there is a noticeable lowering of credit standards; and third, heavy dependence on leverage.”(According to Henry Kaufman) The US sub-crime crisis and the Icelandic financial crisis are all deeply influenced by the economic concept high privatization, deregulation etc . free market

2.How could the Iceland financial crisis have been avoided?
1)To avoid the malinvestment Those misdirected resources and entrepreneurial errors need to be liquidated. Prolonging their existence prevents the economy from moving production and consumption patterns to those that are conductive to long-term growth. 2)To regain the traditional prudence The consumption-led boom changes the inhabitants of Iceland and created the time preference of nation. Icelanders need to regain their traditional prudence about credit and spending. 3)To control the privatization. The profits of privatization are highlighted in the global environment of “free market”. But the cross-holding caused many problems such as gap between wealth and poor, society stability, corruption and the economic bubbles. The cross holding makes the Iceland economy grew too fast. The Icelandic economy become less controlled and less protected. The objective function of a state owned company is made up of two components: social welfare and private benefits of control. The objective function of a private owned firm consists of cost cutting and profit maximization. So, in this sense, the government need to make up the shortages of privatization like developing the social welfare, and at the same time, set a series regulations and restrictions of privatization and enhance the legislation to control effectively the privatization.

4)Don’t trust the magic of leverage & cheap foreign credit and enhance the economic management internally & externally Law environment in Iceland is much more suitable for the ones who are interested in these types of immoral business activities than in many other Western countries. Iceland put economic future on international banking, without having the necessary protection in place and takes advantage of ample capital in international markets to fuel a high degree of leverage and exponential growth without control. This is the main reason of collapse of Icelandic economy. The Icelandic government should implement the appropriate policies, regulations and law to regulate it. And at the same time, a good communication with European Economic Area (EEA), the Central Bank (CBI), the financial regulator (FME) is also very necessary. Especially central banks should take more responsibility; the governor of the central bank had to have economic training and their power should be well controlled by banking supervision department. 5)To adjust the economic structure Iceland should control the size of financial sector and revive the previous mainstays in economy fishing and maritime products. An oversized financial sector is not necessary for the economic health, because it has removed resources from those areas where Iceland has a real competitive advantage. The size and structure of financial sector should depend on the economy of Iceland.

3.Why is political and economic sovereignty so important to Iceland?
Political part Iceland, after 500 years of colonial rules, received sovereignty in 1912 and declared independence in 1944. Geographically Iceland is very isolated which has probably had an unconscious effect on the Icelandic people as being very independent and self-reliant. It also was a turning point in their country’s history and is something that Icelanders take a lot of pride in. It was occupied by UK and US and after a political battle with UK, has the exclusive territorial right to large portion to Northern Atlantic Ocean. Iceland has the political and economic sovereignty means that it has the equal status as other countries in the international community and platform. As a independent nation state Iceland has the right to refuse any interference in the internal affairs from other countries. It get also has supreme independent authority over a geographic area and capacity to enter into relations with other sovereign states. It can decide its own constitution, form of government, administrative and other legislation, with the exclusive right to enforce such legislation within its territory. Keeping the cultural identity has been a key issue in many political debates. The preservation of their language and traditions has created a sense of pride and achievement across Iceland. Normally, only sovereign states can become parties to international organizations. The recognition of sovereignty entitles a nation to participate in the community of sovereign states with all the attached rights and obligations. This entails the right to membership of international organizations and participation in bilateral or multilateral treaties with other sovereign nations. Economic part

The political sovereignty is the premise of the economic sovereignty and the economic sovereignty is the guarantee of the political sovereignty. The driving force of the world economy is trade. Many states are entirely dependent on international trade, which led to co-operation and subsequently the establishment of alliances between states centering on trade and economic affairs. Thus, Iceland has in this co-operation curtailed our own powers to increase custom duties or subsidize agriculture, and we have also consented to permit the import of agricultural products to some extent. The interests of Iceland and other small states in the existence of the World Trade Organization is considerably greater than the interests of larger nations, as open global trade is so important to us. The access into WTO is obviously significant for countries like Iceland which are engaged in global competition with U.S. exporters. Iceland is a member state of EFTA, which has concluded a total of eighteen free trade agreements providing for the abolition of tariffs on certain goods. At the same time, these agreements restrict our scope for imposing tariffs on the other member states. There is a open discussion about EU, some people think that It can be argued that membership of the EU would secure Icelandic sovereignty better than the EEA does now, since as members of the EU we would participate in the shaping of our own destiny and in the formulation of the rules that the citizens and enterprises of this country are bound to observe. By joining the EU it would mean that all of its efforts put into becoming an independent state would be put to question as it would have to conform to EU laws and regulations. Many politicians from Iceland are against joining the E.U completely and being part of the Euro zone, as that independence maintaining sovereignty has become a primary goal. More deeply, the Icelandic culture will be influenced by the others countries via this common platform. In this case, it would give up a great deal of its sovereignty. There is an increased tendency to channel the struggle against international crime into a joint effort where a group of states agrees on systematic measures in the struggle against the criminals and solve the common problems like environmental pollution. In this case, with the political and economic sovereignty, it can help Iceland to against the financial oligarch and to deal with the crisis.

4.If you were the head of states, what steps would you take to get the Icelandic economy back on track? Iceland was brought to the brink of collapse by financial crisis in 2008. If we were the head of states, we must do many things to recover the economy.
1)To restructure the banking sector. Iceland has nationalized the most important banks but the other ones should remain private. This way, national banks can carry out some type of activities and private ones others. Moreover, the government should financially help the private banks (by bringing in money) so they can “re-launch” as well as possible. 2)To cooperate with IMF.

To borrow loan from IMF based on maintaining its sovereignty is also a way to ease the crisis. Iceland needs a loan to be recovered. In order to restructure the banking sector Iceland needs to borrow from IMF, while keeping the leverage at a sustainable level. 3)To revalorize Icelandic natural resources(export) Iceland is the country which has rich natural resources (fish, aluminum, green energies…) and we need to concentrate on maintaining and increasing their exportation. These exports, as trustful real economical revenue, must represent an important part of Icelandic GDP. 4)To apply for the membership of EU Taking up the Euro as the official currency instead of Krona will resolve the problems on failed currency. Otherwise, as a member of EU, Iceland would possibly be protected by EU from another external shock.

5.What are some of the business opportunities created by the crisis?
1)For the short term, Because of the weakening of Krona, Icelandic companies in the exportation industry can become very competitive and gain more market shares in their respective sectors. It also allows Iceland to develop new businesses creating goods and services that will be very competitive abroad. Besides, the country can also advertises Icelandic tourism and attract tourists looking for cheaper exotic trips (or even health tourism). In fact, Iceland has experienced a nearly 20 percent increase in tourism in 2011 as a result of its marketing efforts over the past year. Furthermore, as a fishing export country, its maritime industry has an opportunity to be re-developed. 2)Iceland has its particular geographical location and exotic landscapes. For the long term, the crisis can lead Iceland to further develop green energies and export it to its closer neighbours.

6.On Ethics: How did the financial crisis and the IMF bailout affect an ordinary Icelandic citizen, such as a teacher, nurse, or police officer? Was the increase in interest rates and the transfer of private debt to the taxpayer “fair”?
1)If the bankers fail, the bill will always be sent to taxpayers, ordinary Icelandic citizen, such as fishermen, police officers, teachers, nurses and so-on. So thousands of Icelanders had to struggle with fundamental change in their economic situation, loss of income, loss of property, even loss of benefits for their retirements, increased burden of loans, unemployment and so-on. People working in public functions such as police officers, teachers and nurses find themselves unemployed due to government’s cuts in public spending. These people who have nothing to do with the over-leveraged banking sector, who have most certainly never owned shares in the stock market and neither owned a very wealthy bank account, lose their job from a day to another. They have no savings to continue paying their credits and they cannot either borrow from the bank because the interest rates have grown too high. What stays from their monthly income is now too low relatively to all these routine goods that became too expensive due to inflation. Their household capital is probably half lower since even the value of their house has gown down. Not to mention, they cannot anymore think about having holidays and feel better since on top of everything there are restrictions on currency exchange. Moreover, their comfortable retirements are no longer guaranteed by being unemployed.

In terms of IMF bailout, from the case we can see the strings attached to the IMF loan to Iceland included fiscal tightening and some systematic cut-backs in welfare spending. That means because of the IMF bailout, the ordinary citizen’s social welfare can be maintained, but had been reduced. 2)We think that it’s depends. In the one hand, it was unfair because those who are not at the origin of the financial crisis, who have never enjoyed easy cash from financial speculations and that are the less armed to face it are the ones who have to pay the consequences. In the other hand, it was fair because it is necessary for Iceland to reduce debt burden, and for long-term perspective, if the government can’t payback the debt, it also will threaten the citizens’ daily lives, as the citizens of Iceland, they have to take the obligation to partake. Besides, the interest rate is a very important measure of a government’s macroscopic readjustment and control, to increase the interest rate; it can control the inflation efficiently, and ease the devaluation of the currency to some extent.

The issues related to our course “International Trade”:
1)The IMF played an important role in the financial crisis of Iceland. The IMF Stand-By-Arrangement helped Iceland economic recovery. The IMF program for Iceland was over about a year and a half ago from today. The managing director of the IMF branded Iceland’s economic performance “impressive”. In the last few years, Island has managed to shrink its deficit, reduce unemployment, and allow its economy to grow. During the process of international trade course, IMF was also been emphasized many times and taught as one of the most important institutes in the world. From the course, we learned the function and duties of IMF. Furthermore, we knew how exactly it effected in the global financial system. 2)From the case, we can see Icelanders have for a long time been resistant to apply for the membership of the EU, though the country is a member of the Schengen border – free travel zone and the European Free Trade Association (EFTA). Iceland tries to adopt the Euro as the official currency to replace the failed currency Krona. That’s why it was eager to join the EU. However, there are negative effects that Iceland may lose the national and exclusive fishing rights, not to mention the popular Icelandic hostility against joining the EU. 3)The fast destruction the financial crisis caused on the Icelandic economy can be seen as an example to many fast growing economies that have privatized without any real regulation as human greed and feeling of prosperity overtakes any kind of rational thinking. Iceland learnt the hard way that relying on international capital to fund its economy was of a high risk and that its independence is the key to prosperity both politically and economically.