The entire economy of Iceland has come under massive speculative assault in the past several months, as the most ludicrous example of an overextended, overleveraged, underfunded European economy.
As of December 2006, its rolling annual trade deficit was 26 percent of GDP. That has come down to “only” 15 percent as of January 2008.
However, Iceland’s currency has bled 26 percent in the interim. Because Iceland is a tiny economy, adverse shifts in foreign exchange are telegraphed extremely rapidly to every corner of the economy.
May 16, 2008 | 1735 GMT
The central banks in Denmark, Norway and Sweden have offered a $2.3 billion loan to Iceland to bolster its faltering currency, the krona, which has lost some 26 percent of its value since January amid concerns that Iceland’s banks carry too much foreign debt, Bloomberg reported May 16. The currency rose 3.7 percent versus the euro on the news. Inflation in Iceland hit 11.8 percent in April, the highest level in nearly two decades, despite a key interest rate set at 15.5 percent.
This is small-scale proof that currency implosion today equals consumption implosion tomorrow. The only variables are the relative size of the country’s economy (smaller economy = faster price realignment in line with forex fluctuations), the size of the country’s trade deficit as a percentage of GDP (larger deficit = sharper adjustment), and the absolute size of the country’s trade deficit relative to all other national trade deficits.
Turning points in the global economic cycle usually hit the smaller, more vulnerable economies first. The big boys get hit last, but hardest.