How a "Rich" Country Can Go Bankrupt

Last year, if you were to look at the GDP per Capita country listings, you would have found Iceland at number four.  Nowadays, It has moved down the list quite a lot.  This is because its 3 biggest banks have gone under.  Now you may be thinking, this is not such a big problem.  Lately, huge corporations, including financial institutions have filed for bankruptcy in the United States, and while the repercussions of this have been easily noticeable, the US itself is still the economically most powerful country in the world.  

The main difference between the United States and Iceland is its population.  However, this alone would make no difference in what happened to Iceland.  How this influences, is because with a very small country, it is much easier to have corporations be much more financially powerful than the government.  Powerful corporations, can take out very big loans, and in Iceland, this is exactly what happened.  The GDP (nominal) of Iceland in 2007 was 20.2 billion US Dollars, which even though small compared to bigger countries, is very respectable for its population.  This brought its GDP per capita (nominal) to 65,500 US Dollars. By Comparison, The US's GPD (nominal) in 2007 was 13.8 trillion US Dollars, giving it a GDP per capita (nominal) of 45,700 US Dollars.  

In Iceland, the debt amassed by its 3 largest banks was close to 80 billion US Dollars, or roughly 4 times it's GDP (for reference, Germany was only required to pay about 85% of its GDP in reparations after World War II).  The reason for this debt is that because Iceland had a high inflation, and to make up for this inflation, its banks raised interest rates (which were extremely high, around 15%).  This paved the way for an influx of investments in Icelandic banks, mainly from, Britain and the Netherlands.  The Icelandic banks in turn sought after high return investments to pay that high interest rate.  These high return investments also carried a high risk associated with a higher return.  When the US's economic crisis hit the rest of the world, Iceland was hit hard.  Many of Iceland's investments were hit, and The government could not afford to bail out its banks.  After one of its banks went broke, Britain froze the assets Icelandic banks had in Britain, to protect itself from Iceland defaulting on its loans.  This caused the other 2 big banks to go bust because they couldn't make payments that were due on short term loans.  

Iceland is now turning to its oldest lucrative industry to try to repair its economy.  Fishing.  

Normally when people look at countries like this, they never believe they will be hit so hard by a financial crisis.  Other Countries like this include Luxembourg, Monaco, and to a lesser extent, Switzerland.  By moving a countries industry mainly to finance, without producing anything, there is a very big risk, because it places the country at the mercy of the "big players" of the world.  In an economy like this, if the US or the EU sneezes, Iceland got pneumonia.  

Lets hope what happened to Iceland is the exception, and not the rule, because otherwise, we will be seeing many other financial based countries succumb the same way Iceland did.  One large advantage Luxembourg and Monaco have is that the belong to the EU, which would shield them somewhat, but what some people consider the mecca of finance does not belong to the EU.  That is Switzerland.