Iceland: What Happens After Imploding?

Recently Iceland imploded. See the post Iceland Melts, 77% Single Day Drop for some charts that point straight to hell. So what happens afterwards?

The simple answer: Nothing pleasant…

Iceland Central Bank Raises Key Interest Rate to 18% (Update2): “Iceland's central bank unexpectedly raised the benchmark interest rate to 18 percent, the highest in at least seven years, after the island reached an aid agreement with the International Monetary Fund.

Policy makers raised the key rate by 6 percentage points, the Reykjavik-based bank said in a statement on its Web site today, taking the rate to the highest since the bank began targeting inflation in 2001. It will publish the reasons for today's move at 11 a.m. local time.

The central bank is raising rates as Iceland, the first western nation to seek aid from the IMF since the U.K. in 1976, faces a prolonged contraction, coupled with possible hyperinflation and rising joblessness. The economy will shrink as much as 10 percent next year, the IMF forecasts. Iceland will receive about $2.1 billion in aid from the Washington-based fund, according to a deal struck on Oct. 24.”

A sudden 6% overnight increase by the central bank has got to mess with local mortgage rates. Inflation in Iceland is expected to hit 75% because the economy is heavily import dependant and the currency has collapsed. This has instnatly tripled the costs of everything entering the country.

“History shows that attempts to save currencies from plunges by raising interest rates are prone to failure. The U.K. on Sept. 16, 1992, boosted its benchmark rate by 5 percentage points in two moves to 15 percent in a doomed effort to keep the pound in a European exchange-rate system. Britain gave up the attempt the same day and canceled the second rate rise; the pound lost 22 percent against the dollar in the final two months of the year.

During the 1997-98 Asian financial crisis, the International Monetary Fund advocated high rates to help restore confidence in sliding currencies. Central banks from Indonesia and Thailand to South Korea and Singapore lifted borrowing costs. South Korea took its main rate to 30 percent in December 1997.

The strategy failed to prevent exchange-rate collapses across the region. South Korea's won lost 47 percent against the dollar in 1997, the Thai baht fell 45 percent and Indonesia's rupiah plummeted 56 percent.”

Clearly, nobody ever learns anything. Looks like more of the same all around.