It is often said, even by supposedly responsible people, that the tools used by central banks all over the world to combat inflation will not work here in Iceland, not least because of the way globalisation treats small currencies like the króna, and because of how many investors, through the shelter afforded by globalisation, have the means to avoid the Central Bank’s thumbscrews. The cannons on Iceland’s coast guard cruisers were no weapons of mass destruction, and the difference in size between Thór and Aegir, on the one hand, and the British navy, on the other, was horrific, but we managed nonetheless. Of course, a reference to the Cod Wars is merely a metaphorical one, and I use it more or less in jest, as it doesn’t fully apply to the current situation. But the comparison between the Central Bank of Iceland’s tools and those of other central banks, which enjoy the relative security of a large currency, is worth examining. In the past few months, though, large currencies have not been protected from tremors, shocks, and even wide fluctuation. For example, the euro has appreciated by more than 70% from its weakest point against the US dollar, an enormous change in a relatively short period of time. The Icelandic króna has not been nearly so volatile despite all of the shocks it has had to tolerate. A volatile króna in a turbulent season tends to indicate that the króna is effective as a currency, and not the reverse.
But by now most have realised how unlikely these problems are to disappear so quickly. There is every reason to believe that the coming months could prove difficult as a result, and there is correspondingly little reason to believe that the crisis is past. Uncertainty abounds. A huge investment bank like Merrill Lynch could not foresee that, in only two weeks’ time, it would have to write down billions of dollars’ worth of outstanding debt. The CEO of the company has had to pack his bags and leave, albeit with a generous going-away present. The largest bank in the world is also beset by the restlessness, and it isn’t yet fully clear what the effects will be, but that CEO has received his marching orders as well. And according to the latest reports, while there are reported write-downs of a mere 20 billion dollars on subprime mortgages, the actual amount could in the end be between 250 and 300 billion. BIS Review 131/2007  3  One cannot help but wonder whether market participants in Iceland and elsewhere preferred to suffer through a shaky third quarter in the hope of some redemption in the fourth quarter, and in the process, avoided recording some items that should have appeared in third-quarter accounts.