Last updated: 28 april, 2009 - 12:46 GMT

Peter Day's Comment

Iceland feels the Heat

It's eight years since I first reported from Iceland, when the country had big ambitions to turn itself into a hydrogen economy. There were mighty plans to use abundant geothermal heat to generate the gas to power vehicles, first buses, then cars, then boats and even planes. The whole island would be carbon free by 2030; at least that was the intention.

There are still very few cars and buses powered by hydrogen in Iceland now, but I think you will be able to take a hydrogen-powered ship out of Reykjavik to go whale watching this summer. But despite the apparent slippage, Iceland's quest to supplant a carbon economy with hydrogen still has a certain plausibility.

Another fascinating business in 2001 was a pioneering biopharma company called Decode Genetics. Amid much controversy, it had bought the country's medical records and was trying to combine them with Iceland's centuries of amazing family records and the human genome project to find new ways of doing drug discovery.

Decode has had a roster of research successes. But it is now caught up in its own financial crisis.

But that is nothing remarkable in Iceland these days. This country with just over 300,000 inhabitants is effectively bust, though bankers always used to insist that countries cannot go broke since they carry on regardless.

Volcano

Going on regardless is what Iceland is trying to do at the moment, in the middle of the ruins of a runaway economy.

In a sort of suburb on the boggy outskirts of the capital, hundreds of unsold houses dot the roads across the hill. On the way from the airport, our obliging taxi driver took a detour to show us another phenomenon - a speculative housing estate built on a volcano. Hasn't gone off for 4,000 years, but (as he pointed out) that is not long in geological time.

When I first went to Iceland, it was pretty much what I had expected: bright, hardy, people with very good education and good English, living and working in low-rise simple buildings clustering round the seacoast in the capital, and on lonely farms in huge valleys all round the populated fringe of the island.

When I went back on holiday three years ago, the change was extraordinary. Icelanders had discovered the joys of borrowed money. Reykjavik was sprouting multi-storey buildings, and Icelanders were feeling very rich and beginning to wonder where the money was coming from.

Some people I talked to then thought the banks were laundering Russian mafia money. Others, including some reputable economists, thought Iceland was modernising in an almost admirable way, abandoning the traditional vagaries of fishing (and aluminium production with cheap electric power) for the new financial services industry.

Quotas

Well, the Icelanders have learnt one hell of a lesson, or are in the middle of learning, since nobody yet seems to have worked out how bust the banks actually are, and what liabilities will have to be assumed by the government or someone else.

But where did it all start, this extraordinary transformation? There's an intriguing suggestion in a recent Vanity Fair (of all things) by the clever writer Michael Lewis (who wrote the wonderful "Liar's Poker" about the extravagances of investment banking in London when the going was good).

He thinks that the seeds of destruction were sowed in the 1970s when the hardy, impetuous, risk-taking Icelanders decided to manage their vital fishing resources by introducing a quota system for all the fleet owners fishing Icelandic waters.

Effectively Icelandic fishing was privitised, and then the fish were securitised.

The total amount of fish likely to be available in any one year was calculated by Icelandic fisheries scientists and the catch divided up between the local owners of quotas.

And the fishing quotas (turned into money) created the first Icelandic financial bubble. Enterprising fleet owners bought extra quotas from less enterprising fisher folk, and flush with cash for the first time, the ex fleet owners began to do financial speculation.

They bought banks and other Icelandic businesses. and it now turns out they had little idea how to run them, and the regulators had no idea how to rein them in.

Animal spirits carried them all away, and it may well be that it was the fishing bubble that started everything.

Though Iceland is in the middle of the Atlantic its clocks are on European time : it sticks to GMT, even though fears of having to share those precious fish with the rest of Europe have kept it out of the EU.

But so fraught is the great Icelandic financial disaster that there is now much talk of abandoning those deep fishing worries and applying to join both Europe and the Euro. A great big risk, but it might bring Iceland in from the cold.

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