In 2008, Iceland was afflicted by a banking crisis caused in part by its banks raising huge sums of deposits from foreign savers at high interest rates and the investing of these deposits in questionable assets marked at values that proved impossible to realize. Banking assets as a percentage of Iceland’s small GDP grew to mammoth size. But this was not the first Icelandic banking crisis. There were two that shook the country in the 1920s and 1930s and these were caused in part by the fishing-dependent nature of Iceland’s economy and investment in the fishing industry, with all its volatility.

Fish

            In sharp contrast to today, Iceland was a relatively poor country in the early 20th century, at least compared to its neighbors. In 1913, its GDP per capita was just 59% of the Western European average. Iceland is, with the exception of its fisheries, a resource-poor country, isolated, and with a small population, so the development of many industries would have been impossible. As for fish, haddock, saithe (pollock), herring, and most importantly cod, are caught in large quantities in Icelandic waters.

            In 1913, fishing made up about 25% of the country’s GDP; together with agriculture, 60% of GDP was attributed to the ‘primary sector’ of the economy. Manufacturing accounted for just over 6% of GDP. Fish products made up 75% of merchandise exports before the First World War and this fraction was growing, reaching 90% after the war. Mutton and unprocessed wool were the only other notable exports.

            As for fishing specifically, in the early 20th century, this industry was becoming more productive as motorboats and trawlers replaced rowing boats and sail vessels. There was a five-fold increase in the size of the fish catch between 1902 and 1930, from 80,000 to 400,000 tons. Employment in the fisheries increased 50%. In contrast, the processing of fish, such as the curing of salt fish, remained labor intensive. Consequently, employment in this industry tripled over the same period.

            Iceland was dependent on fishing output and market prices for fish, which could be very volatile, in part because supply does not typically respond to changes in price as reliably as in other industries. So, growth became faster but also more volatile in the early 20th century. Iceland also became better connected with the outside world when an undersea telegraph cable was laid in 1906 and work on a new harbor in Reykjavík began in 1913. This exposed Iceland to global economic headwinds and tailwinds in a way that the isolated island country had not been before.

Balance of Payments

            Iceland relied a lot on trade. It offered the world a narrow range of exports, mostly just fish, but these accounted for a large fraction of national income. Most manufactured goods and about half of its food was imported. Growing trade made the use of money more important in Iceland which saw an influx of foreign money. The Danish krone was particularly important.

            Unfortunately, Iceland’s foreign trade suffered during the First World War. It lost some export markets and the war disrupted imports. While prices for Icelandic products rose, the country was not able to fully exploit this, but import prices rose as well. So, like other countries, Iceland saw high inflation, at an average annual rate of 27%, and worsening terms of trade. Growing protectionism elsewhere after the war did not help bring about a recovery.

Credit

           Besides foreign manufactured goods and foodstuffs, Iceland also relied on foreign credit, which helped support the country’s banking system. Danish merchants had been active in Icelandic trade historically but Danish capital, and British capital after the First World War, invested in Iceland’s banking system, became more significant. An Icelandic bank, Landsbanki, had existed since 1886; however, the credit it provided became insufficient for the economy so a new bank was founded in 1904, Íslandsbanki. This latter bank had only foreign investors, mostly Danes, but it was huge for the size of Iceland’s economy. Its equity capital alone amounted to 10% of the country’s GDP.

Landsbanki in Reykjavík, pre-1915

           The influx of foreign capital allowed Iceland’s banking system to converge with those of other Western countries, both in size and structure. Banking system assets as a percentage of GDP rose from about 15% to nearly 50% in just a few years. Also, the Icelandic banks were modelled on Danish financial institutions. In Iceland though, these banks financed the purchases of trawlers by fisherman, typically financing about half of the purchase price. In the banking crises of the 1920s and 1930s, the exposure of banks to fishing was of fundamental importance.

Banking Crises

            The first of the twin banking crises of the 1920s and 1930s coincided with the global economic slowdown of 1920. This crisis started with a downturn in business conditions while inflation was still quite high, a subsequent halt in capital inflows, and then a currency and banking crisis. In Iceland, output fell 14% and banks suffered losses on loans as a result of bankruptcies among indebted fishing companies. The crisis badly impacted the two largest banks, Íslandsbanki and Landsbanki, which together provided nearly 80% of total lending.

            This crisis also saw a shortage of foreign currency as banks did not have Danish kroner on hand, so cross-border payments were suspended. Instead, a black market developed for foreign currency. Iceland was threatened with a loss of financing by foreign creditors. This was not entirely down to anyone’s choice but other Scandinavian banks, including among them the creditors to the Icelandic banks, collapsed during the same crisis, which affected much of the world.

            A recovery began in 1921 and in 1926, per capita GDP finally returned to pre-First World War levels. The economy performed well in the later 1920s, partly as a result of technological improvements in the fishing industry. The implementation of these new technologies was typically financed by credit and so the fishing industry continued to be associated with high debt burdens.

            Iceland was also affected by the global crisis of 1930s though. During this crisis, fish prices fell and tariffs were introduced by importing countries. The value of Icelandic exports fell from 74 million kronur in 1929 to 48 million kronur in 1932. Unemployment, both in the country and in the small but growing Reykjavík, increased. Surpluses accumulated as per capita demand fell 18% and output fell 3%. There was also a banking and currency crisis. Loan losses were unavoidable as companies had been grappling with high real interest rates amidst deflation. Currency controls were put in place in 1931. In this crisis as well, there were shortages of foreign currency. Unlike the earlier crisis, this one did see the demise of a major bank with the bankruptcy of Íslandsbanki in 1930.

Resolution

            The resolutions to these banking crises saw substantial government intervention. In the 1920s crisis, the Icelandic government guaranteed a large foreign loan to Íslandsbanki and Landsbanki which ended the crisis in 1921. After the crisis of the 1920s, the government sought to expand the state-owned Landsbanki at the expense of Íslandsbanki which was owned by foreign investors. Foreign ownership of firms, especially if special privileges are involved, has tended to be more controversial in Iceland than elsewhere. The government required that Íslandsbanki sell its precious metal holdings to Landsbanki at a discount and also injected capital into Landsbanki, which turned into a central bank. After the 1930s crisis, a new bank, Útvegsbanki, was formed from Íslandsbanki.

            Another outcome of the crises was an experiment with floating exchange rates. In the early 1920s, brief import restrictions were imposed to preserve foreign currency. The Icelandic currency was then allowed to float freely from 1922 to 1925; thereafter the Icelandic króna was linked to the pound sterling.

            Crucially, access to foreign capital was maintained. Indeed, foreign funding as a percent of banking system liabilities even reached a peak of 18% between the two crises, in 1923. Again, since much of the foreign investment in Icelandic banking came in the form of equity investment this understates the role of foreign capital, at least until the banking system was effectively nationalized after the crisis of the early 1930s.

            The resolution did not come without some pain. The government did not make a new guarantee after the early 1930s crisis. After its collapse, foreign creditors of Íslandsbanki agreed to a partial debt to equity swap and this was eventually repaid. Still, there was a weak recovery from the second crisis. It took eleven years before per capita demand had recovered from the downturn.

Lesson

            Iceland may seem like a peculiar example. It’s a small economy defined by some unique challenges, largely geographic. In a few ways though, Iceland resembled other resource-dependent economies in the late 19th and early 20th century, the likes of Australia, New Zealand, and Argentina. The usual characteristics such as dependence on one or two volatile commodities, dependence on trade over domestic demand, and a volatile financial system were all present. So, the story is not so unique that the experience is unhelpful to others. Iceland shows that these sorts of countries may benefit from tighter regulation of the financial system or more active government, if for no other reason than to act as ballast for what will almost unavoidably be a more volatile economy.

More from the Tontine Coffee-House

           Read about financial crises in other economies dependent on one or few resources: Australia, New Zealand, and Argentina. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts. 

Further Reading

1.      Einarsson, Bjarni G., et al. The Long History of Financial Boom-Bust Cycles in Iceland, 30 Mar. 2015.

2.      Jonsson, Gudmundur. “The Transformation of the Icelandic Economy: Industrialisation and Economic Growth, 1870–1950.” Exploring Economic Growth. Essays in Measurement and Analysis., Sept. 2021, pp. 191–165.

3.      Karlsson, Gunnar. The History of Iceland. University of Minnesota Press, 2000.

4.      Ólafsson, T. Tjörvi. “There Is Nothing New except What Is Forgotten: Short History of Monetary Issues in Iceland.” Presentation at a SWIFT meeting. 20 May 2015, Reykjavík.

Leave a comment

Your email address will not be published. Required fields are marked *

Social Share Buttons and Icons powered by Ultimatelysocial
LinkedIn