I guess this is the question we all want to answer. The first thing we need to think about is whether Iceland is about to crash in anything meaningful way. I still think this is doubtful even if the recent depreciation of the Krona was quite severe. Wolfgang Munchau from the FT discusses this in a recent note and as he points to all this is driven by the speculation rather than fundamentals. Yet, this is scarcely comforting since experience tells us that once we are this stage the link between fundamentals and animal spirits is often blurred.

Clearly, the financial sector in Iceland is taking an undue beating and those credit default swaps (i.e. implied probability of defaults) seems to be rather high given the fact that these banks are well diversified. But then again, who knows what they got on their balance sheets at this point?

If Iceland defaults on part of its debt or if one of the big banks collapses it would obviously have consequences for the rest of Europe not least as a knock-on effect on confidence which is already low, but on the real economy; not a whole lot. I also think that we need to remember that the Icelandic banks have branches in Europe which would allow them to tap the ECB for liquidity so the odds are still fairly low I would say.

In the end it is impossible to tell at this stage since the markets are very jittery. The best thing you can do at the moment is to watch closely and be careful where you put your money . The heavy depreciation of the ISK recently is definitely a sign that the we are not done yet.

I still think that Iceland and/or Eastern Europe could be potential sources for even more drama than we have had so far but at this point we are in the middle of a process very few investors understand so reactions will be anything but forseeable.