The crisis goes sovereign

With European countries in a rush to take banking sector liabilities onto the public balance sheet, they might want to take a look at where that route goes, in extremis: Iceland, as a banking crisis becomes a full blown macroeconomic crisis.  Today has seen a bewildering series of events, even against the backdrop of a problem that had been viewed as unsustainable for a long time (gross external debt 550% of GDP).  We have: Russia apparently emerging as the lender of last resort (which must indicate other requests that were turned down), and the adoption of a what looks like a crazily overvalued peg for the króna (130/euro official when it’s trading at 200/euro).  The underlying cause is the huge size of the banking sector and its reliance on overseas liabilities relative to the size of economy — a situation that will have uncomfortable echoes in non-Eurozone eastern Europe.   Indeed, it’s only that Iceland is so small that the situation has not already caused more panic than it has.   But it’s a disturbing parable for the overall banking crisis.