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Iceland's economy is minuscule, and its population is smaller than that of Pittsburgh, but its banks are deeply involved in global markets.

Bank default worries slam Iceland's currency
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Here's something you probably thought you'd never have to worry about: the condition of Iceland's banks.

Investors are circling Iceland like sharks that haven't been fed for a while. Worries that a major Icelandic bank may default — and send losses rippling into European economies — are showing up in markets for currencies and credit insurance.

"There is a crisis everywhere. We are facing it maybe more than some other countries," said economist Hjördís Vilhjálmsdóttir of Glitnir, a commercial bank.

Iceland's currency, the krona, has plunged against the dollar this year forcing the central bank last week to raise interest rates to 15%. The price that major Icelandic banks such as Kaupthing and Landsbanki must pay for credit insurance has skyrocketed in recent days. And the principal stock exchange, down 22% this year, has lost half its value since mid-July.

The market upheaval is a sign that the financial crisis stalking the global economy has reached this tiny island nation near the Arctic Circle.

Iceland's economy is minuscule, and its population is smaller than that of Pittsburgh, but its banks are deeply involved in global markets. A default by one of the major institutions would likely be felt from the United Kingdom to Scandinavia, though perhaps not in the USA.

"Honestly, I doubt whether the dominoes are going to topple because of what happens in Iceland," said John Williamson of the Peterson Institute for International Economics in Washington, D.C.

The global credit crunch that began in the U.S. mortgage market pinched investors who borrowed money in low-interest-rate countries to place in Iceland where they could earn double-digit returns. When money available for such "carry trades" dried up, demand for the krona fell. That's caused it to sink in value, prompting the central bank's action last week.

Like Paul Volcker's Federal Reserve in the late 1970s, Iceland's central bank is determined to crush inflation. Prices rose 8.6% in March and are expected to increase 10% this month.

Amid the continuing financial turmoil, Iceland has drawn increasingly critical reviews. In February, Moody's downgraded the debt of the major banks and earlier this month lowered to "negative" from "stable" its outlook on the country's banking industry.

Financial experts in Iceland say the market tremors are being fueled by speculators, not reality. On Friday, the head of Iceland's central bank, Davíð Oddsson, called for "an international investigation on such attempts to bring a healthy economic system to its knees."

Indeed, Iceland's major banks have virtually no exposure to the subprime mortgage crisis in the USA. The government's balance sheet is robust and the country has a track record of weathering such episodes, notably in 2006.

"There is no more danger — probably less danger — than in the American banking system," said Tryggvi Herbertsson, CEO of Askar Capital in Reykjavík.

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