“Iceland's debt repayment limits will spread” -- Perhaps the U.S. should follow Iceland’s lead.

Can Iceland and Latvia pay the foreign debts run up by a fairly narrow layer of their population? The European Union and International Monetary Fund have told them to replace private debts with public obligations, and to pay by raising taxes, slashing public spending and obliging citizens to deplete their savings.

Resentment is growing not only towards those who ran up the debts - Iceland's bankrupt Kaupthing and Landsbanki, with its Icesave accounts, and heavily geared property owners in the Baltics and central Europe - but also towards the foreign advisers and creditors who put pressure on these governments to sell off the banks and public companies to insiders. Support in Iceland for joining the EU has fallen to just over a third of the population, while Latvia's Harmony Centre party, the first since independence to include a large segment of the Russian-speaking population, has gained a majority in Riga and is becoming the most popular national party. Popular protests in both countries have triggered rising political pressure to limit the debt burden to a reasonable ability to pay.

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This agreement is, so far as I am aware, the first since the 1920s to subordinate foreign debt to the country's ability to pay. Iceland's payments will be limited to 6 per cent of growth above 2008's gross domestic product. If creditors thrust austerity on the Icelandic economy there will be no growth and they will not get paid.

A similar problem was debated 80 years ago over Germany's first world war reparations. But many policymakers remain confused over the distinction between squeezing out a domestic fiscal surplus and the ability to pay foreign debts. No matter how much a government may tax its economy, there is a problem turning the money into foreign currency. As John Maynard Keynes explained, unless debtor countries can export more, they must pay either by borrowing or by selling off domestic assets. Iceland today has rejected these self-destructive policies.

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Will Britain and the Netherlands accept Iceland's condition? Trying to squeeze out more debt service than a country could pay requires an oppressive and extractive fiscal and financial regime, Keynes warned, which in turn would inspire a nationalistic political reaction to break free of creditor-nation demands. This is what happened in the 1920s when Germany's economy was wrecked by the rigid ideology of the sanctity of debt.