Iceland’s wealth has long been a mystery. For centuries the volcanic, windswept island clung to the edge of Europe, scraping a hard living from the barren land and the cold seas. Even after independence from Denmark in 1944, Iceland remained poor – though laying the basis for future prosperity with an excellent education system, near-universal literacy and a work ethic that drove almost every adult to take two or even three jobs.

By the start of the millennium, however, Iceland had become extraordinarily rich, with a living standard measured in 2007 by the United Nations Development Report as the world’s highest. With an enviable health service, high life expectancy, rich cultural heritage and near-total technological literacy, an island with a population no larger than Coventry was reaching out way beyond its shores. Companies such as Bakkavör and Baugur were buying up high street names in Europe, and especially Britain, by the score: Singer & Friedlander, Geest, Hamleys, House of Fraser and Karen Millen, to name just a few of the firms targeted by aggressive overseas expansion. Iceland was not only climatically cool: quirky pop music, zany fashions and cutting-edge research into genetics accompanied the emergence of billionaires in the Russian oligarchs’ league. An Icelander even bought West Ham, a trophy Premier League football club.

The wealth, however, was built not simply on hard work, initiative and valuable catches of cod. It was also built on a massive inflow of funds into the country’s banks and highly leveraged raids on the riches of Western Europe. By the start of this year, Iceland’s three banks had foreign liabilities of more than $100 billion – dwarfing the country’s gross domestic product of $14 billion. Now, suddenly, everything may be gone, the economy wiped out with the same cataclysmic devastation that was regularly visited on the land by the eruptions and plagues of earlier centuries.

The mood in Reykjavik today is grim. There is no panic. But the Prime Minister has spoken dramatically of returning to Iceland’s fishing and farming roots, rebuilding by simple hard work what may have been lost. And politicians are casting around for those to blame, settling on entrepreneurs who took massive and risky advantage of the deregulation of the formerly state-controlled financial sector. Pressure is also mounting on David Oddsson, a long-serving former Prime Minister who has become chairman of the central bank (and in many people’s eyes is still the country’s real ruler). There is a palpable sense that a nation of such proudly independent people has betrayed its own heritage in becoming so dependent on the vagaries of international capital.

Iceland’s crisis is not only a morality tale of global concern, given the number of foreign, especially British, investors; it also lays the country open to predators ready to seize this prize. Russia has offered to bail out Iceland to the tune of €4 billion (see page 8). Moscow has the money, means and motivation. And however nervous this staunch Nato ally may feel, Iceland’s politicians have little option but to talk. For the Kremlin there could be no greater relish than extending its influence into the North Atlantic. If we are not careful, Iceland will signal the ominous start of a new round of mergers and acquisitions – not of companies, but of whole countries.