Yesterday afternoon Geir Haarde, the Icelandic Prime Minister, neat and square-faced with an oversymmetrical smile, went on television to announce a Bill to salvage the country’s collapsing banking system. He said he hoped that it would avoid chaos, but gave warning that the banks might become dysfunctional “to some extent”.

Good luck to him. After a day in which the Icelandic krona fell by a quarter against the euro and shares in its banks were suspended, Icelanders - and the estimated 150,000 people in Britain who have put their money there - may struggle to feel safe. Two months ago the island’s best claim to world headlines was that its handball team nearly won the country’s first Olympic gold medal (losing to France in the final and bringing Reykjavik to a halt for the day). A year ago it was that the United Nations had pronounced it the nicest place to live (Sierra Leone was bottom of the list).

Now headline writers have run out of puns on frozen assets and hot water as the Icelandic miracle unravels. The question is whether the country that turned itself from one of the poorest in Europe to one of the richest in just half a century is about to see that triumph erased.

The ubiquitous image on the travel posters for Iceland is the Blue Lagoon, a tourist spa with opaque, turquoise water, surrounded by black lava, the heads of bathers bobbing groggily in the sulphurous steam. But the real sense of luxury - and strangeness - if you arrive from any other European capital is not just the landscape of Jules Verne’s Journey to the Centre of the Earth, but the sheer lack of people. The population has only just reached 301,000, most of whom live in the capital. This gives a heady grandeur, by comparison, to Scotland’s dreams of separation for its five million people. A diplomat tells of one Icelandic official at a banquet some years ago who answered a polite question from his Chinese counterpart about how many people lived in Iceland, and received the shocked retort: “That can’t be true. If it were, you wouldn’t be sitting next to me.”

Iceland’s success has come from holding only a few cards, but ones that others do not have, and playing them very well. When it won autonomy from Denmark in 1904 the country had a high level of education (literacy had been almost universal for a century), despite its poverty compared with much of Europe.

Iceland’s medieval sagas, the country’s proudest literary treasure, were an early exercise in extreme literacy applied to the daily details of a hard life; so, seven centuries later, was Independent People, the work that helped to secure the 1955 Nobel Prize for Literature for Halldor Laxness. It is an astonishing book, probing with bleak wit the costs of extreme independence; all the same, it is an unusual achievement to win a Nobel for a chronicle in which the main character’s wives both die, as do most of his children and his sheep.

After the Second World War Iceland turned its location to its advantage, offering Nato an invaluable base between the US and Europe. It played the Nato card adroitly to win the three Cod Wars against Britain in 1958, 1972-73 and 1975-76, arguing that it needed exclusive fishing rights for 200 miles around the coast, because without fishing, it had nothing. It still has a point (and is convinced enough of this to have kept outside the EU, for fear of losing control of its waters). Fishing is now only about 15 per cent of gross domestic product, but two thirds of exports. Iceland learnt the lesson of the collapse of its herring stocks in the 1960s and controls stocks with tight quotas, an admirable model if not easily reproduced elsewhere.

It has begun to make more of another extraordinary card: very cheap, clean electricity from its huge, wild rivers and underground hot water (the island sits on top of an upward-thrusting spike of lava, not far from Verne’s imagination). It smelts aluminium for other countries, in essence a way of exporting electricity.

Then came finance, which now dominates the economy. Iceland’s banks used the steady deposits and pension schemes as a base from which to offer extensive credit. That allowed people to spend freely and businesses to borrow to buy abroad. A country where rising wealth had been spread remarkably equally had, for the first time, billionaires and entrepreneurs (many fond of the modern Viking look, with long blond hair). Suddenly, it had its own “Wall Street” - a line of small glass tower blocks rising along the seafront of Reykjavik.

That part is over. Yesterday’s moves may bring some stability, but it will take months to reveal the solvency - or otherwise - of the banks. The narrow base of Iceland’s success always made it fragile. All the same, a talent for playing a few cards well and boldly may give it more agility than other countries for extracting itself from turmoil.

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