Iceland has declared war on bears, not the fur-clad ones but financial spivs which Geir Haarde, the Icelandic prime minister, believes are out to wreck the country's banking system.

He blames bear raids by hedge funds and stock market manipulation for spinning the island's economic problems into a full-blown financial crisis.

The Krona has lost a quarter of its value this year against the euro and this week two debt-rating agencies, Fitch and Standard & Poor's expressed doubts about the solidity of Iceland's sovereign credit rating, hinting at a downgrade due to the risk that its leading banks, Glitni, Landsbanki and Kaupthing might need government support.

There is trouble up North. The economy of Iceland has become almost as hysterical and overrated as its most famous export, the pop singer, Bjork. However, the financial establishment in Reykjavik insists that an overheated economy, mountainous external debt, galloping inflation and a collapsing currency are not symptoms of an imminent financial crisis.

Iceland has been warming at a rate that would even surprise Al Gore, thanks to an investment boom fuelled in part by aluminium smelters. Iceland's almost inexhaustible supplies of cheap geothermal energy have attracted huge projects from Alcoa and Century Aluminuim.

Meanwhile Iceland's own companies, such as the investment group Baugur, have been rampaging across Europe, buying assets with loans in foreign currencies and Iceland's external debt now amounts to almost three times the size of the Icelandic economy.

Meanwhile a surge in inflation to more than 8 per cent has forced the central bank to raise the interest rates to 15 per cent. There are now fears that Icelandic banks will be locked out of global credit markets which are already in go-slow mode.

Comparisons are being made with Thailand's financial crisis in 1997 and, alarmingly say analysts at Danske Bank, some of the economic indicators look worse for the Nordic wolf than they did for the Asian tiger. Iceland's current account deficit is a fifth of GDP and the bank speculates that a liquidity crisis and a plunge in the value of Kronor, could lead to massive falls in the country's stock markets, collapsing consumption and falling GDP.

Meanwhile, the prime minister's rage against short-sellers rings faint bells with a similar tirade by Dr Mahathir Mohamed, the Malaysian leader who accused George Soros of precipitating the collapse of Asia's currencies in the late 1990s.

Should the world worry? Iceland is tiny, a bit of volcanic stubble in the North Atlantic and just 300,000 inhabitants.

Its economy, worth some £10 billion would just about earn it admission to the lower ranks of the FTSE 100. Moreover, we shouldn't bury Iceland yet.

It has a thriving diversified economy of primary metals, fishing and technology. It has become a hugely fashionable tourist destination and as the currency falls it will become more popular.

There is almost no unemployment - Iceland's investment boom was created in a textbook enfranchisement of the population with privatisations and the creation of tradeable fishing rights, allowing a large section of the population to monetise their right to the sea's annual harvest. The Icelandic financial bubble will burst but the underlying economy will thrive.

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