Policy Statement of the Department of State
The long-term objective of US policy toward Iceland is to foster close and friendly relations with a democratic independent Iceland and the close association of Iceland in the defense arrangements of the democratic countries of the North Atlantic community. Our short-term policy involves smooth functioning of the October 7, 1946 agreement with Iceland1 affording facilities at Keflavik Airport for US military aircraft in connection with our control agencies in Germany.
b. policy issues
Our Icelandic policy is shaped by the fact that Iceland is strategically situated on the northeastern air and sea routes between the United States and Europe and that, as a consequence, it would be inimical to our security for a potentially hostile power to gain a foothold there or to obtain preponderant influence. In addition to the maintenance of the Airport Agreement of 1946 and the close association of Iceland in the defense arrangements under the North Atlantic Treaty,2 consideration of our security demands the extension to Iceland of such forms of ECA and other assistance as may be necessary to ensure a viable economy and a standard of living adequate to avoid adverse political repercussions but not above the long-term capacity of the country to maintain.[Page 694]
Prior to 1939 relations between the United States and Iceland were limited by the latter’s relative political and economic unimportance. The outbreak of war, however, made the island a focal point of the competing strategic interests of the belligerent powers and made it necessary for us to reappraise our attitude toward Iceland in the light of its importance to the defense of the Western Hemisphere. In 1940, shortly after British troops had occupied the island as a defense measure, the United States established its first consulate in Reykjavik. In the following year, under the Defense of Iceland Agreement effected July 1, 1941 with the Icelandic Government,3 US troops undertook the defense of Iceland, relieving the British forces of this task.
The end of hostilities in Iceland [Europe?] did not terminate the Defense Agreement since, according to its terms, it was to remain in effect for the duration of the “present war.” In October, 1945 however, we proposed to the Icelandic Government a new agreement which would satisfy both our short-term and long-term military interests in Iceland. The refusal of the Icelandic Government to negotiate for the grant of long-term base facilities coupled with developments in the world political field, led to the formulation of new proposals which culminated in the agreement of October 7, 1946. Under this we agreed to terminate the 1941 Defense Agreement, to withdraw our troops from Iceland within 180 days and to return to Iceland the airport built by the United States at Keflavik, but with the right to continue US Government operation of the airport, directly or by delegation, until such time as Iceland is able to assume its operation and to use it in connection with the support of our control agencies in Germany. Moreover, we undertook to carry out an extensive construction program designed to enlarge and modernize airport facilities. The agreement of 1946 remains in effect for the period of our maintenance of control agencies in Germany but may be reviewed after five years and denounced by either party at any time after five and a half years with termination one year thereafter.
Certain questions relative to the functioning of the 1946 Airport Agreement were made the subject of negotiations which began in the early months of 1949, and culminated in an Exchange of Notes of May 6.4 Under the terms of these Notes, the United States undertook to reimburse Iceland for any losses suffered in the operation of the airport, to define more clearly Icelandic sources of revenue to be [Page 695] derived from the operation of the airport facilities, and to train a specified number of Icelandic citizens for positions of technical responsibility at the airfield. The latter stipulation represents an implementation of our previous agreement that Icelandic personnel would, when adequately trained, assume operational responsibility of the airport.
To make Keflavik into a first-class international airport, the United States has financed an extensive construction program that has entailed replacing the wartime buildings with more permanent structures, erecting suitable housing for the airport personnel, and lengthening the runways, on which work was begun in the spring of 1949. In April 1949, the United States completed construction of a new modern airport hotel to facilitate international civilian air traffic.
The long-term military interests of the United States in Iceland were considerably advanced by Iceland’s decision to join the North Atlantic Pact, a decision which marks a significant departure from Iceland’s traditional policy of neutrality. Out of regard to Icelandic nationalist sentiment and the country’s limited resources of men and materials, Iceland’s adherence to the North Atlantic Treaty was accepted with certain reservations insisted upon by the Icelandic Government. Thus, Iceland will not be asked to receive foreign troops or to provide bases manned by foreign troops during peacetime, nor will it be required in the event of war to make a purely military contribution to the defense of the area covered in the Treaty. It is envisaged that the role of Iceland in the event of a future war will be limited to providing bases for North Atlantic defense troops.
Icelandic adherence to the North Atlantic Treaty which reaffirms the nation’s basic pro-Western orientation should facilitate the future renegotiation of the 1946 Airport Agreement which now can be approached from the broader point of view of defense arrangements in the North Atlantic area.
The increasing pro-Western orientation taken by Icelandic policy during the past year is, to some extent, a measure of the decline in influence of the Icelandic Communist Party which, nevertheless, continues to be a threat to Icelandic political stability and to US security objectives in the area. The Communist Party, which has thrived in the past largely because of the skillful manner in which it has identified its own interests with those of the more nationalistic elements in Iceland, is most vociferous and aggressive in “defending” Icelandic independence and culture against the alleged imperialistic designs of the United States. When the Communists withdrew from the coalition government in October 1946 in protest against the ratification of the Airport Agreement, however, they forfeited the considerable progress which they had made in infiltrating key government positions such as aviation [Page 696] and education and lost the prestige normally associated with participation in the government. More important, perhaps, they gave the non-Communist parties an opportunity to demonstrate that successful government was possible in Iceland with the Communists in opposition. This success has been enhanced by the ouster of the Communists from control of the Icelandic Federation of Labor, an event which occurred in November 1948.
Iceland’s adherence to the North Atlantic Treaty has further isolated the Communists. Despite a Communist-staged riot during the closing days of the debate, the Icelandic Parliament ratified the Treaty by a substantial majority. Moreover, the Communist agitation had a salutary effect on non-Communist political leaders who now are giving consideration to such problems as the adequacy of the Icelandic police force to cope with domestic disturbances and the vulnerability of the Keflavik Airport to sabotage and direct armed attack.
The present coalition government, which was formed in February 1947, has met the Communist challenge with the aid of the economic cushion to the internal economy provided primarily by ERP assistance, but the twin problems of inflation and high cost of production remain unsolved. Basic differences among the coalition parties and inability to agree on a program of deflation have increased the prospect of new elections to the parliament sometime in October 1949. The outcome remains uncertain, but there are strong indications that the Communists will suffer a loss in strength and that another non-Communist, pro-Western coalition will succeed to power.
[Here follows a section on Iceland’s relations with other states.]
Iceland has what may be described as a one-crop economy in that more than 90 percent of the country’s exports consist of fish and fish products, the returns from which make possible extensive imports vital to the Icelandic economy. During World War II Iceland’s traditional trade relations with Europe were wholly disrupted, but lend-lease financing of fish exports to Great Britain, dollars earned from services rendered to the military forces in Iceland, and certain purchase rights in the United States that were granted in the Defense of Iceland Agreement of 1941 all combined to make possible a standard of living unprecedented in Icelandic history. In spite of the relative availability of goods, the rapid increase in wages and the high rate of investment encouraged by the government’s monetary policy contributed to bring about inflationary conditions that have forced the current cost of living index to more than three times prewar.
The cessation of hostilities in Europe ended these extraordinary opportunities to earn dollars but did not restore the prewar trade [Page 697] pattern nor end Icelandic dependency on the United States for certain vital imports. Moreover, the United States was not and is not a significant market for Icelandic exports. The resulting dollar import surplus was financed during the early postwar years by drawing on dollar reserves accumulated during the war years, and after the middle of 1948 through various forms of ECA assistance granted to Iceland in part out of recognition of its strategic importance to the United States.
The related problems of internal inflation and high costs of production, the true extent of which has been hidden by extensive subsidies to fish producers and others, have continued to plague the Icelandic Government. Iceland has in fact maintained competitive prices for its exports only through the use of extensive subsidies to its fishing industry. Trade with Europe, however, has not resumed its traditional prewar pattern in every respect, and the lack of convertability of European currencies which has necessitated the system of bilateral trade agreements has operated to the marked disadvantage of Iceland. Not only is Iceland weak in bargaining power because it has only one major export, but it is critically dependent upon imports for practically all items of consumption. Only a multilateral system of European trade would enable Iceland to develop more favorable terms of trade by permitting it to export to its natural markets while securing imports at prevailing competitive prices.
a. Trade Relations
Icelandic exports to the United States are small and face the competition of our own fish industry. Even cod liver oil exports to this country have been reduced by competition from other and cheaper sources of supply. Only by drawing on extraordinary sources of dollar income such as ECA assistance has Iceland been able to continue its current level of imports from this country.
In Europe, Great Britain continues to be Iceland’s most important export outlet and source of supply. Opportunities for further expanding trade with this country are definitely limited, however, because England has its own extensive fish industry.
Efforts to resume trade with the traditional markets of southern Europe have met with only limited success both because of Icelandic prices and the inability of these countries, in the absence of currency convertability, to supply the goods required by the Icelandic economy.
Spain, before the civil war in that country, was a large traditional market for Icelandic dried salted fish. In an effort to resume trade relations with the area, Iceland recently, and alone among the Scandinavian countries, exchanged with Spain a chief of mission with the rank of Minister. The Icelandic Government feels that this step is justified on grounds of its own urgent commercial needs, and we intend to interpose no objections. Two obstacles remain, however, to the successful implementation of a trade treaty. The relatively extensive hand labor required to prepare dried salted fish will practically insure a high [Page 698] selling price, and Spain is certain to request Iceland to balance its trade by accepting goods of Spanish manufacture, not all of which are essential to the Icelandic economy. However, insofar as this is a step toward expanding Icelandic trade with the European area, we are sympathetic in principle.
Largely through our assistance, Iceland has been able to resume in 1948 fresh fish exports to Germany, an important prewar outlet for Icelandic exports. By an agreement with the British, Iceland was permitted to deliver to German North Sea ports up to 70,000 tons of fresh fish payable in sterling; for 1949, 67,000 tons has been decided on as the maximum. Even though we did not participate in the negotiations in 1949, we nevertheless desire in the interest of the stability of the Icelandic economy to see this important export market retained.
Trade between Iceland and the Soviet Union has been on a purely commercial basis and greatly limited in extent following failure to renew the profitable trade agreement of 1946 and 1947. By contrast, trade with Czechoslovakia has steadily expanded. The latter is based on bilateral agreements whereby Icelandic exports command high prices—a point emphasized by the Communists—, as do also the goods of Czech manufacture that must be accepted in turn.
b. ERP and Iceland
Iceland’s initial approach to ECA was cautious and reserved. The Icelanders traditionally have been reluctant to contract national debts with foreign powers. Communist propaganda, moreover, played on nationalist feelings by stressing that ECA assistance was merely one more step toward the complete loss of Icelandic independence. As a country that had suffered no appreciable war damage, Iceland expected to derive primarily indirect benefits from the reconstruction of the European economy, thereby reopening traditional markets for its fish exports.
Under the impact of economic difficulties arising out of domestic inflation and declining fish markets abroad, the Icelandic government during the summer of 1948 asked for a loan of $2.3 million, and later in the year received a conditional grant to encourage the sale of fish in Europe amounting to $3.5 million. It was evident, however, that great as its needs might be the Icelandic government was reluctant to ask for further loans, to which the Icelandic people traditionally have been opposed on principle. Moreover, a request of this type would practically have assured further parliamentary debate in the course of which the Communists would enjoy a tactical advantage with their anti-American propaganda and their alleged concern for Icelandic independence. Under the circumstances, the Department concluded that political considerations were paramount and that the need for a further period of adjustment for the Icelandic economy was necessary to prevent adverse internal political repercussions. On this basis, consequently, an approach was made to ECA, which agreed to make an additional direct grant of $2.5 million, thus raising the total ECA contributions to Iceland to $8.3 million. It is further assumed by ECA that the Icelandic dollar deficits during fiscal 1949–50 will total [Page 699] roughly $7 million, a sum that probably will be covered by further direct grants.
The United States in its economic policy toward Iceland faces a long-term problem, the solution of which is not yet clearly evident. Iceland hopes to attain economic viability by the end of 1952 through expanded production at prices competitive on the world market, the reopening of traditional markets such as those in Spain and Italy, greater diversification of its economy through domestic production of certain items now being imported such as fertilizers and cement, and the expansion of agriculture. The Icelandic production goals, however, are subject to the known hazards of an economy based on the catching and processing of fish. Iceland’s great dollar earner, the herring, for example, has not appeared during the traditional summer season for several years. Construction of fertilizer and cement plants, which in turn will require expansion of hydroelectric generating facilities, raises the problem of financing, which in this instance is known to be beyond the capacity either of private industry or the government, and is almost certain to require some form of ECA assistance. In principle, however, the US favors all steps toward greater diversification of the island’s economy so as to reduce the extent of its dependence on fish exports.
Some reduction in the present comparatively high standard of living in Iceland seems inevitable in that it now seems reasonably certain the country’s exports cannot finance imports sufficiently to maintain that standard. Our economic policy envisages a stabilization of the living standard at a level sufficiently above prewar to prevent Communist exploitation of this as an issue, but nevertheless at a point more in line with the level of imports that can be maintained. We seek to encourage the Icelandic Government to recognize these facts and to take appropriate remedial action.
The dollar exchange rate of the krona in Iceland has remained unchanged since 1939, even though Icelandic prices have risen greatly as is indicated by a cost of living index more than three times above prewar. Under the terms of its ECA bilateral agreement Iceland agreed to “establish or maintain a valid rate of exchange.” Since the end of the war the Icelandic economy has been characterized by balance-of-payments deficits which recently have been checked only by subsidies and rigorous controls over foreign trade and foreign exchange. In these circumstances it appears reasonably certain that an adjustment in the value of the krona is indicated. Because the price level has remained relatively stable during the past several months, and if this can be continued, the government could presumably carry out devaluation without producing a disastrous price inflation. This in turn should make possible elimination of the necessity for export subsidies which currently represent an important inflationary expenditure. Devaluation would not settle Iceland’s dollar problem, however, exports to the United States being relatively small, but it would probably have a salutary effect on Iceland’s trade with non-dollar countries.
The question of devaluation is a part of the current political dispute in Iceland with the non-Communist parties divided on the subject. [Page 700] Consequently, even though the United States favors devaluation in principle, any attempt to force this on the Icelandic Government would produce highly unfavorable domestic reactions, and would only serve to play into the hands of the Communists. Devaluation may be more feasible after the elections which are scheduled for October 1949 than at any time in the postwar period. Most important, Communist capabilities for creating political instability are almost certain to be at a low ebb. One question in the expected electoral campaign is certain to be the question of devaluation, public discussion of which may lead to a clarification of party attitudes.
The recognized international importance of the airport at Keflavik has tended to make the Icelanders more air-minded and thus has contributed toward breaking down the walls of isolation within which the people lived for so many centuries. Not only has an element of national pride emerged over possession of this air center, but it is now evident that Icelanders are looking forward to the time when they will be responsible for all details of the airport operation.
Iceland concluded a bilateral air agreement with the United States in January 19455 and subsequently a CAB foreign air carrier permit was granted to the Loftleidir air transport company with landing rights in New York as well as Chicago. Air traffic under this agreement remains on a non-scheduled basis for the Icelandic company, however, although American Overseas Airlines conducts regular flights to Iceland.
Because of the international status of its weather reporting facilities and the heavy financial burden that this entailed, the Icelandic Government with the support of the United States in 1947 asked the International Civil Aviation Organization for assistance. ICAO was favorably inclined and a final agreement was signed at Montreal on September 16, 1948, under the terms of which Iceland received 7.5 million kronur (roughly one million dollars) as compensation for the cost of maintaining international air navigation facilities from 1946 through December 31, 1948. Beginning in 1949 Iceland will receive thereafter as a contribution to its expenses for navigational facilities in the North Atlantic up to 4.2 million kronur (about $650,000) a year, which will be paid by the ten signatory powers in accordance with a schedule drawn up in Geneva, Switzerland, in June 1948. Iceland will pay 17.5 percent of the total costs and the United States 48.7, with the balance distributed among the other signatories. In addition to recognizing Iceland’s contribution to international aviation, this agreement will also bring each year to Iceland several hundred thousand dollars in needed hard currency.
The Keflavik Airport itself, however, is not self-supporting and the net costs of its operation, as well as of its improvement, have been borne almost exclusively by the United States. Iceland apparently envisages [Page 701] complete operation of the airport facilities in the near future, but it has shown no disposition toward assuming the financial burden that this will entail. It appears to assume that the United States in return for certain concessions to its strategic interest in the airfield will continue to finance the airport operating deficit.
d. policy evaluation
The United States has achieved a measurable degree of progress toward attaining its policy objectives in Iceland during the past year. By adhering to the Atlantic Pact, the Icelandic people have given concrete expression to their basic pro-Western orientation. Increased friendliness on the part of Icelandic political leaders toward the United States has been noted, and the early hesitancy and even unwillingness to credit the United States and the ECA for definite economic benefits rendered to Iceland have largely disappeared.
Icelandic officials, largely as a result of their experience with the Communist-inspired riot against membership in the Atlantic Pact, have begun to show a gratifying realism in their approach to the fifth-column threat posed by the Communist Party.…
Our policy of economic aid to Iceland, while not immediately successful with respect to the country’s balance of payments problem, nevertheless has given the coalition government an opportunity to institute several corrective measures without creating severely adverse economic conditions susceptible to Communist exploitation. The Communist Party currently is at the lowest ebb of strength and prestige since the end of World War II, a fact that should facilitate more realistic consideration by the government of the twin problems of inflation and high cost of production.
With respect to the Keflavik Agreement, which must be renegotiated before the end of 1952, it now appears certain that the United States will be required to accept a more subordinate status in the operation of the airport. This will not necessarily mean a deterioration of the air facilities at Keflavik, or that the latter will cease to play its present significant role in transatlantic air traffic. Just as the points in dispute growing out of the Airport Argeement in 1946 were satisfactorily resolved in May 1949, so it is believed that the Icelandic Government as a signatory of the Atlantic Pact will in the future give consideration to the purely military aspect of the United States interest in Keflavik airfield.
It would be wrong to conclude from all this, however, that the intense nationalism of the Icelanders has thereby disappeared, or that Icelandic political leaders will be less alert to defend what they regard as Icelandic interests. It should be recalled that Iceland as a member of the Atlantic Pact has assumed no military obligations in [Page 702] time of peace, although it does have an implied obligation in time of war. Moreover, many non-Communist Icelanders have retained their original dislike for the Airport Agreement of 1946. Negotiations with Iceland in the future as in the past will have to proceed with careful regard for Icelandic sensibilities.
- For text of agreement between the United States and Iceland regarding the termination of the Defense Agreement of July 1, 1941, effected by exchange of notes on October 7, 1946, see Department of State, Treaties and Other International Acts Series No. 1566, or 61 Stat. (pt. 3) 2426. Related documentation, not printed, is in Department of State files 859A.20 and 501.AA.↩
- For documentation on Iceland’s participation in the North Atlantic Treaty Organization, see pp. 1 ff.↩
- Documentation on the negotiation of this agreement is printed in Foreign Relations, 1941, vol. ii, pp. 776 ff. For text of the Agreement, see Department of State, Executive Agreement Series No. 232.↩
- Not printed.↩
- For text of Agreement, respecting air transport services, effected by exchange of notes signed at Reykjavik, January 27, 1945, see Department of State, Executive Agreement Series No. 463, or 59 Stat. (pt. 2) 1464.↩