Early Sunday afternoon, I have coffee with Vigdís Grímsdóttir, a writer living in a quiet neighborhood just south of Reykjavík's main drag. Vigdís is the author of 11 novels, three collections of short stories, two volumes of poetry, a biography, and one children's book. The first thing she talks about after seizing my coat ("Take off your clothes. Not all of them") is how the couple downstairs lost their jobs and are moving out. As she speaks, her mind seems to commute between two moods—one distant and portentous, the other brisk, playful, and slightly frazzled. At one point, she stops midsentence to gape in horror at my coffee. "It must be cold!" she says in a half-whisper. "Is it bad?"

I've come to see her in the hope of finding out how one of Iceland's most prized assets—its national literature—is weathering the crash. Normally, early winter is the season of bounty, or what passes for bounty in Iceland, among local publishers. Almost every book is released in the two-month run-up to the holidays (called the jólabókaflóðið, or "Christmas book flood"), the idea being that hyperliterate, winter-bound Icelanders are, essentially, the world's most concentrated gift-book market. With production costs up and wallets slim this season, though, the plan risks falling flat. Roadblocks loom on the creative end as well: The government has paid tens of Icelandic authors' salaries every year, effectively helping to keep the country's literary output afloat. That sponsorship is almost certain to be scaled back, given changed  regulations and the economic pinch.

At fiftysomething, Vigdís wears black the way some people wear red—a heavy shawl thrown dramatically around her shoulders, a whoosh of ebony hair—and she moves with the aloof intensity of an offstage actor. The literary world has come at the collapse with new fervor, she says, with previously standoffish authors stepping into the fray. "Now they're writing articles in the newspaper, much more than before," she tells me. "So many writers are coming from their shells." Vigdís has noticed a difference in public attention, too: Beginning last winter, when she was doing publicity for her latest book (a biography of an Icelandic everywoman), each reading she gave was packed. To her, this spelled impending crisis. "I could feel it in the air," she says. "There was something changing. People wanted to hear about—themselves, maybe." She thinks it showed readers' distrust of stories about highflying success and affluence.

So far, this year's jólabókaflóðið has not been hindered. Jóhann Páll Valdimarsson, publisher at the Icelandic house Forlagið, which is responsible for about two-thirds of the book market, says in an e-mail that sales this fall are strong and "probably up quite a bit from last year." He has deliberately kept book prices low, despite an increase in production costs, in anticipation of a larger-than-usual readership this winter—Icelanders, he thinks, seek solace on the page. Editorial cutbacks are inevitable, though. They will show up next year. "What we decided the day the first bank collapsed," he says, "was to postpone many titles we had in the pipeline for next year and 2010."

At a low table in Vigdís' kitchen, whose windows overlook the valley of southern Reykjavík, she talks about concern over next year's government stipends. Some writers have already started courting private donors, apparently; Vigdís has not. She says: "I always thought, 'Well, if someone wants to read me, he will find me.' " She also says: "I think we have to open our mind much more to the community of others, everybody, and stop rowing our boats alone, like the Vikings. … This beautiful little island—and it is beautiful—is just a picture of the world."

But what, exactly, is that picture? The next afternoon, en route to lunch, I stumble on a group of people gathered on the sidewalk outside the prime minister's office. They're dressed in black and carry black flags, one with the anarchist's symbol on it. The ringleader, a short, blond woman with a megaphone and a trash bag, shouts and pitches food at the building's facade. Mustard is squirted on the wall. So is something I've good reason to believe is rémoulade sauce. The woman with the garbage bag intones a spiteful-seeming speech, and then the crowd sets off across the street, over the grass of Arnahóll Hill.

Subsequent investigation of the crime scene reveals the thrown food to be raw meat, smoked lamb (deli-sliced), and two wedges of blue cheese. This, I learn, is "rat food," left for Geir Haarde, the prime minister. (It is also unsettlingly like my hotel breakfast.) The blonde is a witch who just cast an evil spell. By the time I follow them across the green, the witch has disappeared inside the jagged concrete bunker of the Central Bank, hoping to lure out (or perhaps to hex) Davíð Oddsson, the chairman of the bank's board of governors. The inner doors have locked behind her, so her posse waits in the foyer, where motion sensors nudge the outside doors open and shut.

The witch exits eventually, alone. Stopping to face the waiting crowd, she opens up her garbage bag and brandishes what looks like an oddly appointed sex doll. It has a pillow head, a hipster-tight white shirt with buttoned pockets, and a suit in the dimensions of Joe Pesci. A mop of yarn hair mimics Davíð's iconic thatch. The witch marches away from the bank, bearing the effigy on her forearms like an animal pelt, then she pulls its pants down and, with awkward flourish, whips the stuffed cloth buttocks with a clump of twigs. She throws cloth Davíð to the ground. She picks him up. She stuffs him back into the garbage bag and walks away.

Just a few years ago, this might have qualified as provocation, but today it's more like flogging a dead horse. For Iceland, Davíð Oddsson is an object lesson in diminishing political returns. He's spent most of his adulthood in government, first as Reykjavík's mayor and then, for an astounding 13 years, as prime minister. (He served briefly as foreign minister, too, before taking the reins of the Central Bank in 2005.) The Davíð doctrine is heavily inflected with the Reagan-Thatcher creed: At the peak of his power, he pushed for deregulation, privatization, and, eventually, tax cuts. He turned a budget deficit to surplus and set the groundwork for the growth of the past decade. From his last years as prime minister, though, he has been increasingly embroiled in controversy. Now he is the symbol of a leadership thought to have led its people off a cliff. The rush of criticism winds back to his actions well before the crash: Outside the bank, one protester lambastes him for enrolling Iceland in the coalition of the willing.

It is an accusation that sits uncomfortably, a reminder that this weird public Kabuki is, somehow, the glint off larger problems. The evening before, my girlfriend and I shared a geothermic pool with a National Guardsman en route home to the Midwest after a year abroad. "Afghanistan," he said softly. Steam spiraled from the water as he told us how he'd worked with Taliban defectors, trying to steer locals from the lure of short-term profit and from mullahs teaching a perverted, corrupt Islam. "They say, you know, 'hearts and minds,' but it's really more like carrots and sticks now." Across the pool, Icelandic twentysomethings on their stomachs in bikinis swirled their ankles in the air. A half-submerged couple nearby seemed for a moment to listen to the guardsman's stories; then they started talking softly in the tone that's used to plan the next day's errands.

Not long after my encounter with the witch, I come back to Arnahóll Hill. It is a holiday, the day Iceland got sovereignty from Denmark, and instead of a parade, there is a protest. Today's rally is just as inscrutable as the last one for me, so I talk with a group of people holding question-mark and exclamation-point signs against the wind. (The cumulative effect among the crowd is ??!?!!?!?, like punctuation in a late-night e-mail.) When I ask Sára Riel, who designed the signs, what they're supposed to signify, she looks at me as if I'm a moron. "I think it's pretty obvious," she says. "We have questions, and we have demands." I ask what the questions are. "Lots of questions," she says.

The rally ends. As people file back into the downtown streets, I talk with a guy selling civil-disobedience literature on a foldout picnic table, a guy who identifies himself, when I ask, as "Siggi, a local anarchist and nurse." Siggi directs me toward the bank, where "leftists" have resumed the heckling of Davíð. The insurgents made it past the foyer this time and to a second doorway where police in body armor hold a blockade line. The demonstrators raise their hands above their heads to show they are unarmed. Behind the police and their transparent shields, a gaggle of businessmen are milling. For nearly an hour, nothing changes. People occupy themselves as they might spend a boring car trip: They chant ("Davíð, come out!"). They sing. They play Icelandic hip-hop on a big, tubular ghetto blaster. Smokers light up, and the foyer of the bank starts feeling like a basement disco.

Finally, one of the bank administrators shuffles out behind the line of armored officers. He makes a little speech. The people cheer. The demonstrators turn and leave, exuberant. What happened? A bearded young man tells me, "They said, 'If you leave, then we'll leave.' And they left. And so now, we're leaving." He grins and pumps a fist into the air, then looks into the courtyard, where music is playing. It's twilight. The sky outside has the effect of being low and broad and slightly canted, like the fabric of a tent collapsing toward the pole.

"It was like a small victory," he says.