Saturday, February 14, 2009

Eastern European Crises Spread West

I don't often just repost entire articles of others. However, after reading primarily North American news, I understand how limited good information about the rest of the world is to come by. Ambrose Evans-Pritchard of the UK Daily Telegraph has consistently been providing front-line info from the Eurozone. Although he is hindered by his orthodox economic education in trying to suggest solutions, that has not stopped him from rejecting the common maxim of "kumbaya" in Europe and pointing out the obvious storm that is brewing. Much of the information contained in the following article was not new to me, but I had only read of it in newspaper footnotes while doing my daily "German reading comprehension" exercises - not exactly reliable. Some of this is completely new to me. But what this article does is compress much of the most important info into a small space. I'll spare you of my interjections. But you might want to get comfortable before reading this.

Failure to Save Eastern Europe Will Lead to Worldwide Meltdown

By Ambrose Evans-Pritchard
Last Updated: 9:23PM GMT 14 Feb 2009

If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the
ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East.

Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Stephen Jen, currency chief at Morgan Stanley, said Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.
"This is the largest run on a currency in history," said Mr Jen.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

Under a "Taylor Rule" analysis, the European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

But I digress. It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, told me the region may need €400bn in help to cover loans and prop up the credit system.

Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights.

Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

"This is much worse than the East Asia crisis in the 1990s," said Lars Christensen, at Danske Bank.

"There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU."

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter.

If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.

The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

So we watch and wait as the lethal brush fires move closer.

If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?

Pritchard suggests throughout that if somebody were to do something, this could all be averted. There is more debt in the system than there is capital. Default is the only possible solution. No amount of firemen can put out an avalanche.

Lastly, I'm not so sure when this will all culminate. Suggesting that chaos will occur in days or weeks, like Pritchard does, is mere speculation. But it will happen. There will be failed states and political turmoil.

To me, this is far more interesting than 600 idiots quibbling over a few billion in a stimulus package.

But that's just me.

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Mike said...

Ambrose Evans-Pritchard wrote,

"If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerun"

Who is the world policy establishment? G7? UN? Illuminati?

Nevertheless, it was a great piece and Ambrose Evans-Pritchard has consistently been writing provocative pieces.

It seems to me that all bad debt must be liquidated into strong hands so as to resume production. .. the sooner the better.

Bailouts. even if financed through monetization will most likely stymie productive resources.

The ultimate worry must be a crowding out of credit which could put a halt to planting and harvest.

Anonymous said...


Let's carry this through further. Assume AEP is correct about eastern Europe, as he has been lately. The only outcome of this is a collapse of the EU experiment.

If it's not the no-clothes emperor in Brussels, then who will be defining the framework and moderating the rough spots?

There's going to a successor economic regime in this area because people will keep on living. AEP proposes "world leaders". I guess he means the G7, the G20 and the Davos set.

China has made plain that it's looking exclusively after China. Japan will soon be reporting a trade deficit. The UK's G7 membership is purely ceremonial at this point.

Does AEP imply that "World leaders" will be able to force Germany to despoil itself to provide endless bailouts to the PIGS and now to bad loans made by PIGS?

I suggest to you the most likely outcome is a Berlin-Moscow axis will emerge that will organize eastern Europe as a co-dominium for its mutual benefit.

Berlin possesses leading edge industry. What it needs is the strategic depth of energy, raw materials and markets for this industry. Moscow otoh lost much of its industry when the USSR collapsed. But it still has vast natural resources. Russia is no longer strong enough to hold Siberia alone.

Compared to this what is it the PIGS have that either Germany or Russia need on a daily basis? Nice summer tourist destinations? These will be much cheaper once the local currencies depreciate by 75%.

Anonymous said...

Put another way, Germany with 80 million has a limited capacity to execute "Bailout" of foreign states. Therefore these have to be carefully targeted at areas that are truly vital to the German economy.

On the other hand there is every indicator that Russia will need its own bailout this year.

These hard facts of material economic reality have been proven time and again over the last 100 years.

Matt Stiles said...

Germany is not without problems either. They share the same demographic plight as most of Europe. 40-60% income taxes are the norm now. Yet the country will still be aging for at least another 15 years. How high a tax rate will the young put up with to support this? 70%? 80%? Push hard enough, and they will push back.

The demographic problem is one that is completely forgotten in this crisis, yet it is a ticking time-bomb itself.

At it's root, the credit problems are the same in Europe as they are in North America: too centralized a decision making process. No rational Swiss depositor would have lent their own money to fund Polish mortgages; the decision was made for them at UBS headquarters. No rational person would lend to their deadbeat friend who has no job so he can buy a 500k mansion in the 'burbs; that decision was made for them in Washington.

The endgame will be the same as it always is: conflict. Either civil, which would lash out at this centralization and claim a larger piece of the legislative pie closer to home; or global, which would signal that a last ditch effort by the bankers to stoke a nationalistic fervor and convince them that the crisis is the fault of someone else; or both.

Anonymous said...

The demographic problem is one that is completely forgotten in this crisis, yet it is a ticking time-bomb itself.

Demographics are indeed destiny. They're far more determinative than momentary fictitious "market values".

mannfm11 said...

Houston we have a problem! One of you guys mentions productive assets, but the world runs on credit, not productive assets, which lie idle without credit. I have spent several years debating this deflation subject with gold bugs that insist it can't happen and that we are going to hyper inflate. What the hell is China going to do without cash flow? We have enough Chinese crap piled up in the US that we don't need any more for the next 30 years. It appears the European banking system is about to vaporize very suddenly. You know, Europe almost didn't get out of the trench in the 1990's and much of Asia fell into it along with Russia. It appears that the US reached maximum potential to create new credit to keep the machine going and the entire game is blowing fuses. If they had a real banking system in China, I am quite certain it would have flamed out in the early 2000's. As the flow of Western credit dries up, we will find out soon. I bet they just puke in China when they see that the US can just drum up their entire foreign reserves to bail out a few banks? We are in one hell of a mess. Many talk about Dow 6000, like it is some far off figure. I am thinking more like Dow under 1000 before this one is done. Peak Oil? What about bottom Oil,where they can't cut the production low enough?

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