Wednesday 18 March 2009

Europe takes the world to the edge of the abyss

Via LeftBanker, a member of Scotland’s socialist party, the Scottish Socialist Party, and the FI, Fourth International.

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. This will be difficult because most lenders wish to rein in high risk debts and need the loans to supplement their diminishing capital.

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 36% of its foreign reserves since August 2008 defending the ruble.

In Poland, 60% of mortgages are in Swiss francs. The Polish 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 have exposure to both while US banks are only exposed to the sub-prime market.
Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. Plus, European banks account for an astonishing 74% of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to Eastern Europe than American or Japanese banks, and they are 50% more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico’s car output fell 51% 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 European Union (EU) Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

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 unraveled. The country — facing a 12% 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 10.5% in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

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 countries will be the trigger for a massive crisis with contagion spreading into the EU.’ Europe is already in deeper trouble than the European Central Banks (ECB) or EU leaders ever expected. Germany contracted at an annual rate of 8.4% in the fourth quarter. If Deutsche Bank is correct, the economy will have shrunk by nearly 9% before the end of this year. This is the sort of level that stokes popular revolt. The German government passed legislation to allow them to nationalise their banks one week ago.
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 112% of GDP next year, just revised up from 101%), or rescue Austria from its Habsburg adventurism.

This is why some people think the US dollar is going to remain strong over the coming months: because the rest of the world is falling apart even faster than the US.

Eastern Europe has borrowed an estimated $1.7 trillion, primarily from Western European banks. And much of Eastern Europe is already in a deep recession bordering on depression. A great deal of that $1.7 trillion is at risk, especially the portion that is in Swiss francs. It is a story that could easily be as big as the US sub-prime problem. Much of the lending is wait for it on speculative property based schemes!

In Poland, as an example, 60% of mortgages are in Swiss francs. When times are good and currencies are stable, it is nice to have a low-interest Swiss mortgage. And as a requirement for joining the euro currency union, Poland has been required to keep its currency stable against the euro. This gave borrowers comfort that they could borrow at low interest in francs or euros, rather than at much higher local rates.

But in an echo of teaser-rate sub-primes in the US, there is a problem. Along came the synchronized global recession and large Polish current-account trade deficits, which were three times those of the US in terms of GDP, just to give us some perspective. Of course, if you are not a reserve currency this is going to bring some pressure to bear. And it did. The Polish zloty has basically dropped in half compared to the Swiss franc. That means if you are a mortgage holder, your house payment just doubled. That same story is repeated all over the Baltics and Eastern Europe.

Austrian banks have lent $289 billion (230 billion euros) to Eastern Europe. That is 70% of Austrian GDP. Much of it is in Swiss francs they borrowed from Swiss banks. Even a 10% default rate (highly optimistic) would bankrupt the Austrian financial system, says the Austrian finance minister, Joseph Proll.

The problem is that in Europe there are many banks that are simply too big to save. The size of the banks in terms of the GDP of the country in which they are domiciled is all out of proportion. The US equivalent would be as if the bank bailout package were in excess of $14 trillion (give or take a few trillion). In essence, there are small countries which have very large banks (relatively speaking) that have gone outside their own borders to make loans and have done so at levels of leverage which are far in excess of the most leveraged US banks. The ability of the “host” countries to nationalize their banks is simply not there. They are going to have to have help from larger countries. But as we will see below, that help is problematical.

This has the potential to be a real crisis, far worse than in the US. Without concerted action on the part of the ECB and the European countries that are relatively strong, much of Europe could fall further into what would feel like a depression. There is a problem, though. Imagine being a politician in Germany, for instance. Your GDP is down by 8% last quarter. Unemployment is rising. Budgets are under pressure, as tax collections are down. And you are going to be asked to vote in favor of bailing out (pick a small country)? What will the voters who put you into office think?
However, getting all the parties to agree on what to do will take some serious leadership, which does not seem to be in evidence at this point. The US almost waited too long to respond to the crisis and they had the “luxury” of only needing to get a few people to agree as to the nature of the problems. And they had a central bank that could act decisively and quickly.

For the ECB to print money as the US and the UK (and much of the non-EU developed world) will do, takes agreement from all the member countries, and right now it appears the German and Dutch governments are resisting such an idea.

German finance minister Peer Steinbruck has said it would be intolerable to let fellow EMU members fall victim to the global financial crisis. “We have a number of countries in the eurozone that are clearly getting into trouble on their payments,” he said. “Ireland is in a very difficult situation.

“The euro-region treaties don’t foresee any help for insolvent states, but in reality the others would have to rescue those running into difficulty.”

Ireland is indeed in dire straits, and is particularly vulnerable as it is going to have to spend a serious percentage of its GDP on bailing out its banks and may need to raise taxes to help do so.

This is a new twist and manifestation of the global crisis of capitalism’s financial system; one that will almost certainly push Europe and the world into a prolonged deep recession. Or in other words a depression.

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