Eastern Europe is About to Blow

East Europe is about to blow. If it does, it could take much of the EU with it. It’s an emergency situation but there are no easy solutions. The IMF doesn’t have the resources for a bailout of this size and the recession is spreading faster than relief efforts can be organized. Finance ministers and central bankers are running in circles trying to put out one fire after another. It’s only a matter of time before they are overtaken by events. If one country is allowed to default, the dominoes could begin to tumble through the whole region. This could trigger dramatic changes in the political landscape. The rise of fascism is no longer out of the question.

The UK Telegraph’s economics editor Edmund Conway sums it up like this:

A “second wave” of countries will fall victim to the economic crisis and face being bailed out by the International Monetary Fund, its chief warned at the G7 summit in Rome. . . . But with some countries’ economies effectively dwarfed by the size of their banking sector and its financial liabilities, there are fears they could fall victim to balance of payments and currency crises, much as Iceland did before receiving emergency assistance from the IMF last year.

Foreign capital is fleeing at an alarming rate. Nearly two-thirds gone in matter of months. Deflation is pushing down asset prices, increasing unemployment, and compounding the debt-burden of financial institutions. It’s the same everywhere. The economies are being hollowed out and stripped of capital. Ukraine is teetering on the brink of bankruptcy. Poland, Latvia, Lithuania, Hungary have all slipped into a low-grade depression. The countries that followed Washington’s economic regimen have suffered the most. They bet that debt-fueled growth and exports would lead to prosperity. That dream has been shattered. They haven’t developed their consumer markets, so demand is weak. Capital is scarce and businesses are being forced to deleverage to avoid default. All of Eastern Europe has gotten a margin call. They need extra funds to cover the falling value of their equity. They need a lifeline from the IMF or their economies will continue to crumble.

The UK Telegraph’s economics correspondent Ambrose Evans-Pritchard has written a series of articles about Eastern Europe. In “Failure to Save East Europe Will Lead to Worldwide Meltdown” he says:

“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 . . . .

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.

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. 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).

An economic crisis is quickly turning into a political crisis. Riots have broken out in capitals across Eastern Europe. Mr. Geithner had better be paying attention. The prospects for political upheaval are growing. Public anxiety can spill out onto the streets at a moments notice. Governments must act quickly and with resolve. These countries need hard currency and guarantees of support. If they don’t get help, the simmering public fury will turn into something much more lethal.

UK Telegraph’s economics correspondent Ambrose Evans-Pritchard:

“Global banks have so far written down half the $2,200bn losses estimated by the IMF. On top of this, EU banks have $1,600bn of exposure to Eastern Europe — increasingly viewed as Europe’s subprime debacle, and EU corporate debts are 95pc of GDP compared to 50pc in the US, a mounting concern as default rates surge.

“It is essential that government support through asset relief should not be on a scale that raises concern about over-indebtedness or financing problems. Such considerations are particularly important in the current context of widening budget deficits, rising public debt levels and challenges in sovereign bond issuance.”

It’s the same wherever banks merged their commercial and investment branches. Debt has skyrocketed to unsustainable levels destabilizing the entire economy. The banks have been operating like hedge funds, concealing their activities on off-balance sheets operations and maximizing their leverage through opaque debt-instruments. Now the global economy is caught in the downdraft of a collapsing speculative bubble. East Europe has been hit hard, but it’s just the first of many bowling pins that will fall. All of Europe has been infected by the same virus that originated on Wall Street. Monday’s New York Times summarizes developments in the EU:

Europe sank even deeper into recession than the United States in the closing months of last year, according to figures published Friday . . . The economy of the 16 countries sharing the euro currency declined by 1.5 percent in the fourth quarter, (an annualized drop of roughly 6 percent) according to the European Union’s statistics office. That is even worse than the 1 percent decline in the United States economy during that period, compared with the previous quarter.

Today’s data wipes out any illusion that the euro zone is getting off lightly in this global downturn,” said Jörg Radeke, an economist at the Center for Economics and Business Research in London. (“Europe Slump Deeper than Expected”)

The “liquidationists” would like to see governments cut off the flow of funds to ailing financial institutions and let them fail by themselves. It’s Darwinian madness, like waiting out a heart attack on the kitchen floor instead of rushing to the hospital for emergency care. The global economy is decelerating at the fastest pace on record. 40 percent of global wealth has been wiped out. The banking system is insolvent, unemployment is soaring, tax revenues are falling, the markets are in shock, housing is crashing, deficits are soaring, and consumer confidence is at its lowest point in history. This is no time to cling to half-baked ideology. The global economy is undergoing a massive system-wide contraction that could spin out of control and plunge us into another world war. Political leaders need to grasp the urgency of the moment and keep the vehicle from careening into the ditch.

Mike Whitney lives in Washington state. He can be reached at: fergiewhitney@msn.com. Read other articles by Mike.

14 comments on this article so far ...

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  1. Daniel Gerber said on February 19th, 2009 at 10:07am #

    Unfortunately like the US and Britain, most eastern European countries have run current account deficits for nearly 2 decades. They are facing similar challenges than we are, minus the housing crisis. The IMF has already lent to Hungary, Latvia and Ukrain other countries will follow. The EURO area still has considerable leeway in lowering interest rates, contrary to the Fed and the Bank of England. Budget deficits in spite of some bailouts and stimulus, remain between less than 3% (as prescribed by Mastrich) to 4.5%, well below the project US deficit. Bailout packages are being discussed in all the large European economies. Unlike the US, most of the Eastern European countries do not have to simultaneously tackle ever increasing health care costs as a share of GDP. They do however, as much of the world does, have a looming crisis of unfunded pension liabilities. All in all, there are problems, the financial crisis will stem consumer demand and in all likelihood reduce current account deficits. Some Banks will go under, some Banks will get support, just as it has been in the US.

    Your figures on corporate debt simply represent a different way of financing of corporate expansion in Europe relative to the US. In the US, typically extra corporate financing is sought in the stock market by issuing more stock, while in Europe the thight relationships with Banks tend to lead to more borrowing. It has little implications on how efficient operations are and often, since Banks are more interested in longer term gains instead of short term stock prices, many European companies can actually affortd to take a much longer view on investing. Some argue this leads ot better decision making at the management level.

    The problems are worldwide and no doubt Eastern Europe will suffer and some corrections will take place, but it is doubtful that it would lead to another world war in Europe. There is much more worry about dropping governement revenues in oil producing countries where budget revenues have collapsed by 50% in some cases, and unfortunately this leads back to areas in the world that have been historically unstable, Middle East, the Former Soviet Union, and the poorest and most inequitable part of the world, Africa.

  2. lichen said on February 19th, 2009 at 10:57am #

    Political upheaval is good; it can lead to good places, better places; riots are good, they can destroy stupid things and intimidate right-wing governments and multinationals. I’m glad, glad, glad they are happening, and I hope Geithner does nothing.

  3. Tree said on February 19th, 2009 at 12:53pm #

    Germany reportedly ready to shore up IMF if needed

    By William L. Watts, MarketWatch
    Last update: 1:10 p.m. EST Feb. 19, 2009
    LONDON (MarketWatch) — Germany is willing to shore up the International Monetary Fund if it becomes necessary to do so, German Chancellor Angela Merkel said Thursday, according to news reports.
    The remarks, at a Berlin news conference with European Commission President Jose Manuel Barroso, come amid rising hopes that the German government will lead European Union efforts to support troubled economies in Central and Eastern Europe.
    “Germany will not refuse to (financially) support the IMF if necessary, ” Merkel said.
    Merkel also praised the region participating in the single currency as “strong” and said it “has proven its worth in the crisis.”
    However, she reportedly declined to say whether Germany, with the largest economy in Europe, would come to the aid of euro-zone nations under severe fiscal stress.
    German Finance Minister Peer Steinbrueck this week dismissed as “absurd” any speculation that fiscal strains within the euro zone could lead to an exit by any of the single currency’s 16 members.
    Steinbrueck, in comments repeated on Wednesday, said euro-zone countries would likely have to come to the aid of other troubled members.
    The consequences of a euro-zone breakup would be too far-reaching, Steinbrueck said Wednesday, according to Dow Jones Newswires.
    “Could you imagine anyone would be wiling to put up with this?” he said.
    Steinbrueck’s remarks followed a further widening of government bond yield spreads, with markets demanding a higher premium for lending to governments such as Ireland that are under severe fiscal strain. The cost of insuring against default on sovereign debt issued by Ireland soared to record levels in recent days. See earlier story.
    Easing worries about strains in the euro zone helped contribute to a rebound in the euro in Thursday’s foreign-exchange dealings, traders said. The single currency changed hands at $1.2689 versus the U.S. dollar, up from $1.2532 in North American trading late Wednesday. See Currencies.
    William L. Watts is a reporter for MarketWatch in London.

  4. Daniel Gerber said on February 19th, 2009 at 12:55pm #

    Lichen – How about you visit Mogadishu, or other places where government authority has collapsed years ago, and see for yourself how well chaos works

  5. lichen said on February 19th, 2009 at 2:08pm #

    Daniel, why don’t you go to Argentina, where the citizens collapsed the government and forced seven consecutive presidents to flee the country, and where they ended up with better lives afterwards. Why don’t you go to Bolivia where revolts and rebellions led to massive social movements that put a new government and then constitution in place. Why don’t you go to the 1930’s America, where the social upheaval, general strikes, and militancy of the social movements forced roosevolt to make the new deal to prevent a revolution. Social upheaval, riots, strikes, rebellions and the like are good, and have brought all of the good changes that have come to the world.

  6. Tree said on February 20th, 2009 at 9:45am #

    Good argument, lichen. I’m happy to see you don’t resort to sweeping generalizations and black and white thinking. Keep it up.

  7. Gary Lapon said on February 20th, 2009 at 2:54pm #

    The character of the uprising is pretty important. Social upheaval can lead to progressive or even revolutionary change, but it can also be deeply reaction (see Nazi Germany, draft riots during the US Civil War, etc.). We need to build revolutionary organization to harness and focus this anger and channel it to the left, not the right.

  8. Dan Littauer said on February 20th, 2009 at 11:33pm #

    Daniel, excellent article – this also explains the increasing racism in these countries – a strong correlation between economic decline (coupled with historical trends) and the popular resentment against “outsiders”; already certain populist politicians from the left and right are deploying what can only be described as racism. Indeed we should be very concerned that the European politics of breaking down frontiers and trying to legislate for tolerance will become very difficult if not derailed by racism, homophobia and populist anti-EU rethoric from the left and right…

  9. Barry said on February 21st, 2009 at 7:50am #

    Lichen – I agree that riots and chaos can turn out to be a good thing. But collapsing societies are also an opportunity for the reactionaries as well. That would be Germany after WWI, Russia, with the collapse of Communism where the West administered shock therapy (or Poland for that matter), so as to transfer what was rightfully the people’s wealth into the hands of oligarchs and private capital.

    But I get your point.

  10. bozh said on February 21st, 2009 at 9:00am #

    a few astromers looked at the moon and sun and saw that it was a sphere. i’ve read s’mwhere that an egyptian had 3K yrs ago proved that earth was round.
    the bible and torah asserted that the Earth was square and flat.

    a few observers in 1800s have looked at US social structure and saw that it differed not at all from societal structure of any other empire or country.

    but the constitution and religion asserted that US structure was fair and square.
    and to this day, 90% of USans firmly believe that US is noble, fair, helpful, etc.
    even slavery, lynching, disappearance of indigenes, numerous wars cld not as yet convince the about 90% of USans that they are serfs and cannon fodder for the iniquitous society. thnx

  11. Barry said on February 21st, 2009 at 10:19am #

    Bozh – Well, it wasn’t 3000 years ago but the ancient Greek geographer Ptolemy determined the earth was round – in Egypt. He did it by having shadows measured at different places at the same time. How he got it done at the same time, I don’t know.

    I once told someone that the Bible says the sun rises. The believer replied well, that’s just a metaphor. I then said that maybe the entire Bible is a metaphor.

  12. bozh said on February 21st, 2009 at 12:11pm #

    so it had been ptolemy who proved that the Earth is an orb. as you say, by placing two sticks 1k miles appart an dobtaining a shadow cast by one stick and not by another.
    but, as you say, the riddle is how he knew of the shadow in north egypt if he was near equator, the person who reported this did not explain.
    it had to be at noon, i guess. at noon sun wld be directly above but not 1 or two K miles away.
    so he must have had the stick when the sun was highest; so, it cld have been observed within an hour of high noon. enough to prove that the orb is round.
    he cld have also seen that as time elapsed the shadow was getting longer as well.
    but wld we obtain an eventual shadow in the equator as well? thnx

  13. Suthiano said on February 21st, 2009 at 12:27pm #

    It wasn’t Ptolomy who preformed this experiment, it was Eratosthenes.

    Eratosthenes knew that on the summer solstice at local noon in the Ancient Egyptian city of Swenet (known in Greek as Syene, and in the modern day as Aswan) on the Tropic of Cancer, the sun would appear at the zenith, directly overhead. He also knew, from measurement, that in his hometown of Alexandria, the angle of elevation of the Sun would be 1/50 of a full circle (7°12′) south of the zenith at the same time. Assuming that Alexandria was due north of Syene he concluded that the distance from Alexandria to Syene must be 1/50 of the total circumference of the Earth. His estimated distance between the cities was 5000 stadia (about 500 geographical miles or 950 km). He rounded the result to a final value of 700 stadia per degree, which implies a circumference of 252,000 stadia. The exact size of the stadion he used is frequently argued. The common Attic stadium was about 185 m, which would imply a circumference of 46,620 km, i.e. 16.3% too large. However, if we assume that Eratosthenes used the “Egyptian stadium”[2] of about 157.5 m, his measurement turns out to be 39,690 km, an error of less than 1%.

    Ptolomy was most famous for his cataloging of the stars in The Almagest, although he apparently only did some of the observations, and borrowed the rest from Hipparchus.

    In his Geographia, Ptolomy does draw maps of the ancient world. The maps look distorted as compared to modern maps, because Ptolemy’s data were inaccurate. One reason is that Ptolemy estimated the size of the Earth as too small: while Eratosthenes found 700 stadia for a great circle degree on the globe, in the Geographia Ptolemy uses 500 stadia.

  14. Barry said on February 21st, 2009 at 12:49pm #

    Right you are Suthiano – Erathosthenes. I knew it was a Greek in Egypt. At least I think they are both Greek.