Wednesday, February 25, 2009

You and Me and Eastern Europe

Huh! What does Eastern Europe have to do with us?
Glad you asked. It's something like that old song that says "Da hip bone connected to da leg bone..." Pay attention here:

Roubini's weekly letter says

The Central and Eastern Europe (CEE) region is the sick man of emerging markets. While the global crisis means few, if any, bright spots worldwide, the situation in the CEE area is particularly bleak. After almost a decade of outpacing worldwide growth, the region looks set to contract in 2009, with almost every country either in or on the verge of recession. The once high-flying Baltics (Estonia, Latvia, Lithuania) look headed for double-digit contractions, while countries relatively less affected by the crisis (i.e. Czech Republic, Slovakia and Slovenia) will have a hard time posting even positive growth. Meanwhile, Hungary and Latvia’s economies already deteriorated to the point where IMF help was needed late last year.

The CEE’s ill health is primarily driven by two factors – collapsing exports and the drying-up of capital inflows. Exports were key to the region's economic success, accounting for a significant 80-90% of GDP in the Czech Republic, Hungary and Slovakia. By far the biggest market for CEE goods is the Eurozone, which is now in recession. Meanwhile, the global credit crunch has dried up capital inflows to the region. An easy flow of credit fueled Eastern Europe’s boom in recent years, but the good times are gone. According to the Institute of International Finance, net private capital flows to Emerging Europe are projected to fall from an estimated $254 billion in 2008 to $30 billion in 2009. Whether or not this is formally considered a ‘sudden stop’ of capital, it will necessitate a very painful adjustment process.

(I got that via G-mail so I don't know how to put up a link, but here's another link to the RGE site with much the same content.) He goes on to describe the particulars. The details are of great interest to a lot of big shots with skin in the game. I'm not in that group so I didn't play close attention and moved on.
It didn't take long running a couple of searches to turn up similar observations elsewhere. This, by NY Times writer Nelson D. Schwartz, says much the same thing.

Last week, Wall Street plunged after Moody’s Investors Service warned that Western banks that had recently beat a path to Eastern Europe’s doorstep now faced “hard landings,” spooking investors with new fears that the exposure could spread beyond Europe’s shores.

“There’s a domino effect,” said Kenneth S. Rogoff, a professor at Harvard and former chief economist of the International Monetary Fund. “International credit markets are linked, and so a snowballing credit crisis in Eastern Europe and the Baltic countries could cause New York municipal bonds to fall.”

Got that? A credit crisis in Eastern Europe can cause problems with New York municipal bonds. As every schoolboy knows, municipal bonds are almost as safe a place to put your money as a coffee can in the back yard. Or they used to be. I don't want to ruin your day, but take a look at this:

International finance officials fret that the worst regional economic crisis since the Berlin Wall came down could set off a contagion among the region’s currencies, with echoes of the Asian financial crisis of the late 1990s. Then, emerging markets like Thailand borrowed in foreign currencies to fuel growth, but suddenly owed more than they could afford to pay back once their own currencies lost value.

Since peaking last summer, Poland’s currency has slumped 48 percent against the euro; Hungary’s has fallen 30 percent and the Czech Republic’s is off 21 percent. “Very simply, Eastern Europe has become Europe’s version of the subprime market,” said Robert Brusca of FAO Economics in New York.

On Monday, the central banks of Poland, Hungary, Romania and the Czech Republic sought to restore calm by issuing statements arguing that the recent sell-off was not justified by economic fundamentals.

In addition, Western banks [uh-oh] could very likely suffer a further increase in nonperforming loans. “Most of the banks in this region are from the euro countries and will have to undergo further recapitalization,” Gillian Edgeworth, an economist with Deutsche Bank in London, said.

Another problem is that big institutional investors in Western Europe — banks, pension funds and insurance companies — have large holdings of East European debt. If the banks need further infusions of capital from Western governments already straining to pay for stimulus packages and to maintain their social safety nets, itcould put additional pressure on the euro as well.

“The threat to more developed economies goes through the banking channel,” Dominique Strauss-Kahn, the head of the monetary fund, said in a recent interview.

As the downturn worsens across the Continent, Mr. Rogoff explained, risk aversion can quickly spread to other parts of the world. Some investors hurt by plunging markets in Europe are having to sell American assets to raise money, [See how that works?] adding pressure to a United States stock market already weakened by fears of nationalization.

“It’s one big trans-Atlantic money market out there, and these banks lend money to each other all the time,” said Simon Johnson, another veteran of the monetary fund who is a now a professor at the Sloan School of Management at the Massachusetts Institute of Technology. “Deutsche Bank and UBS and Goldman Sachs and Citi are all intertwined.”

In Eastern Europe itself, the risks for Western companies doing business there have also surged.

Until recently, for example, Eastern Europe and Russia were rare bright spots for the beleaguered American automakers Ford Motor and General Motors. In Poland, where G.M. has a major factory, sales rose 10 percent last year to 38,000 cars, while sales in Russia soared 30 percent to 338,000 vehicles. [Guess where GM's biggest new dealership and show room are located? Moscow! Americans don't have a clue.]

Since then, demand has fallen sharply. In the Baltic countries, which were among the first to feel the chill, G.M.’s sales dropped an average of 57 percent in the final months of 2008. [Hello, Detroit. This is not good.]

Among the biggest victims of the crisis are tens of thousands of workers who had clawed their way to more prosperity, only to see their dreams crumble as jobs and the financial system eroded. [Sound familiar?]

Because their declining currencies make it more expensive to import goods and to pay off foreign debts, governments have cut spending and reduced public services, leading toa wave of increasingly violent protests across the region that is threatening governments.

On Friday, the coalition government in Latvia — where the economy contracted more than 10 percent on an annualized basis last month — became the second European government, after that of Iceland, to collapse.

Meanwhile, in the Ukrainian capital, Kiev, demonstrators took to the streets Friday as depositors rushed to pull their money out of local banks.

The crisis has forced the monetary fund to step into the breach. In recent months, it has extended Ukraine, Iceland, Hungary and Latvia billions in aid. “I’m expecting a second wave of countries to knock at the door,” Mr. Strauss-Kahn said.

Two years ago, “the idea was very, very consistently projected that the I.M.F. would not have to help emerging countries any more,” and that the “financial markets would take care of it,” Jean-Claude Trichet, president of the European Central Bank, said Friday. Now, he said, this has proved to be “totally false.”

For Mr. Johnson and other students of financial history, the latest developments in Europe — especially in Austria, whose banking industry is heavily exposed to its Eastern neighbors — raise eerie parallels with the 1930s. Mr. Johnson notes that it was the failure of a Viennese bank, Creditanstalt, in 1931 that was a turning point in what became the Great Depression.

Mr. Johnson said he did not expect a repeat of that calamity, but he does foresee a long period of minimal growth, akin to Japan’s “lost decade” of the 1990s, in both the United States and Europe.

And while the United States may have been the trigger for this international financial crisis, it is hardly alone in shouldering the blame. “We set off the sticks of dynamite, but a lot of people had tinderboxes under their houses,” he said.

Mr. Johnson doesn't strike me as a panic-stricken extremist. Academic types are sometimes like that but mostly they tend to be dry as chips. In the case of Nouriel Roubini I wanted to get a second opiinion because he'e from Eastern Europe and might not be a disinterested observer. Also, his recent rock star status might be going to his head, but I don't think so. Seems to me he's staying on task as well as the new president.

What all this means, I don't know. I don't think anyone does beyond the warnings just quoted. If nothing else I am in agreement with the president that doing nothing about the paralysis of the banking and credit markets is not the right option. The Republican option of a big global kick in the ass really appeals to me, but it's like firing a shotgun at a kidnapping thug holding a child, hoping not to wound or kill the child at the same time.

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