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  1. Wealth
March 2, 2009

The next in line

By Spear's

As the East European economies collapse, this begins to look more like the 1930s than a good lending opportunity.

This Australian bushfire of an economic disaster is now swinging in on Eastern Europe and is threatening to burn down the Eurozone on its western flank.

The plight of the former Comecon countries– the three Baltic States, Poland, Hungary, the Czeck Republic, Romania and Bulgaria – are in an economic meltdown of toxic debt worth at least US$1.7 trillion, nearly as big as the mortgage toxic waste problem that bedevils the US.

And the economy of the geo-politically strategic Ukraine, with 45 million people, has stalled and the protesters are setting up camp in Kiev’s central square.  

The problem is simply expressed: the Austrian and Swedish banks in particular have lent about 80% of their GDP to their eastern neighbours, who are now in familiar trouble.

They borrowed this money to set up their own property bubbles that have now gone bust, but they did this by borrowing Swiss francs which carried a low interest coupon: now their properties have lost half their value, and their local currencies of Kroons, Korunas, Zlotys and Forints have halved versus the Swiss franc, and so their mortgages are now up to four times their equity, which also means Big Trouble for the banks who foolishly made these loans.

These banks are now refusing to roll over their loans of Hapsburgian excess, of which some $400 billion are due for repayment in 2009 alone, representing 30% of regional GDP.

The IMF has stepped in to try to avert the looming crisis, but its reserves at $200 billion, of which $50 billion has already been lent, are nowhere near the size of this problem.

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And the IMF needs to see repayment over time, but as the East European economies collapse, this begins to look more like the 1930s than a good lending opportunity. As with so many other aspects of this global crisis, the way forward is far from clear, because the gross errors have already been made, in spadefuls..

This eastern issue impacts directly on the Eurozone, as many of these eastern states acceded to the EU in 2004, but only tiny Slovakia and Slovenia were admitted to the Euro club, making sixteen Euro-member countries out of twenty-seven in the EU.

These eleven, included in but excluded out, see their salvation, as does Iceland, by trading their debt problems through full-blown membership of the Euro, which would then become the joke currency that the Franco-German axis could never contemplate.

And yet this crisis is on the Eurozone’s doorstep and is not about to go away, as the lending banks are in the Eurozone and could destroy the Euro’s status if they collapse. Something has to be done, but what, by who, and more particularly at whose expense?

Germany is not the economic powerhouse it was just six months ago: its economy declined by a massive 8.2 % in the last quarter of 2008, is still falling fast, the banking system has bad debts on a huge scale that have not yet been revealed, other than the eleven Landesbanken and Hypo-Bank which are mostly bust, not least on account of their loans to the East.

The problem for the Euro authorities is that the ECB is not a real central bank: it’s more like the UK’s MPC, which has the power to set interest rates, and that’s it.

The danger of trying to create a Central Bank for a non-political union was always there in the structure: as the late Milton Friedman observed, ‘The Euro is not designed to withstand a real crisis.’

In fact it is even barred by statute from buying in a member country’s debt, so that form of quantitative easing, for which the Bank of England has just received the go-ahead for the first £100 billion, is not an option for the so-called ECB.

With Japan also entering another downward twist, with its January exports down 58% on last year, the export-driven Euro is set to run into crisis with no obvious end in sight, other than its own partial demise.

The PIGS – Portugal, Italy, Greece and Spain – are all in debt-driven full-blown recession, but it looks like Ireland will be the first through the Euro exit door: there are no more hand-outs from Brussels in prospect, there is the Euro Referendum in the Autumn, the economy has collapsed, and the marches of the angry ones have already started.

Things are set to get much worse, in Europe, America and the Far East, as Global Depression marches ever closer.

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