Monday, February 16, 2009

Austria wants a bail-out for Eastern Europe

EUobserver brings an article with the title "Austria pleads with Europe for bail-out of east". It appears that "European banks have a financial engagement of some €1.1 trillion in the region" with Austria the most exposed. Other EU countries are less enthusiastic to give the Eastern Europeans a share in the big stimulus and rescue bonanza, but according to Austria there is no alternative because otherwise "eastern Europe will start to collapse.".

I don't give them much of a chance for the moment. We will rather see a string of local bail-outs. Crisis management means at the moment a string of ad hoc decisions. A structural approach seems far away.

The Telegraph sounds even more alarmist: "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. "

"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."

"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. "

This sounds like a full panic and chaos in the making. The article calls for a stronger role of the European Central Bank to achieve a coordinated response.

Postscript: it seems that a consensus is growing in Europe about how to handle the mess. The price will probably be a weaker euro as a consequence of the high costs of the bailout (good for me as my income is in dollars). More problematic are the weak countries like Greece and Italy. There is some kind of tabu on letting them go from the euro zone as it might weaken the standing of the euro. However, I can't see how they want to accomplish this. The 3 percent limit was already supposed to prevent countries from going bancrupt and it obviously didn't work. I expect that a lot of money will be wasted before the inevitable is accepted: the euro doesn't work with too different economies. for sale

The internet domain is going to be auctioned. It is expected to bring 300,000 to 500,000 dollars for its owner - some Swiss internet company. I thought it was owned in the past by the Decani monks. Looks like they miss the jackpot.

Saturday, February 14, 2009

Japanese crisis lessons: honesty or money?

The New York Times has an article about lessons from the Japan for the US about managing the economic crisis. After a real estable bubble in Japan collapsed in 1990 Japan had its "lost decade" of economic stagnation. Much money was spent on stimulating the economy but the economy only started to recover after the Koizumi government in 2003 forced the banks to account for all their losses.

Yet despite its accurate analysis the article draws the wrong lessons. It concludes that "more money fast" is the lesson from Japan. I think the lesson should be: make the banks (and the economy) honest again. Banking is based on trust. And that trust has been totally destroyed in the US both by the Enrons and the Madoffs, but also by those bankers who sold mortgage packages to their collegues that they knew would never be repaid. If a bank now writes off a huge sum it means that until now it lied about that sum. Worse, it suggests that this or other banks might have more hidden losses. It is this blanket of lies that has to be lifted. That may very well cost a few trillion to the US. But money is not the core of the problem.

Thursday, February 05, 2009

The pros and cons of devaluation

I have plead before for letting the markets have their way with the currencies of Serbia and other countries. This time I want to explore the arguments for it.

The British pound fell 30% against the euro in 2008 and the fall is continuing. Yet the British Central Bank lets it go. It has learned its lesson from 1992 when Soros made US$ 1.1 billion speculating against the pound. Yet surprisingly countries that are new to free markets don't show this reluctance. Russia has spent $200 bln supporting the ruble until now - and has little to show for it. Serbia and other countries keep supporting their currencies too.

Their are basically two supporters for this monetary support: the IMF and the EU:
- the IMF operates defends the interests of foreign creditors. As local companies will need more local money to pay their foreign bills after a devaluation some will get in trouble and go broke. This means that the foreign creditor won't see its money. IMF doesn't like that.
- the EU aims for extending the euro zone. Countries who want to enter this zone need to keep their currencies in line with the euro for some time.

However, one can wonder whether the euro is really such a success as the EU paints it. I love being able to travel without having to change money. But the business case for the euro is weaker: The EU likes to stress how many billions are saved by not having to change money and not having any currency risk. Yet it doesn't show in the rather weak economic growth figures of the euro zone. Given the poor performance of the Euro zone until now in the economic crisis (we do worse than the US) this crisis may well mean the end of the Euro as we know it.

Very threatening is that nowadays people start openly talking that some country in the euro zone might go broke (the favorite examples are Greece and Italy). Italy used to have a high inflation economy and it regularly adapted the exchange rate to keep its currency competitive. This worked very well and Italy had a vibrant economy. Nowadays Italy is in the low inflation euro zone and it seems to have difficulty adapting to it. Being to able to devalue it currency was seen as a blessing by the Italians - not as a curse. This brings me to Slovakia that is very happy that it doesn't have to support its currency as it has entered the euro zone. I wonder whether they still will be happy in a year or two - or that they will broke as it proved to difficult to adapt their economy to the new reality without a devaluation. They are lucky that they didn't have a very skewed trade balance. But the crash of the car market may destabilize their economy.

An often heard objection against devaluation is that people will become poorer as they can buy less for their money. But that ignores that the country is living above its means and that it needs to reduce its trade deficit. Doing so with a devaluation spreads the pain equally over all citizens. The alternative (that the IMF favors) is firing thousands of government employees and stopping most government investment. That means spreading the pain less fair and usually with more damage to the economy.

One has also to consider the price one pays for an overvalued currency. It not only leads to an ever-increasing foreign debt, it also harms the national industry that cannot compete against the foreign imports. Supporting the currency subsidizes foreign imports at the expense of the local industry. All the Asian fast growth economies had an undervalued currency. The only country that used to have a sound economy combined with a strong currency was Germany with the Mark. But Germany compensated it with a very conservative fiscal policy, leading to trade surpluses.

At the moment one can see both models existing next to each other. While Ukraine has - on advice of the IMF - floated its currency that since has halved in value the Baltic states have kept their currency locked to the Euro - and they are paying a heavy price for that. It will be interesting to see which countries come out the best in the long term. In the mean time the Baltics lobby for a fast entry to the Euro zone.

Ethiopia, Yugoslavia, Soviet Union

Today I attended a lecture from an Ethiopian exile who is worried about the future of his country. He fears that it may fall apart with the present legistlation. Ethiopia is a country where no ethnic group has the majority and the largest group (the Oromo) is not the dominant group. However, the country has a very long history.

Ethiopia is at the moment a one-party state. This party was originally marxist, but in its economic policies it has given up on communism. However, its minority policy is a carbon copy of how the communists treated minorities in Yugoslavia and the Soviet Union.

On paper it looks all very nice: lots of minority rights (including the right to secession). Many Western activists love it as the right way to treat minorities. However, it is a kind of Macchiavellian divide-and-rule strategy that cuts the country up in a multitude of rivalling ethnic groups. It leaves an empty center that is only filled by the party. Nothing else is left on that level to challenge the domination of the party.

Countries pay a heavy price for such a policy:
- on the short term there are increasing tensions and low scale violence between ethnic groups. In Ethiopia this is visible in increasing number of deaths. Problematic is that often the local authorities are not neutral and the central government refuses to interfere.
- things become critical when the party falls apart. Then there is nothing left to keep the country together as the communists have removed many of the central institutions. In this situation Czecheslovakia, Russia and Yugoslavia have fallen apart. And even Ethiopia with its long history is at risk. People wonder whether the party would survive its present leader.

One can only wonder whether the West will take the lessons from Yugoslavia and the Soviet Union to heart: That the absence of credible central institutions doesn't mean that people don't believe in the state any more. Holding national elections and creating new central institutions should get priority above breaking up yet another state.