Our Global Economy: How Credit-Crippled Eastern Europeans Can Sink Your 401k

By Marc Lichtenfeld

If the global economy were a hospital patient, you’d definitely find it in the Intensive Care Unit. It’s not on life support just yet, but it certainly finds itself in an increasingly precarious position, due to the numerous negative factors swirling around the financial world.

One of these factors is something you might not be aware of, given the furor here in the U.S. It’s happening half a world away over in Eastern Europe and is just beginning to get some attention now.

So pack your bags and I’ll fill you in…

Pain In Prague And Poland

In Eastern Europe, the economic problems are two-fold…

1. The region is experiencing a similar downturn to the one in the U.S.

2. Local currencies are enduring a significant slide against the euro.

For example, the FOREX exchanges in Prague (Czech Republic) and Warsaw (Poland) have hit multi-year lows. And so-called “toxic foreign currency options” have sent the Polish Zloty into a downward spiral.

So while on the surface, you may see that Eastern Europe has enjoyed strong growth over the past couple of years, scratch below it and you’ll find that this growth was fueled by credit.

Today, citizens in countries like Poland and Romania are losing their jobs and having trouble paying their loans. Sounds familiar, huh?

But just to make matters worse, many of the banks either lent money in euros or receive money from their parent banks in the same. So even if the loans are paid back, they’re worth as much as one-third less because of the falling currencies.

It Wasn’t Just Americans Sucked In By Cheap And Easy Money

We’ve heard a ton about how some American banks got carried away with the availability of easy credit and started dishing out money to practically anyone who asked for it.

But it’s a similar situation in Europe. Austrian, Swiss, German and Italian banks own a majority of banks that do business in Eastern Europe. And these foreign banks have lent boatloads of money to countries such as Poland and Romania.

Not a good predicament to be in, to say the least… not for anybody.

According to The Economist, Austria has lent 230 billion euros to the region, which is equal to about 80% of its GDP - a mind-blowing amount.

And the chickens are coming home to roost now, with Austria’s finance minister, Josef Proll quoted thus in Vienna’s Der Standard newspaper: “A failure of 10% would lead to a collapse of the Austrian financial sector.”

Nope… Not good at all.

The European Bank for Reconstruction and Development estimates that bad loans will make up 10% to 20% of total loans. And the fact that Eastern European countries have to repay - and presumably reborrow - $400 billion this year is a mighty tough number to meet in the tight credit market.

A recent Bloomberg article even floated the notion that big countries like Germany and France might be forced to bail out not just banks, but entire countries.

Because of this, it’s quite reasonable to imagine that if big European banks start falling apart as a result, we’ll experience the ripple effect in the U.S. And with the investor psyche already perilously fragile, quite frankly, our markets can’t suffer another systemic crisis without severe ramifications.

So what’s the solution?

If Eastern Europe Goes South, Head For The Exits

There are some who argue that Eastern Europe is fertile enough ground that foreign banks will do whatever it takes to ride out the storm. After all, those banks have generated meaningful profits in that neck of the woods in the past, and they’ll doubtlessly want to do so again when the smoke clears.

But while they’re probably right, it’s certainly worth monitoring this situation. If it gets worse, you can expect rapid deterioration in our markets as well as the contagion spreads. You’ll want to move your money to safe investment vehicles and fast.

The flight to safety could include assets like the U.S. dollar, which could benefit as Europe’s currencies head south. But this in itself is a risky bet, given its volatility.

As we’ve stated here several times over the past few weeks, we think gold investing is one of the best options at the moment. In addition to highlighting a lesser-publicized reason why gold could head even higher from here, we’ve also alerted you to a gold price indicator that can tip you off on when the metal could rise, plus reasons why you should invest in gold.

And our commodities expert has given his own outlook for the yellow metal in his “Commodities Corner” column over the past few editions. Make sure you check out his gold price projections here.

Disclosure: No positions

Comments

[Roger Knights:]

If CreditInstaldt (sp?) fails again in Austria, it could be 1931 all over again. So gold could jump $100 in a day and $250 in a week, sometime in the next three months. (Shorts be wary.)

Feb 22 09:55 AM

[SW Richmond:]

Thanks for the article.

Gold is not a commodity, it is a currency. If you view it as a commodity it will bite you on the ass because it will do things you won't understand. So get your currency guy to look at it, not your commodity guy. Those who cannot come to grips with this reality should avoid gold, as one should never make an investment one does not fully understand. Gold's behavior makes perfect sense only when you view it as a competing currency, one that is in direct competition with governments and central banks.

In that respect, and in only that respect, I agree with Rolexdaytona's comment to another SA gold article: "there are big hand watching this market that knows when to punch a knock out."

There will be no knockout, but I do expect massive and ongoing attempts at suppression of the gold market, specific cap gains taxes on PM's, and continued announcements of CB / IMF sales threats. I expect gold buyers to be publicly denounced as "evil speculators" who are "ruining the world's chances of recovery." I expect taxpayer TARP money to aid these schemes.

None of it will matter. It's clear to me now that we have crossed the event horizon. Everything I've seen so far, since August of '07, convinces me that the world's economy suffered a fatal infection in that month, and we have been dying of sepsemia ever since, a dead man walking. Gold is the final safe haven. The gold market is so very tiny, when the real rush starts there won't be any to be found.

DYODD.

Feb 22 11:09 AM

[otbricki:]

Gold is high compared to other metals and oil right now, very risky. Much better to buy other metals like silver, platinum - much lower downside risk.

Feb 22 11:23 AM

[Dragoman:]

This is pure NONSENSE. Have you heard of the Bank of International Settlements? Did you bother to inform yourself before publishing this ?

Poland, Czech and Romania which you mentioned represent 80% of the GDP of the EU-10 accession. As you failed to mentioned to readers, Central Europe credit portfolios are built on primary deposits from Czechs and Poles and is not covered by Austrian GDP, as suggested by the author and quite sensationally by the Austrian magazine - Profil - this week. I know this is probably an old-fashioned feature of the EU-10's banking world, but in Central Europe, hard-saving EU citizens give their cash to banks who then make loans to responsible borrowers - and we know they are responsible because delinquincy rates are lower than the US and Western Europe. While smaller EU-10 economies rightly belong in the 'sin bin', in Poland, Czech and Romania, deposits exceed loans, and bank Tier 1 capitalization is higher.

By example. a few quotes from leading Romanian financial newspaper Ziarul Financiar :

"Erste does not need the support of the Romanian state" Andres Treichl, CEO of BCR-Erste, specifically in regard to the stupid article in Austrian magazine Profil which sensationally suggested the Erste's entire Romanian portfolio could default.
"The capacity of local banks to absorb the economic shock is large, with core ratios of 12% capital, the local banks could be described as super-capitalized” Ion Dimitru, chief economist, Raiffeisenbank Romania,
"There is no need for the Romanian state to assist the banks, and there is not one bank in a situation to need such support,” said Bogdan Baltazar, Board Director of BRD-SocGen,

I have seen no sense of proportion in any analysis regarding the central european economies. Latvia is 10% the economic size of the Czech Republic and Poland is three times the size of Hungary. The vast majority of borrowing in these countries is in local currencies. According to BIS data, Romanian borrowers' total foreign short-term funding for refinancing in 2009 will be euro 9 billion. This is absolute peanuts when one considers the borrowers are local subsidiaries of international car companies, oil refineries, industrial multinationals and banks.

Without doubt the banks are screwed in Russia, but pigmies like the Baltic economies are by no means large enough to cause serious problems for the EU, and the hysteric fall in the currencies of the main Central European economies really should encourage value investors to seek opportunities. To me and Starbuck's chief, Howard Schultz, the UK and Western Europe looks to have fundamentals much more out of kilter.

This argument for gold is a joke, when undervalued Czech koruna bonds offer a great yield, are a liquid, safe asset, and probably will yield a currency uptick as the current hysteria abates and the zloty, koruna and lei bounch back in Q2. Goldman Sachs' seems to share this opinion and closed its short positions in Polish zloty and the Czech koruna last week. Does Mr LIchtenfeld know something Goldman Sach doesn't?

Feb 22 11:57 AM

[PastTense:]

This sounds like a "straw that broke the camel's back" type argument. The economies of Eastern Europe are just too small to have such a major global effect--no matter what happens in Eastern Europe.

Feb 22 11:59 AM

[mr freddo:]

Gold is getting a great deal of attention and is about to set new highs due to its reputation as a safe haven. I believe that it is prudent in these perilous times to hold a percentage of your portfolio in gold and silver.

The markets will head lower as the bad news from Eastern Europe ripples through the already fragile global financial system. Any equities that are still being held, should be considered 5 year holds at this point.

Things are about to get a lot worse before they start to get better (say 2012?).

Feb 22 12:38 PM

[Dave Wrixon:]

Yes, it is amazing how clueless Eastern European's are blaming their shrinking exports on things that are happening thousands of miles away across the Atlantic.
When will they face up to the fact that it is decades of currency manipulation by their governments that have led them to be pampered by being over-paid for under-producing increasingly inferior goods that nobody wants? When are they going to stop running economies based almost entirely on shopping paid for on credit borrowed from abroad? What kind of morons are these people?

Feb 23 12:17 PM

[Mad Hedge F...:]

$$ TbH While American banks have their subprime crisis, European banks are being dragged under by their lending to emerging economies in Eastern Europe. Ledd by UniCredit in Italy, Austria’s Erste Group Bank and Raiffeisen International, France’s Societe Generale, Belgium’s KBC, and Hungary’s OTP, banks have lent $1.6 trillion to companies in these formerly communist countries at cheap rates, with minimal documentation, and few questions asked. The easily available credit caused local money supplies to explode, and sparked bull markets in both stocks and currencies. Emerging Europe grew at rates double and triple rates in the West, as local companies pumped up on steroids became the master of leverage. Now $400-$600 billion is due for rollovers this year from nonexistent credit markets, and the chickens….make that vultures have come home to roost. Economic growth has fallen off a cliff, with Poland’s seasonally adjusted industrial output down in December a precipitous 7.4% YOY. The Polish stock market fell 48% last year, and the zloty of off 40% again the dollar from its June peak. The Central European Equity Fund (CEE) has crashed 80% in eight months. The crisis is so severe, it may postpone Poland’s entry into the Euro block, which had been scheduled for 2011. Home mortgage borrowers are in especially bad shape. Up to 50% of their loans were denominated in Swiss francs, so the collapsing Polish currency has caused a near doubling of borrowers’ monthly payments and principals since last year. Austria really has its knickers in a twist, as these heavily syndicated loans account for 80% of GDP. A 10% default rate could wipe out the entire banking system there. Germany has the smallest loan exposure, but has the most to lose, with 25% of its exports headed east. It is now in negotiation with its partners in the EC to cobble together a bailout with the help of the IMF to provide bridge financing for these loans, and hopefully ward off a further economic collapse. It looks like the headlines in Europe are about to get uncharacteristically sensational.

Mar 01 11:11 PM