Seems a long time ago that Eastern Europe was behind this curtain and the world was worrying about that tussle for world supremacy. This region of the world had been getting great press for its transformation in the Bush/Rumsfeld era. Times now suggest that “New Europe” is in a lot of trouble and “Old Europe” may suffer the effects of this contagion.
During the course of the 1990s this region started building the growth ecosystem like private enterprises, functioning capital markets, establishing law and order and creating viable social institutions. At the same time to the east, several “Tigers” where going through a less than “Royal Experience” as the Asian Contagion starting in Thailand spread through most of South East Asia, learning the fickle nature of speculative foreign capital. Great in feeding the credit driven boom but bursting the balloon more rapidly as confidence in the never ending “Growth Story” starts to wane. Most of South East Asia was running large government deficits (>10%), kinda like the US without the benefit of being the principal global currency reserve.
The collapse of their currencies as foreigners rushed to cash in their Bahts, Wons and Rupiahs created a profound depression in the region that was only revived by American consumption driven by the great housing bubble. Most economies shrank double digits, decade’s long progress went up in smoke and an important lesson in economic management and globalization was learnt.
Fast forward to the 2000s, the rapid emergence of Eastern Europe. The initial impetus was the growth of private enterprises to meet emerging consumer demand for Western style goods and services. This was further helped by Western Europe outsourcing some of their high cost manufacturing mainly to more developed countries like Poland, Czech Republic, Slovenia. Then as the flood of global liquidity in middle of the 2000s started to make it via Western banks (especially Austria, Sweden, Swiss, Italy, Germany) and started pushing up home & other asset prices with cheaper mortgages (90% of GDP in Latvia) denominated in Euros, Swedish Kroners, Swiss Francs. Most countries looking to join the European Union, Eurozone were excited at the fresh new capital, companies that were flooding their countries, asked few questions and agreed to currency pegs and deficit goals.
Funny, how times change but they don’t. Much as South East Asia experienced, when sub prime became global conversation and Lehman brothers went out with a bang, investors around the world started to look a bit more closely at their money. In a credit risk averse world, investing in emerging countries borrowing 10% of their government spending, where most mortgages were tied to foreign banks & currencies was not so hot. The flood of money started to attack the weak first as currencies of Hungary (Forint) Ukraine, Latvian start to see 10-30% drops in their value. Western Europe looked on in horror as they realized that their bank savings ($1.6 Trillion) that looked like going up in poof, comparable with anything that subprime had to offer. The currency devaluation had a double whammy because it starved these nations of capital to grow and generate income for its citizens who were also looking at their Euro mortgages that looked so much less enticing when their exchange rates were 30% higher. Europe screamed bloody murder at "American Sub Prime" and insisted on increasing the capital at the IMF available for lending to struggling European economies. However, they were less sympthetic to the pleas for even greater assistance from some like Hungary and insisted on strict conditions that will likely result in Latvia shrinking by nearly 20% this year, Swedish banks are digesting the remains. The currency Euro pegs and deficit requirements straightjacketed the governments from the deficit spending that most of the developed countries indulged in stimulate recovery.
The crisis has separated the effective economic stewards (Poland, Czech republic, Slovenia) from the others (Baltic republics especially Latvia, Ukraine, Hungary). The region as a whole will shrink this year (IMF -2.9%) and start to grow next year as Western Europe’s aging population continues to demand goods and services that stretch the limits of their productive capacity. However, European banks have yet to come clean with the extent of losses that they will continue to see as this saga enfolds. The resulting credit deflation should materially affect their economies into the next year. The Swedish (20% of GDP), Austrian (loans are 90% of GDP), German and Italian economies are likely to bear the brunt of this. This is compounded by the ECBs refusal to cut interest rates and fight the excessive strength of the Euro that is making the problem worse. The currency crisis could worsen especially as countries try to roll over debt (Hungary, Ukrainee) this year and find few takers.
The extent of this carnage will be mitigated by the recovery in global manufacturing as inventories that have been decimated need to be built back up and many factories in Eastern Europe restart the smokestacks. Should the global consumer of last resort (America) come back like Lazarus then things could indeed turn to be a lot better, but given the level of current debts and weak banks any such strong recovery does seem unlikely. The other source is the notably spendthrift German Consumer might decide to live a little and take on “Oh My God” debt….Talk about the Anglo saxon model.
Disclosure: Long TREMX FIEUX DFE DLS FNORX HAINX