by Jules Evans | Dec 5, 2008 | Global system
I’ve covered eastern European markets for about eight years, and all of those eight years, the region has been on a growth trajectory, either because it is converging with the EU, or, in the case of Russia and Kazakhstan, because it has lots of natural resources. It’s been a boom region, with GDP growth averaging above 6% for the last eight years.
In the last two months, the region has been hit by the global financial crisis, and engulfed by it. Now, many analysts say that of all the emerging markets, the CEE (central and eastern Europe) region is the most vulnerable and exposed.
The main reason is that several CEE countries have very high current account deficits, which mean that they rely on FDI to get foreign currency to pay off their FX liabilities. Countries with current account deficits over 5% include Hungary, Ukraine, all the Baltics, Romania, Bulgaria, and Serbia.
The FDI that used to flow to these countries was mainly foreign currency loans – syndicated loans from western banks, or Eurobond borrowing. But the credit markets have completely closed. Now these countries are facing real difficulties in meeting the FX gap, and their currencies are coming under severe pressure.
All these countries have banking sectors that are dominated by western banks. These banks have high levels of foreign currency loan exposure to CEE countries. They want to stop the CEE countries from devaluing, because then their foreign currency loans would be worthless, and some of the foreign banks might even go bust.
However, the CEE countries I mentioned earlier might be forced to devaluate sharply in 2009, because their economies are now grinding into severe recessions, with economies shrinking by up to 4% next year. In the words of one analyst ‘they will have to devalue, otherwise their economic systems might break’.
Another analyst told me, ‘Next year for the CEE region will be like 1998 for the Asian economies. A number of currency collapses and severe recessions.’
The western banks that are heavily involved in the CEE region are desperately trying to prevent an Asia style crisis happening within the EU. Those banks are mainly Austrian (Raiffeisen, Erste Bank, Bank Austria Creditanstalt), but also Italian (Unicredit, which owns Bank Austria) and French (Societe Generale, BNP Paribas).
A senior banker at Unicredit, which is the biggest bank in the CEE region, told me: ‘We have about six months to stop the region from imploding. The EU and ECB need to do more. So far they have felt, it is not in the eurozone, it is not our business. But if there is a crisis in eastern Europe, it will affect western banks, and then it will affect western Europe.’
He also told me there was the real threat of nationalism in eastern Europe, with foreign banks being nationalised for not lending more to CEE economies.
The international financial system is straining, because it depends on international banks, on banks acting as bridges between countries. Now, however, both sides of those bridges are crumbling – western governments are demanding that semi-nationalised banks do more at home; while eastern governments are demanding they support their foreign subsidiaries. It is difficult to obey both.
If the CEE region did collapse, it could put great strain on the local political systems in these countries, and could give rise to isolationist, xenophobic governments, as it did in some CEE countries in the early 1990s. We should remember that the last time there was a major Austrian / CEE banking collapse was in 1931, with the fall of Creditanstalt, which helped give rise to the Nazi Party.
The EU should have the firepower to stop such a crisis from happening – the Baltic and Balkan economies are not that big. The EU or ECB may need to provide major bail-outs or guarantees to the local CEE banking system, in order to help local banks raise credit. Otherwise we are faced with an asymmetric bail-out, where western banking is guaranteed and eastern banking is left to rot.
Another pressing question is what happens in Ukraine, which looks set for a serious devaluation in the new year, and which is now struggling to pay its debts for Russian gas. Much of the EU depends on the gas that comes through Ukraine from Russia, so the EU needs to make sure its supply is protected there.
by David Steven | Dec 1, 2008 | Global system
Doug Short has put together this depressing chart comparing three previous bear markets, with the current financial meltdown. Have a look at the grey (1929 and great depression) and blue (today) lines – and you’ll see that US markets have now declined about as far and as fast as they did in the 1930s.
If this was the thirties, however, the bottom would still be more than 600 ‘market days’ away…
So will things be as bad again this time? John Carney reckons that the market has now reached ‘fair value’ but the price declines could “continue for another decade or so, during which stocks will occasionally become truly cheap.” Japan’s stock market, remember, recently hit its lowest point since 1982 – and has been in decline for almost twenty years.
But I am not making any predictions – unlike the saintlike Warren Buffet who, six weeks or so ago, used the New York Times to urge investors to plough any spare cash into stocks and shares. Major companies would be posting record profits in 5 years, he said – so now was the time to buy:
Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”
Buffet is richer – and more revered – than God, so his words carry a lot of weight. Here in the UK, his advice was picked up by tabloids, who passed it on to their less than sophisticated investors. Let’s hope that they realise that when the great man says ‘long-term’ – he really means ‘long-term’. They should be prepared for wait for ten years, or perhaps longer, before they cash in.
Also wouldn’t it have been a good idea for Buffet to have been a little more upfront about how much money he stands to lose if equities don’t recover? Last year, our Warren bet $37bn – yes thirty seven billion dollars – that US and world markets would be higher than they were then in 15-20 years time.
Given that he’s 20% or so down at the moment, that seems like a pretty big conflict of interest to me…
(photo under a cc license from flickr user swearinglibrarian)
Update – I was much nicer about Buffet here…
by David Steven | Nov 15, 2008 | Global system, London Summit
In our paper on Bretton Woods II (pdf), Alex and I provide rather a gloomy assessment of financial crisis – which we suggest is going to last longer than many think…
Given that we now face what Gordon Brown has described as “the first truly global financial crisis of the modern world”, our bet would be that it takes as long as a decade to bring it fully under control.
Let’s unpack the assumptions behind our pessimism. We start from the premise that, six months back, experts were overly optimistic about how far-reaching the meltdown would be. This is based, in part, on April’s Progressive Governance summit, where heads of state were (a) clearly freaked out; (b) fairly sure they grasped the problem, if not the solutions; (c) not acting as if they expected any further big surprises.
Consider, too, what the IMF’s Dominique Strauss Kahn was saying at the time. He was as worried by inflation, as he was by economic slowdown. Although he was forecasting a “rather important, serious slowdown in economic growth” – the expected pain wasn’t really that bad:
Something around 0.5 percent as a rate of growth for the United States in 2008 and a slight recovery during 2009-an average of 0.6 percent for 2009, which is both linked to the financial turmoil, of course, but also the business cycle.
Next, we look at the lessons of earlier banking crises that, in developed countries, have tended to take four or five years to unravel, cost around 12% of GDP to resolve, and lead to a cumulative loss in output equal to almost a quarter of GDP. The figures are drawn from this useful chart prepared by PIMCO’s Michael Gomez:
Then add in what we know about the banking crisis that gripped Japan in the 1990s, which the IMF ascribes to “accelerated deregulation and deepening of capital markets without an appropriate adjustment in the regulatory framework”. Hiroshi Nakaso’s account is worth reading in full – seven years of crisis management and fire fighting as a senior manager at the Bank of Japan.
“When the bubble burst in the early 1990s, no one expected it was going to usher in such a prolonged period of weak growth in Japan,” he writes. Policy makers underestimated the seriousness of the problem, while banks lacked the ‘foresight and courage’ to confront their predicament head on.
At the time there was considerable schadenfreude in the West about Japan’s failure to get to grips with its crisis. It was eight years or so before its policy makers even found the levers that would begin to inch the crisis towards a solution. Are we right to assume that we’ll now do better? (more…)
by Alex Evans | Nov 13, 2008 | Climate and resource scarcity, Cooperation and coherence, Global system, London Summit
Ahead of this weekend’s G20 summit, David and I have published a short paper entitled A Bretton Woods II worthy of the name. Key points:
– The summit is unlikely to be able to live up to its billing. Leaders do not yet understand the nature of the problem well enough to be able to implement viable solutions. However, the problem is more fundamental than a simple lack of shared awareness.
– History suggests that leaders will only think the unthinkable on institutional reform once the challenge they face has really hit rock bottom. But history also suggests that we are wrong to think that the worst of the crisis is now past, given that many past banking crises have taken five years or more to unravel.
– Bretton Woods 1 looked across the whole international economic waterfront in 1944, while this weekend’s summit will be much more narrowly focused. Leaders will make a big mistake if they try and tackle finance in isolation, given the growing impact of resource scarcity, and that 2009 is supposed to see another ambitious global deal – on climate.
– We need to recalibrate what we expect from globalization through a serious debate about subsidiarity. Where has globalization gone too far, too fast? Where do we need more integration at a global level? These were exactly the questions that preoccupied Keynes in 1933, when he weighed the relative benefits of global versus local across a range of variables. We need a similar debate today as a precursor to serious international economic reform.
– Leaders need to extend their horizons in (at least) five directions: onto longer time scales; beyond financial regulation into wider resource scarcity challenges; into other international processes, especially climate; towards grand bargains with emerging powers; and beyond government, to non-governmental networks.
Full version after the jump, or better yet here’s the pdf.
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