Crisis in the East

Not reassuring:

The latest data from the Bank for International Settlements shows that Western European banks hold almost all the exposure to the emerging market bubble, now busting with spectacular effect....

Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia – all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.

Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain. The US figure is just 4pc. America is the staid old lady in this drama....

The [ex-Soviet block] has borrowed $1.6 trillion in dollars, euros, and Swiss francs. A few dare-devil homeowners in Hungary and Latvia took out mortgages in Japanese yen. They have just suffered a 40pc rise in their debt since July....

Traders are paying close attention as contagion moves from the periphery of the eurozone into the core. They are tracking the yield spreads between Italian and German 10-year bonds, the stress barometer of monetary union.

The spreads reached a post-EMU high of 93 last week. Nobody knows where the snapping point is, but anything above 100 would be viewed as a red alarm. The market took careful note on Friday that Portugal’s biggest banks, Millenium, BPI, and Banco Espirito Santo are preparing to take up the state’s emergency credit guarantees.

Comments

[Kunar]

If this goes really crazy the euro could shrink to a core of Germany, France, Belgium, Nederlands, Sweden, and Luxembourg. Or smaller than that, depending.

It is rather unlikely that Sweden will use the Euro as a currency, even more when other countries reintroduce their own money. In 2003, the people of Sweden voted against the Euro and have kept their Swedish krona.

[Don]

Mrt GOP, you are correct; a smaller but stronger euro would not be the end of the world at all, except for one thing; it probably would mean the end of the idea that the euro can replace the dollar as the world's reserve currency, at least for now.

The problem is not that the shrunken eurozone would be too small to sustain a reserve currency role, although it might be. I think the perception that the eurozone is in retreat would be devastaing however.

As for Spain's role; I don't see Spain becoming a cheap centre for low-end manufactuing, although it could become attractive for higher-end production like pharmaceticals et al. In any case I see Spain as perhaps the least likely country in that list to leave the euro, and possibly less likely than Ireland as well.

I think much depends upon the depth and nature of Spain's banking problems; paradoxically it may be compelled to stay with the euro to prevent it's international debts inflating relative to it's currency - even when other factors would argue for delinkage and devaluation.

One thing which complicates the decision to leave the euro is what form a country's external debts take. If they are large and denominated in euros (as they would be) delinkage and devaluation might also imply bankruptcy. I am thinking of the Icelandic precedent in which galloping bankruptcy has been driven by massive devaluation of the currency relative to the pound and the euro.

But Iceland is a much different case to Italy, who would stand to gin much from devaluation, which would help make the large Italian manufacturing sector much more competitive with the likes of Polnd, for example.

[Mr. Gop]

If this goes really crazy the euro could shrink to a core of Germany, France, Belgium, Nederlands, Sweden, and Luxembourg.

Well that doesn't sound so bad... maybe the euro started a bit too big anyway.

Delinkage to the euro can bring benefits to some of these countries as they may become manufacturing havens for multinationals looking for cheap production.

Since Spain now more or less sees itself as level with the european big players (UK, Germany, France) I don't think they will like that option so much.

[Don]

Of course the figures in that piece leave out a rather large chunk of change the US has to work off, the subprime and other mortgages problem, currently estimated at $1.2 trillion in total (about 9% of the 2007 US GDP). Add this to the exposure to emerging markets and it adds up to a respectable exposure of 13% of US GDP.

Spain seems to have a problem. It's not much exposed to Eastern Europe or Asia, but has a double-whammy; $326 billion exposure to Latin America and an unquantified exposure to it's own housing bust. The Latin American exposure is about 25% of Spain's 2007 GDP. I won't estimate the size of the domestic problem except to say it's potentially very large. Spain has waxed rich from paving much of Spanish coastlines and selling the housing to middle-class Brits and other Europeans; one expects the air to go out of that bubble very quickly. Spain could potentially be in a similar situation to Austria or Switzerland.

[Don]

Crisis in the East (aka Eastern Europe)? Kinda looks that way. But also crisis in Italy, Latin America, Russia, and mayhap crisis in Asia.

Where are the (relative) points of stability in this shifting of the financial tectonic plates? Look to big rich diversified economies with relatively small financial sectors (relative to the size of the economy that is), and not getting the bulk of their revenues from oil or other commodities.

That is (in rough order) the US, China, Japan, Germany, France, Canada, South Korea, UK, possibly Nederlands, Belgium, and Poland.

It's hard to predict who the relative beneficiaries in the longer term will be; I suspect Eastern Europe and possibly Italy Spain, Greece, Ireland, and Portugal will be forced off their linkage(s) with the eurozone, for the present anyway.

If this goes really crazy the euro could shrink to a core of Germany, France, Belgium, Nederlands, Sweden, and Luxembourg. Or smaller than that, depending.

This could make for a paradox - a stronger euro. A smaller central bank can perform better, and the nations who drop away can also pursue better central bank policies for themselves. Italy could really benefit in the shorter term by devaluing the lira, and Spain, Portugal, and Greece are also in difficult straits.

Delinkage to the euro can bring benefits to some of these countries as they may become manufacturing havens for multinationals looking for cheap production - their attractiveness relative to China may rise because of Chinese strength.