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The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
This is the 2nd to last installment in my Pan-European Sovereign Debt
Crisis series. After covering western and southern Europe, we are moving
eastward. Before we go any further, be sure you have caught up on the
previous portions:
- Can
China Control the "Side-Effects" of its Stimulus-Led Growth? Let's Look
at the Facts - Explains the potential fallout of the excessive
fiscal stimulus in China. While not European, it is quite likely to kick
off the daisy chain effect. - The
Coming Pan-European Sovereign Debt Crisis - introduces the crisis
and identified it as a pan-European problem, not a localized one. - What
Country is Next in the Coming Pan-European Sovereign Debt Crisis? -
illustrates the potential for the domino effect - The
Pan-European Sovereign Debt Crisis: If I Were to Short Any Country,
What Country Would That Be.. - attempts to illustrate the highly
interdependent weaknesses in Europe's sovereign nations can effect even
the perceived "stronger" nations. - The Coming
Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western European
Countries
Austria, Belgium and Sweden, while apparently healthy from a cursory
perspective, have between one quarter to one half of their GDPs exposed
to central and eastern European countries facing a full blown
Depression!
Click to Enlarge...
These exposed countries are surrounded by much larger (GDP-wise and
geo-politically) countries who have severe structural fiscal
deficiencies and excessive debt as a proportion to their GDPs, not to
mention being highly "OVERBANKED" (a term that I have coined).
So as to quiet those pundits who feel I am being sensationalist, let's
take this step by step.
Depression (Wikipedia): In economics, a depression is
a sustained, long-term downturn in economic activity in one or more
economies. It is a more severe downturn than a recession, which is
seen as part of a normal business cycle.Considered a rare and extreme form of recession, a depression is
characterized by its length, and by abnormal increases in unemployment, falls
in the availability of credit,
shrinking output and investment, numerous bankruptcies,
reduced amounts of trade and
commerce, as well as highly volatile relative currency value
fluctuations, mostly devaluations.
Price deflation, financial crisis and bank failures are
also common elements of a depression.There is no widely agreed definition for a depression, though some have
been proposed. In the United States the National
Bureau of Economic Research determines contractions and expansions
in the business cycle, but does not declare depressions.[1] Generally,
periods labeled depressions are marked by a substantial and sustained
shortfall of the ability to purchase goods relative to the amount that
could be produced using current resources and technology (potential output).[2] Another
proposed definition of depression includes two general rules: 1) a
decline in real GDP exceeding 10%, or 2) a recession lasting 2 or more
years.[3][4]
Before we go on, let's graphically what a depression would look like in
this modern day and age...
A depression is characterized by its length, and by abnormal
increases in unemployment.
Price deflation, financial
crisis and bank
failures are
also common elements of a depression. 
A depression is characterized by ... shrinking output and investment
... reduced amounts of trade and
commerce.
... as well as highly volatile relative currency value fluctuations,
mostly devaluations.
A former premier has called for a 30% devaluation and a
sitting minister said in June that there should be a "debate."
Meanwhile, chief executive of SEB, Sweden’s number two bank, says totalloan losses would ultimately be little different if the Baltics stayed
the course or devalued now – though rapid devaluation might be tougher
to deal with. (Lex/FT.com)
The global slowdown coupled with the unprecedented financial crisis has
uncovered significant vulnerabilities that can currently be witnessed in
the Central and Eastern Europe in the form of structural imbalances and
growing foreign indebtedness. Not surprisingly, the region, which until
a couple of years back was forecasted to be one of the most profitable
investment avenues, now stands out as the hardest hit with many
countries such as Hungary, the Ukraine, Latvia, and Romania forced to
seek IMF and foreign aid and bail-outs. Heavy reliance on exports and
foreign capital (especially from Western Europe), which fed the economic
growth in the pre-crisis period, has backfired when peak global demand
dried up and the liquidity crunch hit the global financial system.
Countries in this region are highly dependent on foreign trade, with
exports accounting for more than 50% of GDP for many countries. Sharp
declines in exports have triggered a series of internal predicaments
including rampant and rising unemployment as well as declines in
domestic demand that exacerbate trade account imbalances through
declines in imports. However, the problems for these countries have been
aggravated by huge foreign indebtedness and the resultant interest and
income payments that put additional pressure on the balance of payments.
While currency depreciation could have provided some much needed
respite (although that can be seriously debated), for countries like
Latvia, Estonia, Lithuania, Bulgaria and Ukraine which have a fixed
currency peg to Euro, the option is not available. As a result, Latvia,
Lithuania and Estonia have witnessed double digit negative real growth
in GDP and are witnessing structural issues of deflationary pressures
(owing to price and wage cuts) and very high unemployment levels. Click
any
graphic to enlarge...
Source: IMF, European Commission
Notably, except for Hungary with a public debt-to-GDP of
nearly
80%, government debt is within manageable limits for most of the
countries in the region. This is most likely due to the fact that these
countries did not have an overdeveloped banking system that required
bailing out.
This relative benefit was not without its costs, though. Without heavily
developed banking sectors of their own, these countries turned towards
outside banking institutions for their financing needs. The major
financial risk, therefore, surrounding this region is the high foreign
debt to private sector. Foreign banks (mainly western European banks)
play a major role in the CEE region and account for approximately 60-80%
of total bank assets in most CEE countries. While significant leverage
was built up through massive foreign lending to the private sector in
this region during the pre-crisis period, the same has now become a
major source of external imbalance and financial risk. Claims of the
foreign banks exceed 100% of GDP for countries like Estonia, Latvia,
Lithuania, Hungary and Croatia. Loans denominated in foreign currency
amount to nearly 90% of the total lending in Latvia, 85% in Estonia and
65% in Lithuania. While on one hand, the high reliance on foreign
lending puts a lot of pressure on the current account balance and
balance of payments, the increased financial risk of a pull back of
foreign capital can seriously jeopardize growth in these countries.
Deleveraging and de-risking by the foreign banks through reducing their
exposure to these countries as well as curtailing lending will certainly
hamper the prospects of recovery for these sovereign entities. The
simultaneous PIIGS crisis in Western Europe adds to the pressures on
Western European banking sector, providing an added impetus to hasten
the de-risking process.
Further, for countries like Estonia, Latvia, Lithuania, Bulgaria and
Ukraine which have a fixed currency peg, high foreign debt restricts the
possibility of devaluation of currency as the devaluation will lead to
increased debt and interest burdens and shall add to the pending and
inevitable slate of defaults. Thus, these countries are deferring the
devaluation of their currency and are following the painful internal
adjustment process of contraction in domestic demand to counter the high
current account imbalances. This is, in turn, impacting the loan
performance leading to the inevitable increase in defaults. Research by
Danske Bank in early 2009 estimates that under an adverse scenario, loan
losses can reach 30% in Baltic countries (Estonia, Latvia, Lithuania),
Bulgaria, Ukraine and Romania while loan losses in other CEE countries
will range between 10-20%.
It should be made clear that the current PIIGS/Greece
developments
have caused the Euro to slide aggressively anyway, thereby applying the
unwanted currency devaluation to the distressed CEE countries. From an
academic perspective it appears as if the outstanding (non-euro
denominated) debt service just got that much more difficult.
Source: Bank for international settlements, IMF
Austria, Sweden and Belgium stand out at the top the list of western
European countries having relatively outsized exposure to CEE nations.
Total CEE exposure of the banks in Austria stands at 53.4% of the GDP of
Austria while it is 22.8% and 20.4% for Swedish banks and Belgium
banks, respectively. Major Austrian and Swedish banks have high exposure
to high risk countries like Croatia, Hungary, Romania and Ukraine and
Baltic countries (Estonia, Latvia, Lithuania). Professional
and institutional subscribers can download the 30 page
Austrian/Swedish/Greek bank exposure and comparative valuation tear
sheet to view the stats and our opinions on who the highest risk banks
are. Yes, the highly levered Greek banks have significant CEE exposure
as well, as if they don't have enough problems of their own: 
Banks
exposed to Central and Eastern
Europe
2010-02-22 03:55:38 1.46 Mb
There are several banks included in the study that:
- have ADRs
- have credit exposure to high sovereign risk nations including
amounts to 762% and higher of the total tangible equity with the total
non-performing and sub-standard (but performing) exposure standing at
96% of the tangible equity. - have Texas Ratios approaching nearly 100%
- have NPAs growing nearly 500%
- have leverage rations of over 80x
- are trading at BV multiples that apparently ignore the potential
credit contagion, etc.
My next and final post on the Pan-European Sovereign debt crisis will
attempt to tie all of the pieces together along with middle-eastern and
Asian risks to illustrate a road map of the various stress points in
global sovereign debt and related bank exposure.While I am not saying
any particular country will bring about the end of the world as we know
it, there are simply too many risks and contingent crashes waiting to
happen, all inter-connected, levered and amplified across dozens of
borders and financial systems to simply assume that not one country will
falter. That faltering could very well be the first domino to fall
among many...
Interested parties can feel free to contact me by phone
or email.
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Remember that the Baltics and other former parts of the USSR went through a near total societal collapse recently - they should be better able to weather a relatively minor disturbance like the collapse of the world financial system than complacent "first world" countries.
Odd, might things financial not be quite back to normal in Sweden? The Riksbank seems worried:
http://www.riksbank.com/templates/Page.aspx?id=43398
Economic Commentaries : Urgent need for new financial regulations and tools
DATE 15/02/2010
A thorough review of the regulatory framework for the Swedish financial sector is needed. It is high time to take a coherent approach to everything from the winding up and reconstruction of financial undertakings in distress to the responsibilities, division of roles and tools relating to the maintenance of financial stability in Sweden. One or several commissions of inquiry should be appointed urgently to review the financial regulatory framework.
Reggie, could you give any insight on Poland? I happen to live here now, and the local media aren't any more honest than anywhere else. Apparently, the economy is even growing. Or something.
Fantastic work Reggie.
I couldn't agree more. Over at the RGE, I brought a lot of these points up with "London Banker" in a couple of blogging battles we had a few years back.
The financial war continues! As I say, it won't be bombs and bullets, but rather bits and bytes.
All the best,
Rich Hartmann - Miss America
JM 100 oz. bars Rock...!
I can see where the fall of the Euro has hurt the CEE non-Euro denominated debt, but if you ball parked the percentage impacted I missed it, sorry. I had read that there was an abundance of CHF denominated debt in some of those countries, but you weren't focusing on Switzerland. Thanks.
Good Article..... CNN will never show this stuff... Sad..
Question for the day....
What is better than 312 oz. of Silver Rounds...?
answer >>>>>>>>>>> 316 oz. of Silver Rounds.
Five new JM 100 oz bars. Easier to store too.
Well, those Ukraine girls really knock me out. They leave the west behind.
And Moscow girls make me sing and shout. That Georgia's always on my my my my my my my mind.
Latvia? Not even in the mix. Too cold.
Does it really sound like this country will be able to cut its fiscal deficit by 60%? They are having problems producing swap documents upon request, imagine the problems to be had in accomplishing the much harder task of not needing the engineered swaps in the first place:
WSJ.com
Greece Gives EU 'Partial' Response on Swaps
BRUSSELS—The European Commission Monday said it has received only a "partial" response from the Greek government about a series of currency deals it might have used to mask its debt.
The commission had given Greece a Feb. 19 deadline to disclose details of its currency deals. This request followed reports that Goldman Sachs Group Inc. had helped Greece conceal its debt levels through a series of complex derivatives deals.
Remember the compounded exposure of the Greek banks illustrated in the download linked in the post above???
Outstanding work!
Well thank you very much my good man. Wait until you see what I am coming up with next. I have mapped the risk and contingent liabilities of strategic sovereign states from Europe to Asia to Africa and the Middle East, as well as the good 'ole US of A. While some are speculating that the Euro may break up, I am speculating on revolution and the precursor to modern day war (not necessarily guns and bombs...).
The pain that will be required to meet the budget cuts required globally to bring things in line will not be voluntarily accepted by those who will be driven into a depression by such actions. They will rebel. If they do, said nations will be ostracized by the capital markets. If they don't, well very bad recession in the more optimistic case, and since we are already in (or allegedly leaving that condition, globally) chances not minute that a depression(s, as in several) may be in the offing.
I am not being pessimistic, but realistic. The original problems that cause the banking collapse were never rectified, they were just papered over with rule changes (to hide buy rhe problems deeper), liquidity injections (to keep afloat companies who looked like they were extras in "28 Days Later", and the occasional bailout which simply transferred the trash onto the public sector balance sheet where it was bound to do more damage and be more interconnected.
Reggie, got to add my thanks to the list of other posters – ZeroHedge for sure.
Don't know enough to comment on southern Europe but I will venture an opinion on the North.
The problematic member of the Nordic states is Sweden. Norway has oil, ocean trade, a reasonably modest lifestyle and a population of only ~4.4 million (think Louisiana or South Carolina. In other words, if Iceland didn’t do it, forget about default for Norway. Denmark has a favorable sea trade location, lots of small industry and a well educated populace of 5.5 million (Minnesota or Wisconsin).
Sweden (~9 million) might not be so comfortably situated. It may seem trivial but they are very aware of history Russia fought several wars with Sweden, which was the dominant influence in the Baltic Sea states area back in middle ages. Peter the Great wanted to acquire an all weather sea port for his country so he moved into what had been an area of Swedish influence and started building the city that would become St. Petersburg. It would be the Russian capitol until the Bolsheviks took over and moved it to Moscow breaking the connection with Tsarist linage. The last war (Sweden lost) was decided in 1705 and fully ended a few years later. After that Sweden has minimized foreign entanglements and avoided direct participation in war ever since. They are very technical and have a disciplined populace but they may be more committed to the Baltic Sea states across the pond than is publically acknowledged. WWII offered Stalin the opportunity to move in (even with Russian settlers) before he died and try to adsorb the region into Russia.
The Swedes are wary of Russia. After WWII and continuing at least into the late 70’s, they were operating battery powered submarines in the Baltic Sea from underwater access to submarine pens in the mountainous shoreline.
IMO, with some certainty, they want stability and economic prosperity in the Baltic Sea states and may have made commitments to help them along.
Fantastic work Reggie.
I couldn't agree more. Over at the RGE, I brought a lot of these points up with "London Banker" in a couple of blogging battles we had a few years back.
The financial war continues! As I say, it won't be bombs and bullets, but rather bits and bytes.
All the best,
Rich Hartmann - Miss America