Europe on the brink? (And Russia close behind?)

In September, when the financial crisis in the U.S. really started heating up, we were treated to good deal of unattractive crowing from our European and Russian friends. Nicolas Sarkozy, the President of France, announced that the time of “laissez-faire” capitalism, “not . . . constrained by any rules,” was over. Why, I wondered, had he not noticed that capitalism unconstrained by any rules had never been the order of the day and that for the last 150 years or so, capitalism, especially in Europe, had been hemmed in by thousands–actually, tens of thousands–of pages of rules and regulations? Dmitry Medvedev, the puppet president of Russia, told us that the age of U.S. economic dominance was at an end and that the world required a “more just” economic system. But that was before the price of oil had plunged from $145 to $65 a barrel over the course of a few weeks and the tsunami of credit woes that originated in the U.S. had made its way East to Europe and Asia.

How will this financial mess play out? No one knows for sure. Believing as I do in the resilience of capitalism and the resoluteness of the American worker, I suspect that things will sort themselves out in due course. (And how long is a “due”? That’s a good question that I cannot answer.) One thing that is becoming ever more clear, however, is that the economic situation in Europe and Asia is likely to be far worse for a longer period than in the United States. Writing in the London Telegraph today, Ambrose Evans-Pritchard observes that Western European banks hold about three-quarters of the $4.7 trillion in in cross-border bank loans to Eastern Europe, Latin America and emerging markets in Asia. This, Evans-Pritchard notes, is “a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.”

For the last few decades, the West has been pumping money into economic backwaters, taking care first to assure everyone that they were “emerging” markets. But what if it turns out that they only seemed to be emerging when propped up by easy capital, in the absence of which some or all of them reverted to being what they always had been, i.e., submerging markets? What then?

“Europe,” Evans-Pritchard observes, has already had its first foretaste of what this may mean. Iceland’s demise has left them nursing likely losses of $74bn (£47bn). The Germans have lost $22bn.” Demise? Iceland? Well, economically, it pretty much amounts to that: as a professor at the university of Iceland put it earlier this month, “Iceland is bankrupt. . . . . The IMF has to come and rescue us.”

But what happened in Iceland was only the beginning. The crash of so-called “emerging markets” is sending shock waves throughout Europe and parts of Asia. Evans-Pritchard sketches the dismal picture:

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.

Amazingly, Spanish banks alone have lent $316bn to Latin America, almost twice the lending by all US banks combined ($172bn) to what was once the US backyard. Hence the growing doubts about the health of Spain’s financial system – already under stress from its own property crash – as Argentina spirals towards another default, and Brazil’s currency, bonds and stocks all go into freefall.

Broadly speaking, the US and Japan sat out the emerging market credit boom. The lending spree has been a European play – often using dollar balance sheets, adding another ugly twist as global “deleveraging” causes the dollar to rocket. Nowhere has this been more extreme than in the ex-Soviet bloc.

The region 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. Nobody warned them what happens when the Japanese carry trade goes into brutal reverse, as it does when the cycle turns. . . .

Russia too is in the eye of the storm, despite its energy wealth – or because of it. The cost of insuring Russian sovereign debt through credit default swaps (CDS) surged to 1,200 basis points last week, higher than Iceland’s debt before Götterdammerung struck Reykjavik.

The markets no longer believe that the spending structure of the Russian state is viable as oil threatens to plunge below $60 a barrel. The foreign debt of the oligarchs ($530bn) has surpassed the country’s foreign reserves. Some $47bn has to be repaid over the next two months.

In a rational world, these developments would prompt our leaders to reconsider the utopian policies–underwritten, to be sure, by a healthy dose of the profit motive–to issue and guarantee such quantities of risky debt. It should lead to more responsible lending, i.e., lending that proceeds according to the checks and balances of a free market rather than one that is everywhere constrained by the socialistic imperatives of governments that grow ever larger and more controlling. In this world, however, I fear that what we will see are ever more meddlesome initiatives both in the United States and, especially, in Europe. Already we have witnessed tax-and-spend politicians seize upon the credit crisis to propose measures that would take the “private” out of “private property” and would deliver ever more aspects of the economy into the governments’ hands, aiding and abetting their increasingly ambitious efforts to “spread the wealth around.” I shudder to think what embracing such policies would portend for prosperity and freedom.

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