Northern Country

How globalization changes capitalism, the economy and politics

This crisis is far from over

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This weekend finance minister of the G-8 nations gather in the south of Italy hopefully not only to take a sunbath. While leading economists are still warning of high uncertainty regarding growth and systemic risk for financial contagion still lingers the G-8 finance ministers are already discussing a possible exit from fiscal and monetary stimulus programs.

This seems premature. The subprime fiasco seems largely over but other problems prop up in particular in Eastern Europe. This region of the former communistic Soviet Union is a going concern. While some of the worst fears are probably exaggerated systemic risk and possible contagion for some Central European banks still lingers.  Banks in Austria, Germany and Sweden have 1.6 trillion US dollar loan exposure in the region.

Of particular interest is the Baltic mini-state of Latvia. GDP of Latvia was 36 billion US dollar in 2008 but problems might spread to neighboring countries yet and get out of control. Just recently foreign exchange markets got upset by failure of Latvia’s bond auction.

Sweden is Latvia’s biggest creditor and its banks have heavy exposure to the Baltic state. Recently Sweden’s Riksbank borrowed 3 billion euros from the ECB. That shows how serious the situation is. The bank is drawing down on a 10 billion euro swap agreement.

Latvia is now in negotiations with the IMF to secure another round of funding, but first it has to implement spending cuts and restrictive fiscal measures, which could further dampen the outlook for growth and lead to even higher unemployment.

But Latvia is not the only problem. About a third of fund managers polled expect more Eastern European countries to default and about 11 percent expect a full-blown systemic meltdown. This has prompted the ECB to issue a warning for 2010 rather than 2009 if the recession lingers.

According to the European Commission 27 EU states have so far pumped 3.7 trillion Euro into rescuing the banks, that’s almost a third of European GDP. Out of that pool 311 billion have been in the form of direct capital injections, that is more than US banks received.

In the meantime the German government has agreed to implement a ‘bad-bank-model’ where large regional banks, like the German Landesbanken, will be able to transfer their bad investments worth about 600 billion euros until 2010. A similar drastic measure might be necessary for Austrian banks too. It seems to be a weird coincidence that this dumping institution for bad assets has been named after a beautiful Italian opera, AIDA.

Complicating the situation is a moldering conflict within the IMF, where funding in the US seems to be called into question. A proposal to send $108 billion is attached in a supplemental appropriations bill to fund the wars in Irak and Afghanistan. While funding for the wars is most likely to be approved the IMF has come under criticism, mainly because of lack of economic stimulus measures among European states.

Republicans and Democrats in the House of Representatives oppose the fund because they fear that the money will mainly be used to bail out Central European banks. If the administration will fail to garner sufficient votes they can pull the funding bill out and support a war-only funding bill. That’s a smoking gun for Eastern Europe and Central Europe alike.

will it cause a snowball effect?

latvia_exchange_rate_1000_usd

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Written by Alfred

12. June 2009 at 11:13 am

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