Belmont Club

The Iron Curtain

As Western European banks tremble at the thought of their exposure to Eastern Europe, warnings of a “new Iron Curtain”, a new economic division between East and West, were made by the EU leaders. The pleas highlighted the global nature of the economic crisis as more and more classes of toxic assets shouldered their way forward into view.

The deepening recession has forced some western nations to bail out their ailing banks and industries, the auto sector in particular, leading to the protectionism uproar among their eastern partners.

“We should not allow a new iron curtain to be set up and divide Europe in two parts,” stressed Hungarian Prime Minister Ferenc Gyurcsany, whose country is among the worst hit.

Czech Prime Minister Mirek Topolanek, in a pre-summit message, urged his fellow EU leaders not to divide Europe again through “beggar thy neighbour” protectionist policies as recession bites.

But the message was aimed not only at the capitals of Western Europe but across the Atlantic. EU leaders warned Barack Obama not to revive protectionism.

Britain and Europe were today embroiled in the first big row with Barack Obama – and it was over free trade. The US president’s plan for a “Buy American” rule in his £825billion economic stimulus package was condemned as a dangerous retreat into protectionism. The clause decrees that only American-made iron, steel and goods can be bought for projects funded by the recovery package.

A European Commission spokesman dubbed it the “worst possible signal” that the new presidency could give to the world. Downing Street was less outspoken but the Prime Minister’s spokesman said: “Obviously we would not support protectionist measures.” Gordon Brown has made a series of speeches in recent days warning urgently that a failure to uphold free trade risks turning the world recession into a deep slump.London Mayor Boris Johnson joined in the row, saying that Mr Obama was making a major mistake under pressure.

The dramatic expansion of the international financial services industry over the past several decades made possible the invention of various credit instruments. Whole nations and population groups were given the equivalent of their own Visa and Mastercards, so to speak, whose worthiness was based on the assumption that a constant and rising future cash flow would service the repayments. Those national “credit cards” were spent on a variety of baubles: housing bubbles in the US and the UK; building booms in Spain; projects in Eastern Europe; grandiose welfare, public health and environmental projects and overexpansion in many export-led economies. Given some time we were going to buy carbon credits — and would have, if events had not intervened. May still, if BHO has his way. And on installment, too. Nobody worried because it was all for the children; and to save the planet. Few bothered to think that it was the children who were really going to pay for it. Now those “credit cards” are maxed and their holders are jobless. Worse, their holders are now discovering that some of the card repayments are really charges to other people’s cards. The world was banking on the future paychecks to keep the jukebox playing. Now we’ve run out of coins and a silence has fallen across the hall, not so much like an Iron Curtain as like a shroud. The WSJ surveys the wreckage:

The old Soviet bloc shot up this decade. But then the credit crunch hit and capital fled, and it has spiraled down fast.

Three countries have already gone hat in hand to the International Monetary Fund, and more may be on the way. The lesson isn’t about market failure or the downside of open borders for capital. It’s about the importance of sound economic policy. From far away, the region east of the Oder River blends into a single space of collapsing living standards. But there is more than one Eastern Europe.

The Baltics and Balkans succumbed to the same bubblenomics as house-happy Central California or Iceland. Double-digit growth in Latvia, Lithuania and Estonia was fueled by debt and short-term capital inflows. Now these gains are being reclaimed, with GDP slated to fall by double digits in the Baltic states this year. The scene of the crash looks familiar. Residential mortgage debt as a share of GDP in Latvia and Estonia climbed, respectively, to 33.7% and 36.3% — worryingly high because a lot is denominated in foreign currency, though still not as high as Iceland’s 121%.

The government in Latvia, a regional banking hub, fell last week after the IMF imposed austerity measures. Standard & Poor’s downgraded its debt to junk; Romania is the other noninvestment grade member of the European Union. In Russia, Vladimir Putin spooked investors with his assault on property rights, and the collapse in oil prices did the rest last year. The Moscow stock market fell further than any other in the world, straining companies that borrowed heavily overseas. For now, Russia has deep enough reserves to avoid a repeat of its 1998 default-devaluation.

Ukraine isn’t as fortunate. It suffered when prices for its chief export (steel) fell while its chief energy input (natural gas) rose. Though a vibrant democracy, Ukraine isn’t blessed with a mature political class able to put its economy on stable footing. The IMF has stepped in there, as it has in Hungary.

Elsewhere more virtuous behavior has partially shielded countries with stronger fundamentals. The Czech Republic and Poland avoided the worst of easy-money mania and attracted capital for direct investment, often in export industries, that can’t flee at the first hint of trouble. Their economies have made the transition from communism to a market economy built on the rule of law.

The expanded global institutions have made it possible for a variety of political actors to behave like financial deadbeats. All over the world, people are looking at all the happy stuff the politicians gave us for “free” — half finished buildings, four bedroom suburban homes with empty pools, luxury sedans with gold interior trim and nodding dogs, roomsful of junk and past due credit bills. And our reaction to this mess, our way out? Why, to give Washington a  $3.5 trillion line of deficit to consolidate our debts so we can all party again, just as in those commercials which promise freedom from worry to those who have gotten in over their heads in debt. As a concession to hard times, we’ve resolved to buy local. Yeah, that’ll work. But don’t worry, the deadbeats have a plan. They’re going to get all of those who have exhibited virtuous behavior to bail out the guys with the velvet sofas and drawers full of combination potato peelers and pencil sharpeners.

Maybe the first thing we should do is confiscate the credit cards from those very same deadbeat political actors and keep them from talking big. They’ve talked big for too long. And the next thing we should do is keep them from panhandling off those who haven’t maxed their credit cards and are still employed. But that would be too simple.