Monday, October 6, 2008

Fear and Loathing (far from Las Vegas)

Another Monday, another meltdown. Today it's Europe's turn to pour a little gas on the financial fear factor fire. While it might have been the European Day of Languages a couple of Fridays ago, the latest round of panic is threatening to turn the cracks in the EU into irreparable chasms as the different central banks scramble to find their own response to the credit squeeze. While the US markets were able the breathe a sigh of relief as the bailout package was rammed through Congress, the different heads of the European financial hydra don't seem to be able to be speaking the same language. Even Super Sarkhozy seems to have failed to bring the team together as the weekend summit of the leaders of Germany, Britain, Italy, Luxembourg, the European Central Bank and the European Commission at the Elysee Palace in Paris didn't produce any tangible results.

The EU has been on a roll for most of the past decade. Now 27 member states strong, they've enjoyed a decade of growth, prosperity and cooperation for the most part. The 15 nation Eurozone had introduced greater stability into the heart of the European economy, ending the frenzy of competitive devaluations that marked previous financial panics. Sure the Euro was too strong and interest rates a bit high, but while Europe’s patchwork system of regulators and financial authorities may not have worked elegantly in theory, it had been shown to work effectively in practice. Then Dutch-Belgian bank and insurance giant Fortis NV faltered, followed in rapid succession by Bradford & Bingley, and Dexia being forced into accepting government bail-outs. Faced with their first test, the European Central Bank can't seem to find a coherent response. Ireland kicked off the me-first procession last Tuesday by announcing the government would guarantee €400bn ($563bn) of deposits and bank debt of its six national banks. Greece quickly followed suit while France seemed to be pushing for an American style bailout response (300 billion euros), but other states, particularly Germany, opposed it and shot it down. Then, the latest blow to the unity of the system came from Germany itself as they astonished its fellow European nations,and angered the UK Treasury, Sunday night by unexpectedly announcing that it will guarantee all retail savings deposits. Sweden, Austria and Denmark all offered to guarantee deposits today (Monday).

All of this has created a capital flight fear in the other European nations as depositors look for the safest haven for their investments. Today's victim may be more than just a bank, as it seems Iceland's financial structure is melting (sorry for that ice/melt thing). The currency, the krona, has dropped 20 per cent against the euro in the past month (plus a further 23% today), the government has bought a 75% stake in the country's 3rd largest bank, Glitnir, but no plan to deal with the crisis has yet to emerge, besides stopping trading on the country's banks today. With a population of only 320,000 it may not seem like a big deal, but Iceland's problems could foreshadow similar problems across Europe. A significant proportion of Icelanders, plus many of the other smaller European economies, such as my current home of Poland, have in the past decade turned to loans for cars and homes denominated in baskets of lower interest rate currencies such as the Japanese yen and Swiss franc. With the krona’s decline, consumers are left stretched, leading to more defaults, leading to more banking problems. Ironically, what gave the European economy its strength over the last decade, the integration of the economies, could be what leads to further banking collapses across the continent. With this fear in mind, the Spanish prime minister announced plans on Monday to hold an emergency meeting with the heads of the country’s banks. Everyone is pointing fingers at the nations who have moved to guarantee deposits, privately criticising the moves as it will force each country to follow suit. “It will be like dominos,” said one Spanish official. “Now everyone will have to do it.

Could the financial crisis tear the EU apart? We'll have to wait and see, but they definitely seem to be pissing each other off. Fear causes people and therefore nations to do things they normally wouldn't do. "We learned from the worldwide economic crisis of the 1920s that an economic crisis can result in an incredible threat for all of society," Germany's interior minister Wolfgang Schaeuble told the magazine Der Spiegel. "The consequences of that depression was Adolf Hitler and, indirectly, World War II and Auschwitz." The smell of fear is definitely in the air.