Europe may turn its back to the East as depression approaches

Since January, deflation in the economies of East and Central Europe, including the Baltic Republics and the Balkans, has started to to pick up steam as banks crash, stock markets collapse and local currencies plunge.
In many ways, what's happening now across Eastern Europe - including Russia - is reminiscent of the Asian economic depression that began in Thailand in July 1997.

Punch-drunk from easy credit in the 2002-2007 period, regional economies aggressively borrowed from abroad, mainly from Austria and other EU members that included leveraged mortgage loans tied to low interest rate currencies like the Swiss franc. That strategy has violently backfired since last summer as investors fled risky assets en masse.

In some East European countries, Swiss franc-denominated mortgages comprised more than 50% of all outstanding mortgage loans. Combined with plunging local currencies, the cost to service those loans has surged, causing foreclosures and defaults to skyrocket.

Auf Wiedersehen Bull Market

After a multi-year bull market against most major currencies since 2002, the euro is now hemorrhaging since last July as Europe's economic miracle comes undone at lightning speed.

The euro's decline pales compared to the outright plunge of numerous currencies in emerging Europe, especially since mid-January.

Eastern Europe's largest economies - core manufacturing hubs for many Western European companies - have seen their currencies crash almost 20% versus the euro already this year, thanks to growing funding concerns amid a rapid acceleration of deflation across local economies. In December, Hungary received assistance from the International Monetary Fund (IMF). Now governments in the region, including the Austrians, are pressuring the European Union (EU), and specifically Germany, to open its vast purse strings to preserve the euro and save Eastern Europe.

Against the sagging euro, many of the regions' once fast-growing economies in East and Central Europe are now in the midst of significant economic contraction and sharply declining currencies. Credit spreads have surged, credit default swaps are widening and rapidly dwindling foreign-exchange reserves in the region threaten market capitalism, which until recently served as a model for emerging economies in the post-1991 Communist era.

Austrians Plea for Euro-zone Bailout

A fresh full-scale banking crisis affecting Western European institutions is now accelerating this month, with Austrian banks on the hook for ?278 billion ($354 billion) to Eastern Europe - the largest exposure among euro-zone members. Western banks are saddled with $1.6 trillion dollars' worth of Eastern European loans, mostly tied to banks in Austria, Germany, Italy, France, Belgium and Sweden, according to the Bank of International Settlements.
Austrian bank losses are enormous and the cry for help couldn't be louder.

Austria has been the most aggressive investor in Eastern Europe over the last decade. Local banks rank as the largest investors in the Czech Republic, Hungary and Romania (US$142 billion dollars) with several Austrian banks now attempting to secure government guarantees - including Raiffeisen Zentralbank, one of the largest lenders in the region along with Erste Bank.

Emerging European Collapse

Whereas the Austrians - harboring strong historical trading ties to the region - were heavily exposed to Eastern European banks, Swedish banks lent heavily to the Baltic Republics.

Lithuania, Latvia and Estonia are also fiercely contracting since October, with banks struggling to maintain solvency. Other countries in the region - including Ukraine - are barely solvent and require additional IMF funding while Kazakhstan's largest bank saw a run on its deposits earlier this week. The list goes on and on, with several other markets in trouble as funding gaps widen in an environment of tight credit and shrinking bank capital.