Pole Position

“Europe’s Crisis…worse than the US,” writes Henry Blodget.   You’ve got to hand it to us cunning Americans.  We have started a fight in a crowded bar; now, we slip out the back door.

For the last 20 months, the brawl has been going on.  In the United States, stock prices have been knocked down to half what they used to be…but just look at the other guys!   Iceland – that hedge fund in the North Atlantic – has broken almost every bone in its frigid body.  China faces an unemployment line 100 million people long.  The United Kingdom has more debt than the United States…and it depends far more on the financial industry.

The question on the table today is this: who will get the biggest blackeye in this slugfest?

The naked facts:  Eastern Europe borrowed about $1.7 trillion, mostly from Western European banks.  It’s scheduled to make $400 billion in payments this year alone.  Rolling over debt was a cinch two years ago; now it is like rolling over a beached whale.  Sixty percent of Polish mortgages are in Swiss francs.  The Poles borrowed in euros and Swiss francs to take advantage of lower rates.   Now, they earn zlotys, pay back Swiss francs, and weep.

“Along came the synchronized global recession and large Polish current-account trade deficits, which were three times those of the US in terms of GDP,” explains John Mauldin.  “The Polish zloty has basically dropped in half compared to the Swiss franc. That means if you are a mortgage holder, your house payment just doubled. That same story is repeated all over the Baltics and Eastern Europe.”

Bankers are just lemmings disguised as human beings; everybody knows that.  Austrian bankers search out the high cliffs.  The collapse of CreditAnstalt in May of 1931 took the banking sector over the edge, leading to the Great Depression.  This time, Austrian banks have lent the equivalent of 70% of their nation’s GDP to Eastern Europe.  If as little as 10% of it goes bad, the whole Austrian financial system will be broke…and could bring down all of Europe with it.   In the ’31, the economies of France, Britain and the US were contracting at the rate of about 6% per year.  In the last quarter of ’08, the US economy shrank at nearly 7% — and CreditAnstalt hasn’t even happened yet.

But at the stroke of a pen, the Americans can nationalize their banks and save their financial system.  In Europe, it can’t be done.  Big banks, little countries, says Mauldin.  Proportionately, such a bailout would cost $14 trillion in the United States, he estimates.  So when nine Eastern European countries got together and asked for help, Angela Merkel gave the same response that Gerald Ford gave New York City when it asked for a bailout in 1975: Drop dead.

Pity the poor Pole.  He dragged around the bolsheviks’ chains for nearly half a century.  Then, when he finally broke free, the capitalists bamboozled him.  Does he deserve it?  Nope, he just has the bad luck to owe money in a currency he cannot fiddle.

“The crisis strengthens the relative position of the United States,” writes Spengler in the Asia Times, “and exposes the far graver weaknesses of all prospective competitors. It makes the debt of the American government the world’s most desirable asset. America may deserve to decline, but as Clint Eastwood said in another context, “deserves got nothing to do with it”.

The punks must feel lucky, as Eastwood would say.  In the bubble years…the rest of the world mocked them as fat spendthrifts, while offering them more dessert – on credit.    The more Americans spent…the more dollars piled up overseas…the more dollars foreigners lent back to the United States…so the more dollars Americans had to spend! Now that Americans don’t spend, the foreigners’ factories go silent, their banks wobble…and their stocks fall.  Now they buy U.S. Treasury bonds at even lower yields!  This past two weeks, the dollar index rose to a 3-year high – and the 10-year T-Note traded below 3% yield — even as Obama announced a $1.7 trillion deficit.

Of all the cashflows in the world, says Spengler, lending to the world’s longest-lasting government, presiding over its largest economy, has got to be the most reliable.  He reminds us that lending to the United States in the ’80s was a good investment.  Then, the U.S. government cut the top marginal tax rate from 70% to 40% and generated enough growth to pay the interest and boost asset values.

But now, asset values are clearly going down while the top marginal rate is going up.  Lending in the ’80s was lending at high yields at the beginning of a major expansion to the strongest balance sheet on the planet.  Now the situation is reversed; lenders earn the lowest yields in history…from the world’s biggest debtor…at the beginning of a depression.

This bubble in U.S. public debt will end as badly as the last one in private debt.  But for now, the worse things get, the better they are for the people who made them bad.    Not only can the Americans save their banking system…they can save their leveraged households and wipe out their debts too.   The United States financed its spending fest with others’ money.  Now, it finances its trip to rehab the same way – with other peoples’ money.

Lenders can absolutely, positively be confident they will get their money back – with interest, on the appointed day.  But it is money whose value the debtor determines for himself.

If only the Poles could do the same!

The Daily Reckoning