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Thursday, June 4, 2009

Eastern Europe: Latvia Causes First Cracks

FN: We have passed thru the eye of the hurricane and the calm is about to be shattered. The first tremors of instability in Eastern Europe have revealed a few cracks in the Western European banking system...

It all began when a bond auction in Latvia went "no bid". Basically it couldn't have been any worse. Latvia failed to sell about 50 million lati ($99.9 million U.S.) in Treasury bills at auction yesterday after receiving (really) no bids. Apparently there aren't enough lati to go around and this has driven the overnight lending rate (kind of like LIBOR) to a record 16.4%. This is bad. Very bad. Because it means the country can't fund itself.

The original Bloomberg article was entitled: Latvia Fails in Treasury Bill Auction, Gets No Bids (Update2)

This morning the same damn article was titled: Sweden Can Handle Possible Bank Collapse in Baltics (Update1): "Sweden’s government can handle a possible bank collapse, or nationalization, sparked by the economic collapse in the Baltic states, Finance Minister Anders Borg said.

For Sweden, this means that there is a significant risk of loan losses at the banks,” Borg told Swedish television broadcaster SVT in an interview last night, following a failed Latvian Treasury bill auction for 50 million lati ($100 million). Still, Sweden can weather the fallout of loan losses in the Baltics, he added.

The Baltic state’s failure to sell debt on market terms sparked concern amongst some investors that Latvia may be heading toward a default that would precipitate a devaluation of the lats as the government waits for the next tranche of an international bailout. The central bank today released a statement reiterating plans to maintain the lats peg until the country adopts the euro.

The failed Treasury bill auction sparked a 16 percent decline in shares of Stockholm-based Swedbank AB, the biggest bank in the Baltic states. SEB AB, the second biggest lender in the region, dropped 11 percent, while Nordea AB decreased 5.2 percent. Those declines contributed to a 3.1 percent slump in Sweden’s benchmark index."

FN: The first title and article was of course far more accurate. It was not at all clear in the first version that Sweden could handle a devaluation or default by Latvia.

The failed bond auction rippled out from Latvia hitting Sweden and Hungary... but it won't stop there. Austria's and Switzerland's banks are all heavily exposed to the region.

Sweden's Krona Trades Near Six-Week Low on Latvia Loan Concern: "The Swedish krona traded near the lowest level in six weeks against the euro on concern Latvia will devalue its currency, hurting loans in the Baltic country held by Swedish banks.

Sweden’s Riksbank this week noted a deterioration in the Baltic nations as one of the biggest risks to its banks. The krona fell 4.3 percent against the euro since June 1, when the Baltic News Service cited Latvian Justice Minister Mareks Seglins as saying the government should debate abandoning the system that keeps the lats pegged to the 16-nation currency."

Forint Falls Most in Three Months on Latvia Devaluation Concern: "The Hungarian forint fell the most in almost three months, leading declines in eastern Europe, as concern that Latvia may devalue its currency spurred investors to sell assets in the region."

Latvia Traders See 53% Devaluation, Forwards Show (Update1): "Latvia currency traders expect the lats to drop to half its value against the euro within a year as the Baltic nation struggles to cope with the effects of the global financial crisis, said Bank of America Corp.-Merrill Lynch & Co.

Forward contracts price the lats 53 percent weaker than its current spot rate of 0.7073, Benoit Anne, the London-based chief strategist for Emerging Europe, Middle East and Africa, said in a phone interview today. Forward contracts are agreements in which assets are bought and sold at current prices for future delivery."

FN: A devaluation is certain. The question is when and by how much. A 53% devaluation basically means any Latvians that have loans outstanding in other currencies will now have to pay 100% more to retire that same loan. Obviously this isn't likely to work at all and that these loans will just be defaulted instead. The problem is that the whole country is likely to default, because the government borrowed in foreign currencies...

Latvia, Lithuania, SEB CDS rise sharply-CMA: "The cost of protecting the debt of Baltic states Latvia and Lithuania and of Swedish bank SEB , seen as heavily exposed in the Baltic region, rose sharply on Thursday, CDS monitor CMA DataVision said.

Speculation about a possible devaluation in Latvia has hit regional markets in recent days, although the Latvian lat rose on Thursday on hopes the International Monetary Fund might agree to release another tranche of a previously-agreed loan.

Latvia's five-year credit default swap rose to 721.1 basis points mid-price from a close on Wednesday of 675 and a close a week ago of 602.1, CMA said.

Lithuania rose to 481.9 mid-price from 450, and SEB rose to 199.4 mid-price from 148.1.

Five-year CDS for Swedish bank Svenska Handelsbanken also rose, to 106.7 from 95 bps."

Related Posts:
Latvia: Another Government Falls
Global Protests, Riots, Violence as Economies Unravel
Hyperinflation First, Then Global War
Global Violence, Gold: But Not Yet


khalid said...

I imagine that even after the extra burden the US as a whole has taken on recently, the Scandi bloc is still doing worse than the US in terms of national external debt per capita.

khalid said...

And what is it with Bloomberg article titles being changed.
Sydney opening time Monday, they had an article with a heading very bullish US Treasuries.
Something about how China has no other place to invest, no other really viable choices. "Article soon to follow"...

Can you do a post on the real foreign demand for US Treasuries auctioned off last week?

I heard it was pretty good, best since sometime in 2006.

fajensen said...

Something about how China has no other place to invest, no other really viable choices.

Not So: China could invest in itself - there are roads to build and power grids to upgrade e.t.c., China could use it's USD stash to buy itself land and influence in the world, China could buy up raw materials and store them (or buy mining rights).

In fact lots of people would rather bond with China than "the West" because China just pays for the goods and services while "the West" also moralises and demand "democracy" & "human rights" be adopted.

China has to do this soon before the value of it's USD holdings tank!

Tord Steiro said...


You may find it interesting to note that Norway, currently the largest Scandinavian economy, have around 200% of GDP in net government savings. The Scandi-bloc, as a bloc, is definately not heavily indebted.

Yes, some Swedish banks will fail. They have lent too much money to Eastern Europe on too loose terms.

It will probably also be a bit worse then it was in the eraly 90's. Generaly, however, I think Scandinavia will do quite a bit better than many other regions throgh this crisis. the US included.


I totally agree. The problem is just that when the Chinese first start getting out on some scale, the dollar will tank before they manage to sell all they got.

And that dollar collapse is going to hurt the Chinese quite bad. Their dollar trap is far more entangled and dangerous than France's similar Sterling trap after the first world war. No easy solution, I'm afraid.

khalid said...

Thanks for the comments.
I was thinking in terms of Gross Eternal Debt.
See here
Where are you getting the "net government savings" figure from?
Frankly I was surprised by the debt figures from the CNBC link.
Really, the more I search in depth for real economically significant figures, the more I realize the depth and resilience of the USA compared to Eurozone and others.

khalid said...

China is in a dollar trap, definitely. (Thanks for noting the France Sterling trap, by the way, Tord.)

Of course China can successfully invest in itself to extricate itself from the American behemoth but how long will that take?
China has immediate problems that can have a far more expensive toll on its society than that of anything that can happen in the West.
They will require a yuan at stable current levels to go ahead with their decoupling plan and develop domestic consumption. That requires more time (decades) than this global crisis can offer.

I say this as a long-term Chinese bull, but China has a long way to go, we're talking multidecades, for it to even challenge the West meaningfully. I am thinking of the simple things that I take for granted in Europe and America.
India and China require two or three generations of mentality shift...
I guess what I'm saying is that I agree with Steven Roach Morgan Stanley analyst, who has personal experience of China, that there is much much work to do there before they can dictate terms globally.

fajensen, you want to open a business, do business, there is still nowhere better to do it than in places like UK, USA, and a few other places that have high economic freedom scores...

I think the Dollar / Treasuries dilemma is overblown in media and blogs. The people running the US and China might make some dumb calls and decisions but they are still not that stupid enough to not realize what everyone is talking about.

But arrangements have been made at higher levels to maintain status quo.

Sorry for the ramble...

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Tord Steiro said...

@ Khalid

There are two reasons why gross external debt is a bad measure:

1. smaller economies have smaller credit markets, and hence tend to both borrow and lend far more, as a share of GDP, in international markets than do larger economies. The same goes for exports and imports - small countries trade more as a share of GDP simply because they are small. So, comparing economies of different size, you have to look at net figures.

2. Liabilities not noted as debt, such as future pensions, may disrupt this picture severely. When the US government now nails out GM, it also takes over massive 'debt', in the form of future pansion payments. How these type of debt os covered is important in this respect, and it does not show in the external debt figures (or any other debt figure) simply because the decision is not yet taken.

The it becomes pretty relevant to note that all Scandinavian countries have some form of government pension fund, with Norway having by far the largest. The Norwegian pension fund, which is invested abroad, currently hold a value of some 200% of Norwegian GDP. And that is the pension fudn alone, all other Norwegian investments abroad are not mentioned in that figure, but they are vast, compared to GDP.

The same can be said for Sweden, although much of their foreign assets will be destroyed during the crisis in Easter Europe. In Finland, one single company, NOKIA, have huge investments abroad, and possess huge foreign assets, compared to Finalnd's GDP.

Of course the US also have huge investments abroad, but the economy is also huge, so the ratio is far less impressive than for many smaller economies (my apoligies for not having the numbers readily available though).

Hence, I think it is more interesting to look at the relation between net external debt and total exports. Since it is exports, after all, that is going to pay for this debt, and at some point, forex earned on exports will have to be spent on repaying debt rather than imports.

fajensen said...

@khalid: fajensen, you want to open a business, do business, there is still nowhere better to do it than in places like UK, USA, and a few other places that have high economic freedom scores..

I disagree. I think that the "business ecosystem" in the USA and the UK have simply no carrying capacity left!

There are too many parasites to pay for: lawyer-politicians making bad laws for lawyers to fight over in court, litigatious clients, violent crime, totally obscene taxes (when one sums all the nickel & diming up), rampant intrusive bureaucracy everywhere, cronies running / being supported by the government so you cannot compete against them e.t.c.

Better go to younger economies where the parasite-load is not so heavy (yet): Malta, Slovakia - even Denmark and Sweden are easier to set up shop in than the USA!

In Denmark - as long as you do not actually employ anyone - all you have to do to start a business is register for VAT.

The business tax is 25% flat rate on profits - or ZERO if you register as a holding company with the profit-center(s) outside the DK (but this is more paperwork).