Economic Cacophony in Hungary?

At least according to Tibor Erdős that's what's going on right now in Hungary. One doesn't hear as much from Tibor Erdős as, let's say, from Lajos Bokros or László Békesi. Most likely one reason is his age. He was born in 1928. But the few times he speaks or writes it is worth listening to him.

Uncharacteristically, he wrote two articles that appeared in quick succession in Népszava. The first on February 19 with the telling title "Cacophony" (Hangzavar) and the second on February 26 ("Four serious problems"). In both Erdős tries to shed light on the complexity of Hungary's economic situation. Without pointing fingers he makes it clear that the reform economists don't realize that some of their remedies would actually deepen the economic crisis. Such as major cuts in spending. He also discards major tax cuts because the resultant growth in demand would only add to the country's dependence on imports.

So what should the government do? They should stimulate segments of the economy that would provide jobs and would not rely on exports. For example, investments in infrastructure. Moreover, such investment would be useful in later years once the country's economy rebounds. Investments in small and middle-sized Hungarian companies that target the domestic market would also make sense. Such investments are well suited for projects financed by the European Union. Let me add that it seems that this is exactly what Gordon Bajnai, minister in charge of economics and transport, is trying to do.

As for cutting back on spending, Erdős is cautious. He recommends restructuring expenses rather than decreasing the size of the total package. For example, he, like many others, suggests reducing the number of institutions of higher learning. I don't think he would go as far as Lajos Bokros, who would shutter over 60% of these institutions, leaving only 25 of the current 70+ institutions standing. But he would close those institutions that are not worthy of support. It might even help standards, which are fairly low at the moment. Practically anyone who finishes high school can enter some kind of college.

As for reforms. Yes, Erdős says, reforms are necessary but "reform economists and politicians, attention! Be cautious when it comes to reforms in the middle of an economic crisis. Introduce them after the crisis is over." Basically, if I read Erdős right, he endorses the government's program and warns politicians not to get too enamored with the radical suggestions of the reform economists. And this piece was written before the Reform Alliance gurus came out with their plans. Of course, it is possible that Erdős already knew what was brewing. After all, he is an academician, and in Budapest everybody knows everybody, especially within the same discipline.

Although Erdős's ideas are close to the government's proposals (and I wouldn't be surprised if he were one of the advisors the government consulted with) in one aspect he goes against the common wisdom. He suggests that the budget deficit requirement be loosened. A slightly higher deficit would help the country's recovery. That is most likely true, but what about the highly desirable Eurozone membership? Everybody thinks that Hungary should join as quickly as possible, and the government seems to be making some efforts to shorten the waiting period for countries that achieve the requisite inflation rate and budget deficit. The waiting period at the moment is two years. From what Hungarian politicians drop here and there one has the distinct feeling that for the moment at least the introduction of the euro is uppermost on the Hungarian government's mind. They are especially anxious about joining as soon as possible because the weakening forint is a real threat given the high percentage of outstanding loans payable in foreign currencies.

Well, Erdős's warnings didn't make an impression on certain Hungarian politicians. The cuts recommended by the economists of the Reform Alliance are embraced by SZDSZ and MDF. Both parties adopted the plan as their own, and parliament will vote on the question of whether the plan should be an agenda item, subject to the vote of the full parliament. I would wager to say that it will be dead on arrival. MSZP won't vote for it, and Fidesz is adamantly against any cuts in benefits and entitlements. Yet in order for the government's bill to go through they need some votes from either MDF or SZDSZ. So I'm almost sure that certain parts of the reform proposals will be incorporated into the final package to appease the enthusiasts of the Reform Alliance. I do hope that, in the give and take, they won't forget Tibor Erdős's warnings.

Comments

[Mark]

"As for reforms. Yes, Erdős says, reforms are necessary but "reform economists and politicians, attention! Be cautious when it comes to reforms in the middle of an economic crisis. Introduce them after the crisis is over ...... He suggests that the budget deficit requirement be loosened."

At last - some sanity from someone. I do think the government should listen to these warnings - it is fairly clear that early Eurozone membership as a solution to currency instability is an illusion (and membership of ERM II as open and clear an invitation to the currency markets to attack the Forint as one could imagine, unless the rate was much lower than now). And at least - unlike the Reform Alliance's suggestions, or the government's more confused stance - this approach has some chance of success.

[Sandor]

While at least some people decide what to make of all this uncertainty, I propose the only certainty: cacophany is misspelled, cacophony is the correct form.
In Hungary it seems, there is hardly any recognition of the two schools of economic thought usually associated with influencing the macro economy: Keynsianism, and monetarism. (The latter being inovated by the late Milton Friedman, also one of those ingenious Hungarians who made good in Amerika.)
The helter-skelter proposals flooding in from all directions are not showing any sign of being systematic. They are a hodge-podge of random caprices. To make matters worse, applying just some of them, for political expediency is just plain stupid.
Obama is clearly dedicated to the Keynsian school and does what is suggested by it.
The monetarist method I don't see applied anywhere, perhaps because it doesn't have as many examples to rely on as does the other.
However, none of the proposed solutions in Hungary shows any disciplined design, therefore my feeling so far is that the results will be just as chaotic as the proposals were.

[NWO]

Erdos' ideas would make sense if Hungary were not 100% at the mercy of the international capital markets for financing, the household sector was not burdened with Fx loans that become more crippiling each day the HUF sinks, and the banking sector was not insolvent and could be aneffective conduit to put more capital into the economy to help raise economic activity. None of these are the case. Infrastrucutre spending would normally make sense, but the record of effective investment in infrastrucutre in Hungary is dubious, and the multiplier effect from such investment is much less than it should be.
In the end, Erdos assumes Hungary is similarly situated as the U.S. and Germany and can with relative ease go out and finance larger beudget deficits on the cheap. Nothing could be further from the truth.
This is the particulalr crisis that Hungary facs today. The Country's wasteful spending and bad economic choices over the past decade make it impossible for it to run a counter-cyclical policy today. Even countries far more responsible than Hungary like Poland have been punished wildly for promoting pro-growth policies. Hungary is screwed. It must suffer through a massive downturn and restrucutring today for its sins of the past.

[Eva S. Balogh]

Sandor: "I propose the only certainty: cacophany is misspelled, cacophony is the correct form."

You're right. It doesn't happen to me too often but it did this time.

[Odin's lost eye]

Professor you say *** “He also discards major tax cuts because the resultant growth in demand would only add to the country's dependence on exports.” *** Do you mean imports? In the present situation exports would support the forint whilst imports –goods brought into the country- tend to put pressure on the value of the currency or am I missing something here.
Mr Erdős's warnings about reform are timely. Reforms tend to make people both at home and abroad uncertain about their effect. The ‘jitters’ is the last thing you in a crisis of the type the world is going through at present. There is a general ‘damping down’ of all forms of manufacturing activity, partly because of the lack of liquidity in the banking system which supported the interim financing of companies between obtaining orders and receiving payment for the goods shipped, and partly due to the reluctance (or inability) of people to buy items.
Mark you say that *** “it is fairly clear that early Eurozone membership as a solution to currency instability is an illusion (and membership of ERM II as open and clear an invitation to the currency markets to attack the Forint as one could imagine” ***. Entering the ERM II with a weakened currency or an unskilled national bank is an open invitation for currency speculators to ‘make hay’.
NOW.*** “Hungary is screwed. It must suffer through a massive downturn and restructuring today for its sins of the past” ***. Yes it must. For this ALL parties (even Fidesz) must take the blame. Their failure to keep the national house in order and borrow profligately to enhance their popularity is not just a Hungarian problem, but it is those who voted them in to power must pay. What the answer is I do not know, but I would suggest that some part of it lies in the world of micro-economics, the world of little businesses, small manufacturers many of whom were being used by the larger businesses they supplied a additional or alternative bankers. I know of little farmers around here who have not been paid for their products for two to three years!. Their problem is they have no alternative markets.

[Eva S. Balogh]

Odin: " Do you mean imports?"

Thank you. Yes. Temporary insanity. I will correct it immediately.

[Mark]

NWO: "Hungary is screwed"

You may be right. But what Hungary will go through if you are is much more than a savage downturn. The idea that the market and political democracy offer the route to economic salvation will surely be discredited, and this will end not in everyone accepting reform, but in the creation of a kind of economic state socialism presided over by a regime most likely of the far right rather than the far left (the parallels with the 1930s are not encouraging). Anyone who can leave for better jobs elsewhere will have left leaving an ageing and sick population. I hope I'm wrong about this future, but the best guarantee of avoiding it is to attempt to do something about it.

NWO: "It must suffer through a massive downturn and restrucutring today for its sins of the past"

Though versions of this argument have been repeated from Andrew Mellon right to the present day, I have the feeling that it owes more to the influence of the concept of original sin derived from our dominant religion, than any rational analysis of the situation. What you are saying is Hungary has lived a life of excess for which it must be punished (even though countries like the UK, US, Spain have lived to even greater excess and, well, are being punished less - but let's leave that aside - and export-oriented countries - Germany, Japan, China - and eventually Poland, the Czech Republic, and Slovakia will probably join them, are being punished if anything more for refusing to live their life of excess).

Even though the argument is economic nonsense, I also question the morality on which it is based. Hungary did borrow beyond its means; but irresponsible borrowing is impossible without irresponsible lending. The IMF obviously ignores this because since 1982, its major shareholders, led by the US and the UK, have used it to protect their own financial institutions, so they have an interest in failing to recognize the moral hazard caused by making the borrower pay all the costs of irresponsible lending. One would have thought - given the mess that has resulted - that creating this moral hazard was irresponsible. But even then, on the grounds of morality - I have to act why Hungary should pay the full costs of western banks' irresponsible lending - surely both sides are culpable and the losses should be shared.

There is then the question of the extent to which - and this is especially relevant to FX loans - borrowers knew the costs of the loans that were being sold. I remember watching these advertised on television in Hungary with no health warnings whatsoever about the exchange rate risks, even when for over-the-counter headache medicines one is told to consult their doctor or their pharmacist for the possible side effects. Had this happened in western Europe, the banks would have been accused of misselling, and ordered to compensate those who had taken mortgages out. This is in indeed what happened in the UK in the 1990s when borrowers incurred large losses in the recession and ended up with negative housing equity in part because their mortgages were interest only, and linked to endowment policies linked to the stock market to repay the capital (which often did not perform according to original expectations). Mortgage brokers and banks that could not prove they had explained the risks to borrowers were ordered to pay those borrowers compensation. There is clearly a major issue of mortgage and loan misselling here that needs to be raised.

[Mark]

NWO: "In the end, Erdos assumes Hungary is similarly situated as the U.S. and Germany and can with relative ease go out and finance larger beudget deficits on the cheap."

While the issue is relatively easy for the US, given Germany's debt ratio to GDP (larger, not smaller than Hungary's) it is not an easy choice for Berlin. Just as the close to 10% deficit to the UK will run is not an easy choice for London.

He recognizes two things - firstly that the employment consequences of a downturn will serious impair the long-term growth prospects of the Hungarian economy, by exacerbating its labour supply problems. Secondly, that a deep downturn will depress tax receipts and boost demand for public spending, actually ultimately increasing the recession.

Over the medium term even quite a large stimulus will be cheaper financially for the state than a deep downturn. The problem is that because of collosal market failure last September-October, Hungary cannot even borrow rationally to spread the cost of its economic adjustment. We know the the Maastricht Treaty (I think, article 119 - but I'll have to look it up) in these cases allows the European Union to provide the financing when the market fails, against a proper long-term recovery plan. It is scandalous that the EU has not recognized its responsibilities to provide the temporary support needed for rational economic policies.

[Mark]

"actually ultimately increasing the recession."

I'm going mad too "actally ultimately increasing the deficit" is what that should read.

[econom]

Catastrophe Eastern
von Raivo Pommer-Eesti-raimo1@hot.ee

Eastern Europe’s woes are not unmanageable. But they are not being managed. The result could be catastrophe

AMID the wreckage of Latvia’s retailing industry, which has declined 17% year on year according to the latest figures, one item is selling well: T-shirts with seemingly mysterious slogans such as “Nasing spesal”. Latvians are glad to have something to laugh about, even if it is only their finance minister, Atis Slakteris. In an ill-judged foreign television interview, using heavily accented and idiosyncratic English worthy of the film character Borat, he described his country’s economic problems as “nothing special”.

Put mildly, that was an original interpretation. Fuelled by reckless bank lending, particularly in construction and consumer loans, Latvia had enjoyed a colossal boom, with double-digit economic growth and a current-account deficit that peaked at over 20% of GDP. Conventional wisdom would have suggested applying the brakes hard, by tightening the budget and curbing borrowing. But the country’s rulers, a lightweight lot with close ties to business, rejected that. Fast economic growth made voters feel that European Union membership was at last producing practical benefits, after a disappointing start when tens of thousands of Latvians went abroad in search of work, leaving rural villages and small towns depopulated.
Click here

The central assumption, in Latvia and many other countries in or near the EU, was that convergence with rich Europe’s living standards and other comforts was inevitable. Lending in foreign currency went from 60% of the total in 2004 to 90% in 2008. Why pay high interest rates in the local currency, the lat, when the cost of a euro loan was so much cheaper? In a few years Latvia would surely join the euro anyway. Similarly, worries about financing the inflows were dismissed: Swedish banks would no more abandon their subsidiaries in Latvia than they would pull out of, say, southern Sweden.

Last year tested those assumptions nearly to breaking point. First, Latvia’s housing bubble popped. Then the main locally owned bank, Parex, went bust and had to be nationalised, amid fears that it could not pay two syndicated loans due this year. In December Latvia accepted a humiliating €7.5 billion ($9.56 billion) bail-out led by the IMF.

The big cuts in social spending that the package entailed led to vigorous public protests. Now the government has resigned. At a time when strong leadership and public trust are needed more than ever, the country’s squabbling and discredited politicians look hopelessly out of their depth. Latvia is an economic pipsqueak, with just 2.4m people. But the rest of the region is watching nervously, fearful that more bad news from the Baltics could bring others crashing down too.

It is easy to be pessimistic. This is indeed the worst economic crisis since the collapse of the communist planned economies and the wrenching process of privatisation, liberalisation and stabilisation that followed. The main ex-communist economies are likely to contract by 3% this year, according to Capital Economics, a consultancy. Yet the picture is not uniform. Only a few countries have needed an IMF bail-out. One is Latvia, whose economy is set to contract by at least 12% this year, and whose credit rating has just been downgraded by Standard & Poor’s to junk. Another is Hungary, burdened with a larger debt-to-GDP ratio than almost any other new EU member. It received $25 billion in October and faces a contraction of up to 6%. A third is Ukraine—chaotically run, corrupt and badly hit by the slowdown in its main export market, Russia. Ukraine’s IMF deal brought it $4.5 billion in November. But a second tranche of $1.9 billion is stuck; the deal is unravelling as politicians squabble over spending cuts. Its economy is likely to shrink by 10% this year. Other countries with IMF packages agreed or pending include Belarus (a Russian ally which is still expected to see growth this year), Georgia (which was bailed out after last year’s war with Russia) and Serbia.

Most other countries in the region are faring much better, though. Poland—by far the largest economy of the new EU members—is nowhere near collapse. Unlike its central European neighbours, it is big enough not to depend chiefly on exports to the rest of the EU. By European standards, its public finances are in fairly good shape. Its debt-to-GDP ratio is below 50%. Growth will be negligible, or slightly negative, but nobody is forecasting a big decline. Some Polish firms and households have taken out foreign-currency loans—but the figure is around 30% of all private-sector lending, compared with twice that in Hungary.

The second-biggest economy, the Czech Republic, is in good shape too. Its economy may shrink by 2%, but it has a solid banking system and low debt. Its neighbour Slovakia is in better shape still: it managed to join the euro zone this year. Like Slovenia, which joined two years ago, Slovakia can enjoy the full protection of rich Europe’s currency union, rather than just the indirect benefit of being due to join it some day.

Farther afield, the picture is very different. For the poorest ex-communist economies, the problem is not financial meltdown. They lack much to melt. Their exports are raw materials, agricultural products and people. In six countries, money sent home by foreign workers counts for more than 10% of GDP (in Tajikistan and Moldova it is more than 30%). Outsiders who agonise over the Latvian lat or Hungarian forint are rarely bothered with worries about the somoni (Tajikistan), leu (Moldova) or manat (Turkmenistan).

That highlights an important problem. Outsiders tend to lump “the ex-communist world” or “eastern Europe” together, as though a shared history of totalitarian captivity was the main determinant of economic fortune, two decades after the evil empire collapsed. Though many problems are shared, the differences between the ex-communist countries are often greater than those that distinguish them from the countries of “old Europe” (see table).

They range from distant, dirt-poor despotic places to countries in the EU that are not just richer than some of the old ones, but have better credit ratings, sounder public finances and stronger public institutions. In almost any contest for good government, stability or prosperity, Slovenia (under a sort of communism until 1991) looks better than Greece, which invented democracy and was never communist.
The thirst for capital

Historical and geographical quibbles aside, what the ex-communist countries have shared over the past decade is a mighty thirst for capital. Having missed out on decades of growth and integration with the outside world, almost all (a few oddballs in Central Asia aside) are trying to catch up. Money from abroad has come in from borrowing on the bond market, from foreign direct investment or from selling shares. Most often it has come through bank loans.

At one extreme is Russia, which enjoyed huge external surpluses thanks to its wealth of raw materials. But its big companies borrowed lavishly on the strength of that, creating a potential short-term debt problem. Russian corporate borrowers have to pay back around $100 billion this year. At the other extreme lie countries such as Slovakia. They attracted billions from foreign car manufacturers, drawn by a skilled workforce, low taxes and decent roads in the heart of high-cost Europe.

Countries that relied chiefly on foreign direct investment are the least vulnerable now. The new factories may shut down. But it is harder for that capital to flee. Those that rely on foreign investors buying their bonds, such as Hungary, are the most vulnerable: their fortunes vary with every twitch of a trader’s fingers. In the middle are those that rely on lending from foreign banks to their local subsidiaries. That looked solid in the boom years, as Western banks scrambled to win market share by offering good terms to borrowers and lenders in the fastest-growing bit of Europe. It is still highly unlikely that any Western bank will pull the plug on a subsidiary anywhere—even in troubled Ukraine.

But nerves are jangling. The ex-communist countries have survived the first phase of the crisis, thanks to their own policies and some external support. The second phase, in which the rich world is turning stingier and possibly more protectionist and lenders are scurrying to safety, may be harder. The ex-communist economies must repay or roll over a whopping $400 billion-odd in short-term borrowings this year. Coupled with the lazy but easy lumping of nearly three dozen countries together, that creates the region’s biggest danger: contagion (see article). In other words, failure in one place sparks a disaster in another, even though it may be far away and have the same problem in a far more manageable form.

Contagion could happen in many ways. One is if depositors lose confidence that their savings are safe. So far, Western-owned banks have enjoyed rock-solid credibility: more so, in many cases, than governments or other public institutions. But that confidence could be undermined. If only one foreign bank pulls the rug from under one local subsidiary, leaving depositors stranded, it will cloud perceptions of banks’ reliability across the region. The most dangerous kinds of bank runs would be those in which depositors try to pull out either their foreign currency, or local currency which they would then attempt to convert into hard currency. In some countries that could overwhelm the ability of the central bank to support the financial system.

Another weak point is where shareholders take fright. If a foreign bank with big exposure to the region—Swedish, Austrian or Italian—needs to raise more capital but finds that outsiders think its loan book is too risky, what happens? The price of rescue may be that it sheds a troubled foreign subsidiary. Signs of shareholder twitchiness are growing (see chart).

For now, the most likely source of contagion is collapsing currencies. The paradox is that for countries with floating exchange rates, an orderly depreciation would in normal circumstances be a good way of cushioning an external shock, such as the slump in export markets now hitting the ex-communist economies. It stokes competitiveness and, along with lower interest rates, it lays the foundations for a return to growth. Governments with sound public finances might also consider running a looser fiscal policy to counteract the downturn.
Propping up the currency

For most of the countries in the region, such a textbook response is out of the question. Some have currency boards, or pegged exchange rates. In the Baltic states these have been the centrepiece of economic policy for more than 15 years. Abandoning them would not only bankrupt big chunks of the economy that have borrowed in euros. It would also be a huge psychological blow to public confidence in the whole idea of independent statehood. These countries have suffered the most painful part of being in the euro zone—the inability to devalue and regain competitiveness—without getting all the benefits.

Countries with floating exchange rates have a bit more room for manoeuvre. Their problem (a big one in Hungary, a lesser one in Romania and Poland) is that falling exchange rates may bankrupt the firms and households which have, in past years, taken out unwise loans in foreign currencies, chiefly euros and Swiss francs. That was, in effect, a convergence play. If you believed your country was heading for the euro zone some time in the next few years, then why not take advantage of the low interest rates there, rather than suffer the higher ones in your domestic currency?

What seemed a minor risk back then now looks painfully mistaken. For those earning forints or Polish zloty, the big swings in exchange rates in recent weeks have sent the size of both loans and repayments spiralling upwards. The zloty has dropped 28% and the forint 22% against the euro since the middle of last year. If the East Asian crisis of 1997 is any guide, these and other currencies may yet have further to fall.

This risk of a currency collapse will limit these countries’ options. So far many big central European countries have cut interest rates heavily to try to boost their economies—Poland’s central bank cut its policy rate again this week. But currency weakness will limit their room for manoeuvre. The Czech, Hungarian and Polish central banks issued a co-ordinated statement this week hinting they might intervene to support their exchange rates. But that route is tricky. Russia has blown half its reserves in a series of unsuccessful attempts to try to prop up the rouble.

Spending and tax policies would be another way of dealing with a downturn. But these are constrained, too. Those countries with a chance of joining the euro are scrambling to cut their budget deficits to get them in line with the 3% of GDP target set by the EU’s Maastricht treaty. Yet that aggravates the problem. The danger for Latvia and Ukraine is a downward spiral, where cuts in public spending damage the economy in a way that helps to entrench the deficit.

So far, the economic crisis has not translated into populist or protectionist politics. It is the east European countries that have been demanding that the rest of the EU stick by the rules of the single market. Their development over the past decades has been thanks to the free movement of capital, goods and labour. They would like a lot more of it: in a contest to subsidise industries, rich countries always win.

But that stance will not hold indefinitely if things get worse. Willem Buiter, a prominent economist, believes it is only a matter of time before some of the ex-communist countries introduce capital controls. That, in theory, would allow them to concentrate on stabilising their economies without worrying so much about the external value of their currency. If voters find the economic pain of adjustment unbearable, politicians can pass laws that will make foreign-currency borrowings repayable in local currency. That would be met with fury by the foreign banks, who would in effect see their loan books expropriated. But it could happen.

Against that background, what can be done? The east European countries are, belatedly, co-ordinating their approach within the EU, holding their own mini-summit on March 1st. They want to embarrass countries such as France for what they see as its protectionist approach to the crisis. They are supporting each other: the Czech Republic and Estonia were among those contributing to the Latvian bail-out.

But even co-ordinated local efforts are unlikely to make much difference, given the scale of the problem. The real lead, and the real money, must come from outside the region. That brings into play a slew of political problems. Having trumpeted their free-market principles in past years, and dismissed the stodgy approach of countries such as Germany and France, the new EU members from eastern Europe are now turning to old Europe in the hope that it can hurry up the flow of EU structural funds to counteract the downturn, bail out or prop up over-exposed banks in places like Austria, and stretch the rules of the European Central Bank to let it provide support to countries outside the euro zone. The case for such measures is strong, and it is in the interest of all Europe that contagion is contained. But that does not mean that it will happen.

[Andras]

Article 100.2

[Mark]

Andras: "Article 100.2"

Thanks

[NWO]

Mark-

You misunderstand me. I am sorry that I am obtuse. My point on Hungary's situation is not that some form of counter-cyclical stimulus would not "in theory" be helpful to ameliorating the current tensions, but that Hungary actually has no ability to do so (unlike the US, UK and even Germany)and part of the reason it is stuck is becuase of the massive pro-cyclical stimulus offered in the early part of this decade. The reason Hungary cannot carry out a stimulus is literally there is no money. How will the Govt finance such a stimulus? HGB market? Closed. Fx bond market? Closed. The only choice would be to print money and spend it. The problem is (and I think this is where we disagree) to do so would (1) speed up the bankruptcy of the household sector, (2) bankrupt the local banking system, (3) infuriate the EU so as to basically close the door to any serious help from the EU, (4) certainly brake the terms of the Oct agreement with the IMF, (5) destroy the value of foreign capital invested in Hungary which is the basis of any future growth.
This is why I believe Hungary is stuck between this rock and a hard place. It must rely on stimulus in neighbouring countries to shorten the region wide recession, and it must, itself, continue to adhere to a very uncomfortable strict expenditure and budget regime to try and minimize the risk of insolvency. Maybe you are correct that a too hasty entry into the euro will bring more risk than benefit (i.e., long term lack of competitiveness like we have in Greece and Italy). My feeling has been that an expedited euro entry at a reasonable-not overvalued Fx rate- accompanied by a commitment to long termmarket liberalization is still the better bet that relying on a floating/depreciating currency, but this can be argued. I don't think there is really much scope to argue-like FIDESZ believes-that one can really undertake a massive Govt spending stimulus to get the country going again. This is the trajedy of being a small, open economy that has financed itself in currencies other than its own.
Finally, I have been confidant that at the end of the day the EU would understand that it is in their own interest and the interest of all 27 member states to ensure an orderly resolution to the problems in the CEE. I am no longer so sure. We are getting closer to beggar thy neighbour policies across the old EU. If this continues, the Balcans and Hungary are in real trouble, though I think Poland and the Cz Republic may manage to sneak through. For Germany this is key, as Poland is the place they really care about for both historical and economic reasons.

[Sophist]

NWO,

"(5) destroy the value of foreign capital invested in Hungary which is the basis of any future growth."

It's been interesting following your debate with Mark. But I don't understand this bit. "Foreign Capital" is this financial capital denominated in forints, or is this physical capital in plant and equipment?

If it's Forint denominated financial capital then it will obviously be destroyed by printing money, but I don't see how it is the basis of future growth.

If it's plant and equipment, then it is obviously the basis of future growth, but it's value won't be destoyed by inflation.

What am I missing?

[Mark]

NWO: "How will the Govt finance such a stimulus? HGB market? Closed. Fx bond market? Closed."

I think you may have misunderstood me too. My argument is that Hungary is a member of the EU, which is a highly integrated market of 27 member states, each one of which has different means of supporting themselves. Hungary cannot finance itself because of collosal market failure. In this situation it is for all of 27 states to stick together and support each other - if Hungary's mortage market collapses it affects Austria and Italy. The MNB needed to argue for an orderly relaxation of the convergence criteria, and the creation of a safety net for states that met their obligations to the EU in October.

Hungary has assumed during the last 20 years that if it is "good", this will be recognized and it will be helped. This is an illusion - western European states will not agree to assist unless CEE states demand it. Why didn't the Hungarian demand some form of underwriting of its convergence programme, given that it had fulfilled its objectives since 2006? I would expect Hungarian economists to explore solutions that are in the interests of ordinary Hungarian people. Instead, what I find astounding is that they advocate neo-liberal solutions which have been discredited by the economic crisis with ever greater zeal.

I'm also a little amazed at the concentration on high spending governments since 2002, which is more of a symptom of underlying problems rather than the cause. Even more so because Hungary was not the only country that engaged in irresponsible and unfunded spending in its public and private sectors. The US created a housing bubble, cut taxes and spent money on two wars that have not exactly worked out too well; the UK boosted social spending with no real reform of its health and education systems, tolerated a huge housing bubble and joined the same two wars with the US. And we could add Spain, we could add Ireland, the Baltic states, Romania and Bulgaria ....... why does the Hungarian discussion start from the assumption that only those in Hungary were sinful? What angers me is that the disproportionate stress of the media, the economists, the opposition (and some in the government) parties on previous sins, actually undermines Hungary's ability to press for measures that would protect its population, and so damages the population in whose name they all claim to act.

[NWO]

Mark:

So we are closer to each other's view than maybe we thought. However, as yesterday's EU Summit showed clearly, there is NO appetite in the greater EU and the Euro zone to find a collective decision. There is no other EU country yet ready to help in a meaningful way the working through of the debt overhang in Hungary or to support stimulative measures for the region. As Hungary cannot do this itself, it is at the mercy of the capital markets which will not be merciful.
On one point I disagree. I don't think Hungary is being some singled out for blame than the U.S., or Ireland or Spain. It is true that as compared to its "neighbours" (Slovakia, Cz. Republic, Poland and even to an extent Romania) it is being negatively compared. But you will surely acknowledge that its position is weaker than them and its prospects-except perhaps for Romania-are worse. The difference with Ireland and Spain is that Hungary is outside of the Euro zone. The difference with Poland is twofold: (1) Hungary's problems are on a relative basis worse (look at Fx debt/GDP and economic growth) and (2) Poland with 40 million people and the major destination for German FDI in the recent years is just far more important economically and strategically to Europe and the world than in Hungary (kind of like Germany vs. Austria).
Finally, the interesting thing is that the decided inaction by the EU yesterday should continue to open up major fissures within the EU, as Vienna and Berlin must now be seeing this crisis in a far different light. This is going to continue to be horrible to live through, but it could make for some nice theatre.

[Mark]

NWO: "However, as yesterday's EU Summit showed clearly, there is NO appetite in the greater EU and the Euro zone to find a collective decision."

It is really interesting, isn't it, that what is unfolding in terms of CEE and the EU will determine the futures of all Europeans (west as well as east) far more profoundly than anything else in the news this weekend, and western Europe has not yet woken up to it. The Hungarian press thought their request for help was being turned down, the Austrian and German press said that CEE was being assisted, and the UK press (no surprises there) completely ignored it!

I'm not so pessimistic, but all CEE countries have to spell out the economic and political dangers and have to press for such a package. I think Hungary undermined its position by offering up the pension and public sector wage cuts to the IMF last October, and by then wriggling out of them. This reinforces the impression which you've pointed to in a previous post - that I know is widespread in Brussels - that Hungary is an untrustworthy partner.

But there is no doubt that the EU is - and has been for a long time - in denial about the challenge of integrating CEE fully. I think it underestimated how radical the step of a large enlargement was when it took the decision to negotiate with ten states in 2000, and open its doors in 2004 (I'm rather pleased that they did). It was this in mind that one of the concluding sentences in my book, published the day before Hungary joined the EU, states that in future the problems of CEE would become the problems of Europe as a whole, in a way they have never been before. They clearly underestimated the shocks that this would create - though states like the UK and Ireland which have experienced large inward migration from Poland and the Baltic States, and a lesser extent Slovakia have some grasp of this. They also have been, and continue to be in denial about the true costs of integration, that will eventually have to be carried in part by western European taxpayers.

The dilemma for western European governments is interesting. As yesterday's elections in Carinthia show such governments are under considerable pressure to protect their populations along nationalist lines. Among the left CEE is not popular because it is seen as neo-liberal, pro-American and having taken jobs from the core. So, there is considerable public resistance to assistance. And also, Germany and others are also looking at their debts and public finances. But on the other hand, western European policy to extend membership to CEE was motivated by security concerns post-Kosovo; in other words by the realization that if CEE was not integrated fully into European political frameworks this would endanger western European security. Indeed, this for many governments was an extension of the lesson of the Second World War which conceived of the EU as a guarantee of peace. If western Europe persists in doing what it is doing, it risks not only a major loss of prestige for the European project, but potentially a major security problem immediately to its east. If economic collapse is more serious in CEE than in western Europe that in turn risks western Europe's labour markets being flooded with skilled, cheap workers from across its eastern border.

There is a real interest in a pan-European solution, but CEE cannot count on western Europe realizing it before a major catastrophe occurrs. I can say as a CEE specialist living and working in a western European country that the real knowledge that governments, and policy-makers have of the real problems of the region is as close to nil as makes no difference. Established opinion has decided that the real problems are consigned to several "basket cases" like the Baltic States and Hungary, and have been created by poor policy choices - indeed Merkel's comments yesterday suggest this is the German government's position. The situation, even in Hungary and the Baltic states, is not nearly so simple. CEE needs to be united and fairly agressive in making its case. I think it is hard to underestimate the importance of this drama.

[Mark]

NWO: "I don't think Hungary is being some singled out for blame than the U.S., or Ireland or Spain. It is true that as compared to its "neighbours" (Slovakia, Cz. Republic, Poland and even to an extent Romania) it is being negatively compared. But you will surely acknowledge that its position is weaker than them and its prospects-except perhaps for Romania-are worse."

I actually think that it is premature to come to this conclusion about the relative impact of the crisis, and we will have to wait until we are through it. I was always amused by those who talked of Hungary bringing up the rear economically, and being behind its neighbours, because in a strange sense it has been in the lead! It was the first country to meet with the problems of financing its imbalances in 2006, a year before the onset of the crisis globally. Since then its bubble has experienced slow deflation; its manufacturing sector went into recession maybe three to six months before Poland, ther Czech Republic and Slovakia. I suspect that Hungary is not in the worst position of the countries you identify and it only seems so, because its crisis is a precursor of some of what is to come in the others. My own suspicion is that the more a country in CEE is dependent on exports to the western European core, the harder it will be bit. Obviously, we'll know in two years' time if I'm right - ironically, if I am, Hungary will have a horrible time, but probably less so than Poland and Slovakia. My other suspicion is that CEE countries that are highly regarded face a significant contagion risk - in that their economies will be affected adversely by capital markets' perceptions of their neighbours (we saw this in East Asia in 1997-8). Therefore Warsaw and Bratislava may be in for a nasty shock if they try to make political capital out of how much better they are than Hungary, Romania, or the Baltic states. I think it is pretty imperative that the CEE countries realize they are all in this together.

[NWO]

Mark:

On your last post. (1) It is clear already that the contagion risk is substantial for a place like Poland. Its currency has borne a greater brunt of devaluation than even Hungary. (2) Poland-unlike Hungary-actually has a decent domestic market, which-it turned out today-grew 3.6% in Q4. (3) In terms of export reliance, the Cz Republic, Slovakia and Hungary are in the worst positions. The advantage for the Cz Republic is that the economy has financed its growth with Crown loans largely not Fx loans and for Slovakia that they have no Fx risk, but as you have mentioned also don't have the Fx flexibility of being outside the Eurozone.

Yesterday, again, Gyurcsany was seen as the little boy who cried wolf with his bailout package. He was left alone when even the other CEE countries did not support his proposal. The PM deserves credit for getting ahead of the curve in the Fall, but now Hungary's problems have caused total "donor fatigue" in the EU.

[Mark]

NWO,

Though we differ on the relative strenghts and weaknesses of the region's economies, contagion risk is something everyone should take very seriously. The financial press, and analysis generally in western Europe seems to treat CEE as a homogeneous zone. Therefore once the financial markets realize there is a problem somewhere in CEE, all the states are likely to come under pressure.

Though these is no doubt in my mind that the credibility of both Gyurcsány and Orbán is nil (the former because of his famous speech, the latter because he is regarded as a right-wing populist who will promise anybody anything), I don't think the EU's response is due to donor fatigue, I just don't think they get it!

[Eva S. Balogh]

NwO: "Gyurcsany was seen as the little boy who cried wolf with his bailout package."

I guess one can see it that way, but others feel that the lack of solidarity in the Union shows its political weakness. See the International Herald Tribune's article:
"With uncertain leadership and few powerful collective institutions, the union is struggling with the strains this economic crisis has inevitably produced among 27 different countries with different economic histories. The traditional concept of "solidarity," of one for all, is being undermined by protectionist pressures from political leaders with national constituencies and agendas."

[Eva S. Balogh]

The more I think about it this whole fiasco is not really the fiasco of Ferenc Gyurcsány but that of the whole European Union. Here are a few paragraphs from The New York Times: "Whether Europe can reach across constituencies to create consensus, however, has been an open, and suddenly pressing, question.

“The European Union will now have to prove whether it is just a fair-weather union or has a real joint political destiny,” said Stefan Kornelius, the foreign editor of the German newspaper Süddeutsche Zeitung. “We always said you can’t really have a currency union without a political union, and we don’t have one. There is no joint fiscal policy, no joint tax policy, no joint policy on which industries to subsidize or not. And none of the leaders is strong enough to pull the others out of the mud.”

Thomas Klau, Paris director of the European Council on Foreign Relations, an independent research and advocacy group, said, “This crisis affects the political union that backs the euro and of course the E.U. as a whole, and solidarity is at the heart of the debate.”

[Mark]

Ėva: "The more I think about it this whole fiasco is not really the fiasco of Ferenc Gyurcsány but that of the whole European Union."

The two positions are not mutually exclusive.

The big story here is, of course, that the big western European governments have never really taken the needs of CEE seriously. Perhaps I'm being unfair, but they tried to continue in the 1990s as if what had happened in 1989 required no real adjustment on their part. After Kosovo they did expand the EU, but without ever realizing what that meant, and things are now unwinding, both for CEE and some western European states and they seem to be in a peculiar state of denial.

Gyurcsány deserves a lot of credit for arguing for the rescue package. He may have strong presentational skills, but he ain't a great messenger. He has a credibility problem - most of the western European press and informed opinion know him as the person who "lied morning, noon and night".

It is the tragic combination of these circumstances that is most marked.

[Eva S. Balogh]

Mark: "He has a credibility problem - most of the western European press and informed opinion know him as the person who "lied morning, noon and night".

I bet that the person of the messenger didn't matter a bit. The western part of the Union doesn't want to spend more money on the poor relatives. They have enough problems of their own. The problem is not so much Gyurcsány as the lack of political and economic unity within the Union. That's how I see it.

[Eva S. Balogh]

That is also interesting. The quotation is from Bloomberg:

"The euro dropped for a second day versus the greenback as EU leaders vetoed Hungary’s proposal for 180 billion euros ($227 billion) of loans to former communist economies in eastern Europe. The Hungarian forint and Polish zloty slipped to the weakest in about a week against the dollar, while the Swedish krona fell to a record versus the euro."

[NWO]

It is not surprising the Euro is dropping. The Eurozone is in a shambles, defaults in the CEE banking system will wreck the Euro, and it is clear that the Euro cannot act as a true reserve currency. Likewise, the Krona's drop is due to the Swedish banks' exposure to the Baltics and the bail outs undertaken and to be undertaken.
The irony is the rally in the dollar. The USD and U.S. Treasuries in particular are the next big financial bubble on the horizon.

[Sophist]

Gyurcsany's credibility issue.

Feri made it on to Sky news - with still bad but improved English - and all the qualtiy UK press with his "New Iron Curtain" rhetoric - on the basis that there is no such thing as bad publicity this has to be something of a coup for him.

I'm also wondering whether this makes sense of his recent pro-Roma comments; boycott the Magyar Hirlap, introduce Roma quotas in public sector. These comments are simply alienating for the racist 80% of the population, and do nothing for his electability. However, if his intended audience is Western Governments, who are increasily alarmed at the plight of the Roma: US State Dept, Council of Europe reports, then he is highlighting the potential political consequences of economic collapse in CEE, to quote the Economist leader:

"...if the people of Eastern Europe felt they had bueen cut adrift by western Europe, they could fall for populists or nationalists of a kind who have come to power far too often in Europe's history"

Having been to "Cigány Bünezés" demo myself on the weekend - to convince myself that it is still a minority interest - this is not at present a credible story for me, but should it play in the West, there may be a rescue package yet.

[Eva S. Balogh]

Sophist: "Feri made it on to Sky news - with still bad but improved English - and all the qualtiy UK press with his "New Iron Curtain" rhetoric - on the basis that there is no such thing as bad publicity this has to be something of a coup for him."

One may add that I just heard in the news that Gyurcsány is continuing his campaign for his program. Instructed the Hungarian ambassadors to try to convince the governments to which they are accredited.

[Mark]

Ėva: "The problem is not so much Gyurcsány as the lack of political and economic unity within the Union".

I think the truth is worse than this. The leading Eurozone countries believe that they are the passive victims of the deficiencies of Anglo-American market fundamentalism (to some extent the UK does too, they just drop the Anglo from the beginning of the Anglo-American, and Gordon Brown talks alot about American sub-prime lending). They think there is no general problem in CEE, just individual country difficulty, and if those countries take their unpleasant IMF-prescribed medicine and quit complaining everything will be just fine. They are in denial about the depth and nature of their problems.

NWO: "The Eurozone is in a shambles, defaults in the CEE banking system will wreck the Euro, and it is clear that the Euro cannot act as a true reserve currency."

The idea of the Euro as a reserve currency to rival the Dollar was always a bit of an illusion. But the EU is going to have to develop more robust structures of macro-economic policy co-ordination if the Euro is to survive intact. Let's see if it suceeds - or even realizes before it's too late.