With all attention turned towards the struggling economies of the developed world it has become less and less important what happens to other parts of the globe. However, in the current economic downturn one must remember that globalisation has NOT disappeared over night. In fact we are pretty much in the same interconnected world we used to be before all this mess started. This means that what happens in one part of the world will, in one way or another, have repercussions on the other side of the globe. So taking this into consideration, we should then at least show some interest to what happens to other parts of the world, especially those which are strongly related to the West and its financial system/crisis.

The issue

Since November last year (2008) exchange rates across Central and Eastern Europe have been plummeting at unexpected rates. Some have even reached lows that have last been experienced in 2003. Obviously the first suspect is the world financial crisis, but this is just a simple explanation that overlooks the deep roots of the problem and what its repercussions might be on the Western countries.

Why are the rates plummeting?

There are 3 main reasons:

1. Western banks and investment funds have been investing heavily in emerging markets. This is because, as these markets are on the rise and many of their assets are under valuated, there is a good chance they could make a nice profit while maintaining a relative low amount of risk. And one of the best emerging markets is or used to be the former communist states of Central and Eastern Europe.

This means that a lot of western cash (dollars, euros and pounds) have been poured into this region. And now, as things have gotten worse back home, Western investors need that money to plug the holes in their own back yard. As a result, investors are just selling off what they have in Eastern Europe and taking the money home. However, their money is not in their home currency (USD, EURO, GBP) it is mostly hold in the local currency. So as they sell the local currency (the currency of Central and East European countries) for dollars and euros, these local currencies start to devaluate.

2. Losing confidence (risk aversion) – as now investors have a hard time knowing where to put their money, the economies of Central and Eastern Europe seem less certain than those they have back home. After all, they should know more about what happens in their home countries rather than what happens in some country all the way across the sea. Also investors tend to trust more the governments of the rich developed world, believing they are better prepared in taking good decisions than those of less developed countries. This means that less dollars and euros are sent towards less developed regions like Eastern Europe. As a result, there is less demand for the local currencies. Thus, the local Central and East European currencies slowly start to devaluate.

3. Growing western deficits – As the trouble in US and Western Europe becomes increasingly more acute, their governments try desperately to salvage the economies. One of the most used methods is to basically inject money into the system, hoping it will somehow stimulate the economy and bring it out of recession. But the money must come from somewhere…

One solution is to print more money but this can very well just lead to inflation and in combination with the economic crisis it might just spell the apocalypse of the capitalist world. The only other solution is to barrow the money from … somewhere, usually from some banks and organisation specialised in lending to governments. Nonetheless, these organisations also need to get the money from somewhere and that somewhere is the rest of the world. Also the money needed must be in western currencies. That means dollars, euros and pounds because you cannot stimulate your economy by injection some other random currency, you need your own. One of the places where a lot of dollars and euros have been poured into is Central and Eastern Europe and now the West needs those dollars and euros to finance their deficits. As more and more government lending organisations try to buy the dollars and euros from Eastern Europe, the local currencies again start to devaluate as they are being sold for the western currencies.

The implications for US and Western Europe:

Now that things have been explained it remains to understand what this tells to the rich developed countries. Going back to the previous points there are two which need more careful attention. Firstly that dollars and euros are leaving Central and Eastern Europe in order to plug the holes of struggling Western financial institutions and secondly to finance Western government deficits. This is not a major issue as long as there still is an easy way to get the dollars and euros from “somewhere” without creating inflation. But what happens if the money runs out? Money is not infinite…

The basic problem is simple, as long as the West can gather money from Eastern Europe, in other words, as long as the currencies of this part of the world continue to devaluate there is still hope for a sound economic recovery of the rich Western world (they will have from where to get the money to support their economies). HOWEVER, if the West does not show any signs of recovery by the time the devaluation stops and the Central and East Europe currencies start to evaluate again, we can safely say that we are probably experiencing the end of a chapter in human history. Hopefully this will not happen.

Other information:

Central and Eastern Europe is not the only region experience currency devaluation; countries across the global are experiencing this. From Kazakhstan, Tajikistan to Philippines and South Korea currencies have been losing ground against the dollar and the euro. But Central and Eastern Europe has a much closer tie to Western Europe and the US, receiving more foreign investment and thus being a better representative case.

The amount of money being drawn out of Eastern Europe is impressive. In the case of Russia, in less than 6 months, $ 800 billion left the country as western investors were bailing out from the Moscow stock exchange and other short term investments, this was in November last year. It was the period when most stock exchanges in the less developed countries collapsed as Western investors virtually fled these countries. These were short terms investments but now we are looking at medium and long terms investments and deposits, once these are out, there is virtually nothing left.

The amount of public deficit ran in Western countries is breaking historic records. In US, in 2008 government deficit was about $ 450 billion (3.4% of the GDP) and for 2009 it is projected at almost $ 1,700 billion (more than 10% of the GDP). In UK it was 4.6 % GDP in 2008 and projected at 9 % of GDP in 2009.

dollar gone crazy