Failure to Save Eastern Europe Will Lead to Worldwide Meltdown

The unfolding debt drama in Russia, Ukraine, and the EU states of Eastern Europe has reached acute danger point. If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung. Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70% of Austria's GDP. "A failure rate of 10% would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen. The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10% and may reach 20%. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East. Mr. Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that. – UK Telegraph

Dominant Social Theme: The sky is falling?

Free-Market Analysis: Well, maybe. Certainly, the UK Telegraph has certainly taken the lead when it comes to coverage of the European Union and its obviously increasing problems. Today, the EU is a vast undertaking that sets monetary policy for dozens of countries in both Eastern and Western Europe. But its astonishing success, as it turns out, may have as much to do with the recent bubble economy as it does with any slick handling of monetary issues.

What the Telegraph is reporting in considerable detail, and day after day, is the gradual deflating of the bubble, its effects, and the realization that is slowly growing that it may not have been the EU or even the euro that was responsible for the past decade of prosperity. No, it may simply have been good old-fashioned currency inflation and market stimulation – enhanced by cross-border currency convenience to be sure, but now even that is looking suspect.

As the credit bubble deflates, what is left is apparently a dysfunctional fiat-credit regime. Paper money, unbacked by an asset of significance is bad enough when implemented locally. But at least regional fiat currencies can utilize the various inflationary and rate-easing mechanisms that allow a given regime's unwilling participants the luxury of believing they are accruing wealth as their currency subsides. But the kind of broad financial regime created by the euro and its central bank will come under increasing strain as the credit crisis unravels local economies. Ordinarily domestic central banks would embark on a variety of easing programs that would give the appearance of easing the stress. But the EU's one-size-fits-all credit solutions preclude that.

Conclusion: Just as it is with America (see other article) so it is with Europe, where the elites now labor tirelessly to sustain what has been built by spinning domestic social memes to justify what cannot be reasonably explained. Ultimately, the outcome will depend on these arguments and their persuasiveness.

The EU, as it turns out, is in special jeopardy because its value is seen to be derived from the prosperity it can bring. Absent this prosperity, especially if the banking system continues to collapse, it is difficult to see what rhetorical argument the EU can bring to bear that will substitute for the original economic one. In this sense, the EU establishment is even worse off than the American one, as the alternative to the US federal regime is not yet clear. In Europe, however, there is a handy solution: devolution.

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