Wednesday, February 18, 2009

Austria's Achilles' Heal

Ok, first a clarification. When I use the term "Austrian" I usually mean the school of economics, and not the nationality. But in this post, I use it in the "nationality" sense of the word.

Austria's economy does seem at first glance to be doing relatively great. Austria is one of the very few European countries that still have a positive 12 month growth rate. And adjusting for terms of trade, even its quarterly growth rate is positive.

The reason for this success is a reduction in government spending from 54% of GDP in 2004 to 48.4% in 2007, the biggest reduction in government spending in all euro area countries. This spending reduction enabled the Austrian government to both nearly eliminate the deficit and reduce tax rates, particularly the corporate income tax rate. You'd almost think that Austria has been governed by Austrian economists!

But unfortunately, Austria's economy does have its Achilles' heal. Along with Swedish banks, Austrian banks have among the biggest exposure to Eastern Europe relative to its domestic economy of all Western European countries, something which The Telegraph's Keynesian bearish columnist Ambrose Evans-Pritchard has discussed in several columns (for example here). Now, Evans-Pritchard isn't exactly known to be hesitant to exaggerate (He said for example in this column that the Polish Zloty has "halved" against the Swiss franc, whereas it in reality is down just 40% against a brief peak, and only about a third relative to the more year ago level), but even correcting for some exaggeration, the fact remains that Austrian banks have a heavy exposure to Eastern Europe. And considering how many Eastern European countries are falling into an economic depression, that means that Austrian banks will lose a lot of money.

Just how much they will lose remains unclear at this point. But it is not far-fetched to assume that these losses might (I'm not saying it's certain, only that there is a realistic possibility) grow large enough to threaten Austria's apparent economic stability.


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