Hungary is the Latest European Domino to Fall

As if Greece, Spain and Portugal were not enough of a concern for the European financial system, another villain has emerged from behind the curtains: Hungary.

A new government swept into office in late May and the ruling party leader declared the country had little chance of avoiding a Greek-style credit crisis because the former government had been cooking the books.

A spokesman for Prime Minister Viktor Orban said it was not an exaggeration to talk about the potential for default. 

Later, a new set of Hungarian officials said Orban's spokesman was misinterpreted, but the cat was already out of the bag. Hungary is not in the Eurozone, but its own currency, the forint, was thrashed. It makes no difference whose story was right. The fact is, investors got a new country to worry about that wasn't even on the radar. Austrian banks fell heavily on the news because they are large investors in Hungary. 

Surely you remember your history of the Austro-Hungarian Empire? It was ruled by Habsburgs and went by the awesome name Osterreichisch-Ungarische Monarchie. Its politics were dominated by disputes among its subject lands, including people who spoke Bosnian, Croatian, Czech, German, Hungarian, Italian, Polish, Romanian, Serbian, Slovenian and Ukranian. Let's not forget that World War I started as a dispute among these folks when Archduke Franz Ferdinand was assassinated on June 28, 1914.

June is just not a great month for European news in world history.

Back then, a lot of alliances had developed so an attack on Austria by a Slav led to an attack by the Austrians on the kingdom of Serbia. The Serbs in turn called in their chits and before long Germany invaded Belgium, Luxembourg and France, and Russia invaded Prussia. By the time it was all over, a lot of stupid trench warfare killed millions of kids and two empires turned to dust. Don't think that this can't happen again – except this time with financial alliances.

Hungarians in the opposition party tried to quell the concern in Europe over the country's finances.

“The government has created an artificial crisis,” Parliament member Tibor Szanyi told the Wall Street Journal. "They wanted to exaggerate the situation for political ends – [but] it is really dangerous to do that in the heart of Europe."

In 2008, heavily indebted Hungary was unable to borrow in capital markets amid the global credit crunch. So, it turned to the International Monetary Fund (IMF) and the European Union (EU) for help. Hungary got a bailout in exchange for promises to place stringent limits on government spending with the aim of reducing its deficit to 3.8% of gross domestic product (GDP). Now, the old government says it complied with that mandate and the new government says it didn't.

Regardless of who is right, it's another matter that will undermine investors' confidence.

These things pile up.

The bottom line: Western Europe has swung into a period of pain that is no longer just about Greece and Spain. Really, it's much more about the companies that have lent to those countries. Write-downs among European banks will total as much as $239 billion, according to Bloomberg. More money will be required to fill up reserves, but where will it come from in a time of fiscal contraction? 

So far, there have not been any really bad economic numbers reported in Europe, but that could change quickly, as consumer confidence in Germany, France and the United Kingdom is already headed much lower. Reduced spending by consumers will match the reduced spending by governments, which together create the perfect recipe for another recession.

So Europe is dragging the world down, and China is not far behind. 

Don't look for much of an improvement in the United States until the anchors in China and Europe are lifted. We would love to be an island of calm, but China is our creditor and Europe is our buyer. We can no more isolate ourselves economically from them than a catcher in baseball can operate independently of his pitcher and first baseman.  Prepare your portfolios for waves of difficulty over the summer. 

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