By Ralph Atkins in Frankfurt, Joshua Chaffin in Brussels,and Robert Anderson in Stockholm, June 11 2009 03:00

The European Central Bank has acted to head off a financial crisis in the Baltics, providing Sweden’s central bank with a €3bn loan in a confidence-boosting move amid growing fears over Latvia’s economy.

The ECB move signalled the central bank’s willingness to shore up official European help for countries such as Latvia, whose prime minister, Valdis Dombrovskis, voiced optimism that the country would soon receive another tranche of multi-national aid. The ECB’s loan to the Riksbank – a rare instance of aid for a country outside the eurozone – will be used to augment the Swedish central bank’s foreign reserves, increasing its capacity to help Sweden’s private-sector banks, which dominate the Baltic region’s financial sector.

Since the global financial crisis erupted, the ECB has been wary about extending help beyond the borders of the eurozone. Yesterday’s move suggested it was prepared to do that. Jean-Claude Trichet, ECB president, has been careful not to rule out stepping up help to the Baltic region, although such a move could prove controversial within the bank.

The €3bn being lent to the Riksbank is part of a previously undisclosed “swap” agreement, which was struck in December 2007 and allows the Swedish central bank to borrow up to €10bn in exchange for Swedish kronor for up to three months.

Last week, Mr Trichet revealed that it had an agreement allowing the Latvian central bank to obtain liquidity from the ECB, but only against euro-denominated collateral.

The ECB will worry about the financial risks and potential costs involved in stepping up to help for the Baltic countries, as well as the dangers of setting a precedent that might prove awkward in a future crisis in eastern Europe or elsewhere.

The Latvian lat has stabilised this week, boosting sentiment towards other eastern European currencies, after Riga said it had found another 500m lats in budget savings. This has raised hopes the International Monetary Fund will soon approve the next €1.4bn tranche of aid under Latvia’s stabilisation plan.

“This gives us certainty about the next tranche,” said Kristins Strazds, head of trading at SEB bank in Riga. “This should end the devaluation rumours in the short term.” However, Joaquin Almunia, European economic affairs commissioner, stressed in Brussels the need for Latvia to sustain its budget cuts over the long term.

Mr Almunia was speaking after a meeting with Mr Dombrovskis, who expressed confidence that Latvia’s parliament would next week approve the emergency budget cuts. Riga was now turning its attention to medium-term initiatives that would lower the deficit below 3 per cent of gross domestic product, Mr Dombrovskis said.

Earlier, Mr Dombrovskis told the Financial Times that the situation was beginning to stabilise. “It’s important … that people know that we will continue to receive this international loan package.”

EUROZONE INFLATION FALLS TO ZERO

By Ralph Atkins in Frankfurt,  May 29, 2009 

True, America and China, unlike Europe, have pumped trillions in the economy to support demand. Their huge fiscal stimulus seems to be paying off. Problem is toxic assets still plague the US and EU financial systems, and a huge credit card default crisis lies in store, when Bank of America and others will be forced to acknowledge the extent of their losses  on finanical assets in their balance sheets. If consumer credit goes bust, the recovery just won’t happen, unless purchasing power is redistributed — by tax or strike — toward employees and lower social strata in America, Europe, Asia, and a new international monetary system, based on stocks of primary goods and on fixed, but adjustable, exchange rates, comes into being. Kaldor proposed it to the UN thirty years ago. It would provide a firmer anchor for the global economy than current international reserve currencies, and promote North-South economic realignment, since it would regulate the terms of trade between manufactured goods and agricultural and mineral commodities.

Don’t believe the hype: the recovery is NOT around the corner. It remains to be seen what will happen when, especially in Europe, the crisis worsens in late 2009 and early 2010: Anarchy in the EU?

I’m concerned about Europe. Actually, I’m concerned about the whole world — there are no safe havens from the global economic storm. But the situation in Europe worries me even more than the situation in America.

Just to be clear, I’m not about to rehash the standard American complaint that Europe’s taxes are too high and its benefits too generous. Big welfare states aren’t the cause of Europe’s current crisis. In fact, as I’ll explain shortly, they’re actually a mitigating factor.

The clear and present danger to Europe right now comes from a different direction — the continent’s failure to respond effectively to the financial crisis.

Europe has fallen short in terms of both fiscal and monetary policy: it’s facing at least as severe a slump as the United States, yet it’s doing far less to combat the downturn.

On the fiscal side, the comparison with the United States is striking. Many economists, myself included, have argued that the Obama administration’s stimulus plan is too small, given the depth of the crisis. But America’s actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

The only thing working in Europe’s favor is the very thing for which it takes the most criticism — the size and generosity of its welfare states, which are cushioning the impact of the economic slump.

This is no small matter. Guaranteed health insurance and generous unemployment benefits ensure that, at least so far, there isn’t as much sheer human suffering in Europe as there is in America. And these programs will also help sustain spending in the slump.

But such “automatic stabilizers” are no substitute for positive action.

Why is Europe falling short? Poor leadership is part of the story. European banking officials, who completely missed the depth of the crisis, still seem weirdly complacent. And to hear anything in America comparable to the know-nothing diatribes of Germany’s finance minister you have to listen to, well, Republicans.

But there’s a deeper problem: Europe’s economic and monetary integration has run too far ahead of its political institutions. The economies of Europe’s many nations are almost as tightly linked as the economies of America’s many states — and most of Europe shares a common currency. But unlike America, Europe doesn’t have the kind of continentwide institutions needed to deal with a continentwide crisis.

This is a major reason for the lack of fiscal action: there’s no government in a position to take responsibility for the European economy as a whole. What Europe has, instead, are national governments, each of which is reluctant to run up large debts to finance a stimulus that will convey many if not most of its benefits to voters in other countries.

You might expect monetary policy to be more forceful. After all, while there isn’t a European government, there is a European Central Bank. But the E.C.B. isn’t like the Fed, which can afford to be adventurous because it’s backed by a unitary national government — a government that has already moved to share the risks of the Fed’s boldness, and will surely cover the Fed’s losses if its efforts to unfreeze financial markets go bad. The E.C.B., which must answer to 16 often-quarreling governments, can’t count on the same level of support.

Europe, in other words, is turning out to be structurally weak in a time of crisis.

The biggest question is what will happen to those European economies that boomed in the easy-money environment of a few years ago, Spain in particular.

For much of the past decade Spain was Europe’s Florida, its economy buoyed by a huge speculative housing boom. As in Florida, boom has now turned to bust. Now Spain needs to find new sources of income and employment to replace the lost jobs in construction.

In the past, Spain would have sought improved competitiveness by devaluing its currency. But now it’s on the euro — and the only way forward seems to be a grinding process of wage cuts. This process would have been difficult in the best of times; it will be almost inconceivably painful if, as seems all too likely, the European economy as a whole is depressed and tending toward deflation for years to come.

Does all this mean that Europe was wrong to let itself become so tightly integrated? Does it mean, in particular, that the creation of the euro was a mistake? Maybe.

But Europe can still prove the skeptics wrong, if its politicians start showing more leadership. Will they?