States being skittled.

The credit crunch has changed direction: it is now putting pressure on individual states, and this is bringing the IMF and the World Bank, for the first time, to the forefront of the crisis. A series of minor states in the Baltic and Balkans are fighting off bankruptcy, but the pressure is also on big players like South Korea and Switzerland. New Zealand is a more than an interested by-stander in this tense struggle for survival.

The emphasis is on states for two reasons. First, once extensive guarantees have been extended by states such as the UK or Ireland, their banks gained a competitive advantage, and money shifted to them at the expense of states without guarantees. This principle extends from depositors to major funders. John Key has been very alert to this problem, and has called for New Zealand to guarantee inter-bank lending lest external funding dry up before Christmas.

The second reason for pressure on states is that debt has become an important issue. It was tolerated, even encouraged before last year. Debt is now a weakness. States that cannot service their debts have to throw themselves onto their knees to beg for life-giving credit from international organizations. A nation's credit rating has become a vital issue. Fitch, for example, highlights as weakness current account deficits (CAD), external financing requirements, rapid bank credit growth and rising external debt ratios.

Switzerland

The nation which had cultivated the image as the world's most expert, discreet and prudent bankers, has swallowed the bitter pill of funding its two largest banks to prevent a collapse in confidence. It has bought a 9% stake in UBS for about US $6 bn, and allowed UBS to unload $54 bn of toxic assets into a fund controlled by the central bank. It obliged Credit Suisse to raise more capital.

Switzerland had to act because the two Swiss giants would have been torn apart by speculators (as Royal Bank of Scotland nearly was). UBS had net outflows of SFr50 bn in the third quarter, and an outflow of SFr34.5 bn from its asset management division.

Banking is the source of 15% of Swiss GDP, and it was being called "another Iceland' in the media (e.g. The Independent). While Iceland's banks had deposits equivalent to 9 times GDP, Switzerland was exposed because its deposits are 7 times GDP. Yet it has more resources than Iceland, and its other banks do not appear to be affected by the suicidal lunacy that made UBS gorge on subprime.

Switzerland's banks are now well capitalized, and it has said that if refinancing becomes a problem, it would guarantee banks' new short- and medium "“term interbank liabilities and money market transactions. This statement may be sufficient to protect the banks from further speculation and funding problems and could perhaps be a precedent for New Zealand, whose bank's large funding needs were explicitly detailed exclusively in this column last week.

South Korea

South Korea is the eleventh largest economy and one of the world's most dynamic. But the market suspects that it cannot service its debts. It is, therefore. poignantly revisiting the convulsions of the Asia financial crisis of 1997-8, when it was ignominiously bailed out by the IMF. Its currency, the Won, has plunged by 30% this year to a 10-year low amidst an extraordinary scramble for dollars.

The Korean's problems are very similar to New Zealand's'. It banks and consumers have taken on too much debt (private sector debt is 180% of GDP), and rely upon foreign banks for wholesale funding. Korea has $175bn in external short-term debt to be rolled over by next June .NZ has NZ$77bn to roll over in 6 months, and its household's debt is about 160% of income.

In most Asian countries, banks have more deposits than they can lend to consumers, but Korea has a 180% loan "“to- deposit ratio. Moody's has changed its outlook on the big four banks to negative. Fitch also says that "the liquidity squeeze is serious and it may evolve into an issue of solvency".

Although Korea also has a CAD problem, there are positives as growth is 5%, and the central bank has huge reserves. Its exports are very successful and will be boosted by a depreciating won. Yet there is panic; President Lee has urged the people to cut energy by 10% to cut down the CAD, and he also urged cutting down overseas expenditure. The stock market has lost 55% in dollar terms.

On October 19, the state announced a rescue package worth about $130bn for its banks and companies suffering a foreign exchange liquidity crunch. It guaranteed bank debts for three years, and gave an additional $15 to local banks to shore up troubled small business. Korea has perhaps warded off default by supporting its banks which need about $6 bn a month in foreign currency. It has also made provision for banks faced with dollar shortages to draw on a $30bn fund of foreign exchange reserves. New Zealand has about NZ$15 bn in total official reserves.

South Korea's difficulties reveal how rapidly the credit crunch is gaining momentum. It is a successful exporter and has vast foreign exchange reserves, but its domestic debt has exposed it to grave difficulty.

Others

When the mammoth British, American, German and even Swiss banking systems needing government support, it is not surprising that many other countries are in difficulty. Newsweek recently highlighted about 15, including New Zealand. Pakistan has used up its reserves and is courting for loans the IMF, the Asian Development Bank, and such bilateral donors as Saudi and China. The Ukraine has accepted an IMF loan of $14 bn; Hungary has borrowed $5bn from the European Central Bank. Fitch has "negative outlook" for Estonia, Georgia, Kazakhstan, Kenya, Latvia, Lithuania, Romania, Ukraine, Venezuela and Vietnam. (www.fitchratings.com)

Last word

The credit crisis is spreading beyond the banks and other corporates. It is salutary that countries with large debt and current account deficits are encountering sobering difficulty.

*Neville Bennett is a long-time Senior Lecturer in History at the University of Canterbury, where he has taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared.