Farrell: Hungary's Economic Recipe Is Goulash

That's what we are getting out of Hungary recently. A whole big stew, but of mystery meat and nothing clearly identifiable. A couple of officials from the newly elected government rattled the markets at the end of last week saying, essentially, Hungary was in over its head and could default.

A host of others, including central bankers, some folks from the previous government (figure they would say it ain't so), and a lot of credit analysts insisted the warnings were overstated and the country's finances were sounder than Greece's. That's not a very high bar to overcome, but their point was made.

Hungary's debt last year was 78% of GDP, not far from the Euro average of 74%, and a far cry from Greece's 115%. Budapest can still draw several million from the IMF structured loan set up in 2008. Peter Oszko, the finance minister for the previous socialist backed government, says the Fidesz party government led by Prime Minister Viktor Orban, had made exaggerated economic promises during the election campaign.

Now that it's time to prepare the Hungarian nation for further austerity measures mandated by the IMF deal, "They need to explain why they can't deliver an economic miracle", says Oszko.

The current government has naturally accused the prior administration of manipulating figures and lying about the state of the country's finances. We know that all politics is local but fighting in public with inflammatory words like they did is unconscionable. Who knows what is correct but another possibly shaky government can unhinge the market. If it's true, so be it. But keep the spat private until then.

The new cabinet met in emergency session over the weekend and said: No, no - false alarm. Then the PM's chief of staff, Mihaly Varga, said, according to the Wall Street Journal, "Hungary would stick to strict spending limits set in the country's agreement with the IMF and the European Union. He said Hungary wasn't at any risk of default."

"The government has created an artificial crisis," said Tibor Szanyi, an opposition socialist. "They wanted to exaggerate the situation for political ends. It is really dangerous to do that in the heart of Europe."

The theme of the G-20 finance meeting this past weekend was one of deficit reduction. That is raising fears if all the Euro zone members do the same it will result in a significant slowdown and could tip Europe back into recession. Germany, despite a Monday morning announcement of surprisingly strong factory orders, voted a 11 billion euro budget cut.

The Keynesians of the world would argue that a strong Germany should be spending money to fuel growth. Tim Geithner, the US Secretary of the Treasury, had hoped publicly that Germany would ramp up its spending as the weaker European countries focused on fiscal tightening.

If not that, then the European Central Bank should expand its purchase of government debt to grow the money supply. But the purchases have slowed down from EU 16 billion the first week to just EU 5.5 billion this past week. Furthermore, they insist on "sterilizing" the purchases (by issuing short term debt which takes the cash just paid for long term debt back out of the system) so there is no net gain to the money supply.

The stock market tried a mini-rally Monday morning but soon gave up the ghost. It looked like any buying was short covering as there is no conviction causing real buyers to step in, despite the market trading at what seems to be a very fair (if not low) price to earnings ratio. Our downside target has been (still is) 1040 on the S&P 500.

To repeat, that would be a 1/3rd correction of the entire advance from March 2009 when the average bottomed at 666. The market closed at 1050 Monday, off 14 points. Corrections are scary especially when they approach your downside target and fear starts to paralyze you.

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