Europe's D-generation

The spectre of another east versus west divide immediately reverberated worldwide. But the definition of the schism - allegedly between "old" European member states refusing to help the "new" - should have been demolished just as quickly. The first, resounding 'no' came not from the Old West but from the Polish Finance Minister, Jacek Rostowski, who vigorously opposed blanket bail-outs, warning they would bloat public debt. His comments were curiously under-reported but echoed by his Czech counterpart. Both nations refused to support the request, with Poland adding bluntly it had no desire to "end up like Hungary".

Thomas Klau, the Paris director of the European Council on Foreign Relations, says that characterising the EU crisis as Old versus New "makes no sense economically". Greece, for instance, was potentially in much worse shape than, say, Poland, and yet the Czech Republic and Poland had said no to Hungary.

"The old member states have not refused to help," Klau told the Herald. "Angela Merkel [the German chancellor] made clear that help would be offered on a case by case basis if it is needed. Help was extended by the IMF to both Hungary and Lithuania at an earlier stage. Of course both the European Union and the Eurozone are facing serious issues … but at the core of both sets of problems is the question of how much solidarity the member states most affected by the crisis can expect from those who are better off."

No European nation has been spared the Lehman Brothers "perfect storm" unleashed last September: credit markets froze, sharemarkets nosedived, business confidence plunged. Yet the diseases of each of the 27 member nations have manifested differently, straining bonds between the bigger, stronger nations and their weaker, smaller neighbours, and those of the EU as a whole.

German sales are dwindling as demand from its biggest markets in the US and Asia plummets. Deutsche Bank predicts a contraction of 9 per cent this year. For Spain, a collapsed property market delivered the biggest blow. The economy continues to shrink alarmingly, the budget deficit is ballooning, unemployment is skyrocketing and industrial production has had its biggest drop in 16 years. France, cushioned by a big and solid public sector, is now wrestling with an enormous deficit that burst through the EU limit. French growth has slowed dramatically, consumer demand is stagnating and house prices are falling.

In Italy, the appetite of the Prime Minister, Silvio Berlusconi, for reform - except for populist anti immigration and law and order pledges - has abated in the face of burgeoning public debt. Meanwhile Britain, after bailing out poisoned banks, stares down the barrel of mind-boggling public borrowing, a contracting economy and years of fiscal constraint.

Eastern Europe is just as fevered as economies shrink for the first time in years. The IMF has bailed out Hungary, Latvia and Ukraine. Turkey is next, and the IMF is fast running out of cash.

Still, not every nation should be plonked into the same disaster basket. Shielded by a big domestic market, Poland is slightly more stable, despite a battered currency, while Estonia, the Czech Republic and Slovenia have kept lids on debt. But all are casualties of the huge investment from enthusiastic west European banks keen to exploit new markets after the fall of communism. As the crisis bites deeper, foreigners are retreating to their own domestic problems.

IN A pizzeria in downtown Budapest, serendipitously across the road from the Captain Cook bar, a group of Aussie expats - and Aussie Hungarians - are having a drink and monthly get-together. Academics, financiers, a retired banker and diplomat, small business people and retirees all are acutely attuned to Hungary's economic and burgeoning social woes.

Diane Stone, a professor of politics and international studies at Warwick University, in Hungary, says the critical nature of the crisis did not hit with the population until the end of last year.

"Until Christmas everyone was slightly deluded … now it has actually hit, and working people are affected, the rise in mortgage payments … the weight of debt is being felt. There is always a real danger in these times of crisis that it galvanises and fosters a return to nationalistic sentiments and protectionism."

Julius Szekeres, an architect and Budapest project manager, studied in Australia. "Everything new has stopped," he says. "There are huge projects banking up … the message is 'we are putting it on ice, let's wait a year and see what happens'. Ordinary people too are starting to suffer; a lot of people here live day to day."

Karin Bryce, the managing director of Travel Unlimited, has lived in Budapest since the early 1990s. Airlines have reported downturns of 40 per cent. "A lot of the foreign multinationals are making non-local staff redundant." Big clients are scaling back enormously.

The Hungarian currency, the forint, is in free fall, trapping tens of thousands of borrowers who took out low-interest loans in foreign currencies - mostly in Swiss francs and euros via Austria. A human calamity is unfolding as homeowners face multiplying repayments. In Poland the Baltics and the Ukraine, the story of foreign-sourced loans is similar.

Driving through Budapest on Thursday, beneath leaden skies, Lajos Kaszab, 28, our taxi driver tells his story. Married, no children with his young wife a newly qualified lawyer, Lajos has a degree in finance and until a couple of months ago worked as an investigator with the Hungarian financial guards. Now he has left a job he loved to drive a taxi for a Budapest hotel; he can worker longer hours and more days to cover his mortgage, up 40 per cent in just a few months.

"I knew there was a risk with foreign mortgages; we were told but … ." The bank played downthe risk? "Yes. Very much."

Says union boss Petaky, who admits he too has a foreign loan: "The population of Hungary made rational decisions to take out a loan at a lower interest rate within a [monetary policy] it could not influence. Now everyone wants the population to pay."

And there is the rub. The personal problem of Lajos and Petaky is western Europe's problem writ large. Estimates that eastern Europe borrowed $US1.7 trillion ($2.6 trillion), much of it in short-term maturities, means it must repay about $US400 billion this year alone - about the equivalent of a third of the region's economic output. Nearly all this debt is owed to banks in Austria, Belgium, Italy, Greece and Sweden.

Analysts are peering anxiously back to 193,1 when the collapse of the Austrian bank Creditanstalt sparked panic across Europe. While sums are substantially smaller than those bound up in the US subprime mess, Europe is not managed by a single policy maker. Its institutional financial arrangements, therefore, are inadequate for quick, concerted action in an emergency. The rotating leadership has diluted its political messages and no leader has had a loud enough voice - or sufficient clout - to signal to investors and the markets that Europe will intervene as a union if needed.

Meanwhile, the European Central Bank does not have the powers to become the 11th hour lender or to pour emergency funds into the market.

Analysts argue that without a central mechanism to persuade taxpayers of the bigger economies to step in and bail out neighbouring banks and mortgage holders, another catastrophe is around the corner.

Born in the aftermath of World War II to try to secure a level of peace between victors and vanquished, the European Union began in 1951 as a common coal and steel market for the six founding countries - Belgium, France, Germany, Italy, Luxembourg and the Netherlands. It evolved into a coalition bound by common trade and agriculture policies, and then into a Parliament.

After the fall of the Berlin Wall in 1989 and the dissolution of the Soviet Union in 1991 old divisions began to dissolve and the EU expanded further, followed by a single currency. The 1999 introduction of the euro renewed European dynamism and led to the entry of former Soviet bloc nations and, more recently, the Mediterranean islands of Cyprus and Malta. Today, there are 27 member states.

More than ever, analysts warn this crisis must serve as the catalyst for financial and institutional reform so that future economic emergencies are met more decisively.

Klau argues that the EU will be all the stronger if it targets help to the hardest hit member states.

"It is essential that governments and people don't lose faith in the ability that crisis can be overcome with unity … without nothing to fear but fear itself."

On a rattling old bendy bus to the Eresci markets on Budapest's outskirts, the graceful tree-lined boulevards give way to endless grey, grim concrete, graffitied flyways and paddocks covered in debris from abandoned demolition sites. An olive-skinned woman boards the bus with an enormous, half-drunk bottle of cheap wine, and takes a gulp. Two neo-Nazi skinheads swagger the length of the bus with menacing self-satisfaction.

At the flea markets, once a mecca for tourists seeking cheap vintage clothes and antique bargains, Gyorgi, owner of one of the few undercover shops, says things started going bad in October.

"First the tourists, the Italians, the Spanish, they not want to pay so much. Now nobody comes and nobody buys."

Outside, a cold wind has risen and a stallholder selling Nazi memorabilia, badges, helmets, hideous gas masks and embroidered flags, huddles in an old deckchair.

Paola Totaro is the Herald's Europe correspondent.