Today's comment is by Eric Roseman, Investment Director for The Sovereign Society and editor of Global Mutual Fund Investor.

Dear A-Letter Reader,

Hungary faces serious economic troubles right now. And those troubles could possibly cause an emerging markets crisis in Eastern Europe.

Experts, including the World Bank, are warning the Hungarian government to get their act together. Specifically, Hungary has to get its spending under control. Right now, Hungary's debt levels are approaching 10% of the country's gross domestic product.

The last emerging markets fiasco, triggered by Thailand in July 1997, engulfed the entire Asian region and lead to the worst economic recession since the post-WW II period. Almost ten years later, Asia has its economic house under control, supported by rising trade balances, impressive growth rates and generally undervalued currencies versus the U.S. dollar and euro. The region is also home to the largest concentration of U.S. dollar reserves, now approaching $1 trillion dollars in China alone and over $2 trillion dollars, if you count reserves in Japan, Taiwan, South Korea and Singapore. 

But Eastern European economies are now suffering the consequences of rapid economic growth since 1991 and some countries, including Hungary, Poland and Slovakia, face growing fiscal imbalances in 2007.
 
Hungary, however, is increasingly viewed as a "black eye" in Brussels, where the European Union parliament is based. Indeed, Eastern Europe has achieved remarkable economic success over the last 15 years since the demise of communism. Lately, this region has been attracting Western European manufacturing because of its low relative tax rates and cheap labor. But in Hungary, the government and the private sector have accumulated massive levels of debt, over half borrowed in euro and Swiss francs. The danger of borrowing in foreign currencies comes home to roost when a country's base currency declines in value. This is what occurred in Asia in the late 1990s as several currencies crashed.      

Over the last five months, Hungarian capital markets have suffered declines amid broad-based selling by foreigners disappointed by the country's persistently high budget deficits and political chaos. In late September, Hungarians took to the streets of Budapest, protesting the government's false claims during elections that the economy was healthy. In fact, the economy is slowing, interest rates are rising, debt levels are soaring and the country's living standards are declining relative to its Eastern European neighbors.

Although not a severe sell-off by historical emerging market standards, the Hungarian currency, the forint has declined 3% versus the U.S. dollar in 2006, and 10% against the euro and Swiss franc. With every percentage decline, the forint grows more vulnerable to capital flight (i.e. cash quickly leaving the country).

In May, global investors dumped Icelandic and Turkish currencies, resulting in sharp declines in just days. International investors also aggressively dumped Hungary last spring, but Hungary's EU membership and close economic ties to Germany and Austria prevented a sharper correction or a major crash.

But the way I see it, Hungary won't crash. The Hungarian government is now under formidable pressure by Brussels to get its balance of payments back into surplus. The government has raised interest rates to stave-off capital flight and that should stabilize markets. Also, unlike Asia a decade ago, Hungary has close economic and political ties to Germanic countries with substantial investments in the local economy. Both Germany and Austria are viewed as conservative economies historically harboring fiscal discipline. That was certainly not the case with Asia in the late 1990s during the last emerging markets crisis.

Plus, despite all the negative press surrounding the market, the forint has declined marginally while the Hungary BUX Index is down 14% from its May high.

Are there any compelling bargains to be had in Budapest now? Probably, but I'd rather avoid the region altogether until the fireworks subside. For greater bargains accompanied by steeper stock market declines this year, the Baltic Republics look far more rewarding over the next 12-24 months. I'll delve into Lithuania, Latvia and Estonia in upcoming issues of The Sovereign Individual and feature the world's top-performing Baltic Republics mutual fund - up more than 30% per annum since 2000.  

ERIC ROSEMAN, Investment Director
on behalf of The Sovereign Society

• Immunize your investments against downturns or bear markets...
• Access investments, unavailable in your home country, that offer safe income and principal...
• Protect your wealth from personal injury, malpractice, environmental or employee lawsuits...
• Save your loved ones' inheritance from claims and excessive estate taxes or government confiscation...
• And more...