Latvia: saving the banks, not the people.
from Merijn Knibbe
Time flies. Hardly a year ago (July 2009), The International Monetary Fund’s head of the Baltic states (Estland, Latvia, Lithuania) and Poland, mr. Rosenberg, wrote:
“Finally, Latvia has a clear exit strategy from its currency predicament: euro adoption”
Clearly, this is, at the moment, no option anymore. But why did Rosenberg write this? After 1991, Latvia became free again. Economic shock therapy however led, between 1990 and 1994, to a 50% drop of GDP. Some years later, the economy started to pick up steam again and in 2004, the 1990 level was reached again. Post-2004 growth was high and the economy started to overheat: wages rose 20% per year, inflation increased to 10% in 2007 and 15% in 2008, there was a real estate bubble - all this while the Latvian currency (the Lat) was pegged to the Euro.
Post-2008, the Baltic countries (together: about 5 million inhabitants) however experienced the worst downturn of the ‘western’ world, GDP fell about 25% (and is, in the case of Latvia, almost exactly back to the 1990 level). Unemployment is about 20%. The Lat is still pegged to the Euro. By the way, the Baltic governments where quite prudent, fiscally, before 2008. The crisis seems to have bottomed out, but the situation still is dire and it seems that droves of people are leaving the countries.
The IMF still advises these countries to continue the peg, to save the banks:
“Rosenberg also underlines that a devaluation in Latvia would have severe regional contagion effects: market confidence in foreign banks invested in the Baltics and similar countries would likely be affected, with implications for their ability to access wholesale financing. Latvia’s banks, both domestic and foreign, and its legal system are at this point not prepared for such a shock”
The Latvian government has to continue with its policy of ‘internal devaluation’, a slow and painfull proces which aims at cutting wages and which seemingly requires Uber-unemployment. However. Since the beginning of 2010, the Euro appreciated about 10% to the Swedish krona and since May, to the dollar, a swift and irresistible process. When Latvia continues the peg, it’s therefore in fact appreciating – a one day 1,5% appreciation, and such appreciations do happen, might nullify months of internal devaluation!
What’s good about that, Mr. Rosenberg? Do you consider 20% unemployment to be a shock? Should economists consider if the Latvian legal system and society is prepared for such a shock? Believe me, it’s my honest convinction that at this moment the wrong people are unemployed
You might, as you are making the same mistakes all over again, also consider to do some reading about differences in economic growth and unemployment in the countries who, in the thirties, left the gold block and the countries who didn’t (and yes, I do know about the gold hoarding by France – but that’s exactly the point. That also amounted to revaluating an already overvalued currency). And didn’t Argentina do much better after ‘unpegging’ it’s currency and defaulting on its debt?
P.S. Even Dutch economists are starting to argue that banks are loosing their ‘licence to operate’, after a report of a committee investigating bank behavior in the Netherlands and headed by a former head of Unilever became public. Why would that be, Mr. Rosenberg?
P.P.S. – Sweden seems to do fine, at the moment.
Michael Hudson, who was an adviser to the Latvian govt, has a very good blog on this.