Default Latvia, Save Yourself

Sometimes when you go looking for trouble you find it.  Poor Latvia!! Wonderful advanced nation, intellectually and culturally,  brought to its knees by these crazy austerity policies.  

And please accept my apologies for not learning of what has been occurring there before.  Mea culpa, too much main stream media. 

So I went out and did some research on the Latvian economy over the last 5 years.  Thriving growth, with systemic flaws built in so that it could not withstand the GFC (See later).  When I think of a growth comparison, I think of China, which successfully (so far?) has avoided the painful contraction experienced by Latvia.  Evan though it is effectively pegged to the US$ (but closed capital flows).  Then when I think of its flaws, I think of Hong Kong, the pegged exchange rate (to the US$) which brought HK to its knees in the late nineties.  (With open capital flows).

Prof Michael Hudson and Prof Jeffrey Sommers of Global Research wrote about it in February 2010, referring to the policies implemented as “Latvia’s Neoliberal Policies”.  They suggest that “It is not only economic, but demographic. Its 25.5 percent plunge in GDP over just the past two years (almost 20 percent in this past year alone) is already the worst two-year drop on record.”

Then this very comprehensive report (well worth a read), speaks to the fact that it is highly unlikely to overcome its economic problems.  Written in May 2011, it first discusses the “BELLS (Bulgaria, Estonia, Latvia and Lithuania) who in their wisdom decided to adopt and then stick "come hell or high water" to a currency peg with to Euro.”

Rather than referring to the label Neoliberalism, the report refers to the country adopting an “internal devaluation”.  It used to be known as “wage and price deflation”, and is widely disparaged. This is the alternative to an “external devaluation”, ie breaking the peg to the Euro.  In the former the collective population suffer and it is severe and long.  In the latter, the pain is spread far more widely around the world, and is shallow and brief.  

We get an update on the above, with it being reported that “Latvian GDP expanded by a quarterly 1.5% in Q3 2010, by 0.9% in Q4 and by 0.2% in Q1 2011. Thus Latvian GDP has been steadily slowing, and this despite the fact that the export environment in the first three months of this year was exceptionally positive, and Latvian exports were booming. Latvian GDP fell by around 25% during the crisis, and has subsequently rebounded by 5% (over 5 quarters). We are far from a "V" shaped recovery, and pardon me if I mention it, but it is precisely the sort of thing most macroeconomists were imagining would happen.”

But it also provides the most horrific data of all, that 85% of Latvian mortgages are in Euro denominated currency.  So in effect, Latvia may not use the mechanism of an external devaluation – which is a proven successful policy path or 85% of its mortgagors will default and potentially lose their homes.

This report (again, May 2011) then goes on to show that CPI and PPI is rising, as GDP “rebound” – more like a dead cat bounce – is slowing.  That is called stagflation:  rising CPI and falling GDP.  And for growth it is reliant on exports, which represent only 10% of the economy, and of which 70% go to Europe – itself a mess.  Almost hopeless.  It is locked into a boom bust economy with a downward spiral. 

And official data shows that the population fell by 13% from 2000 and 2011.  As its youth look overseas for better paid work.  Unemployment is high at around 14%.  This WSJ also reports, that the IMF lowered its forecast GDP to 1.5% because of the worsening outlook in Europe.  

In this recent interview on the BBC of the Latvian Prime Minister gives a seemingly rational argument for internal devaluation, but who in the end wears the cost?  It has been horrific.  “Low government spending has kept unemployment high, at over 16%, which is more than in Greece. And even those still in work say that wages are often too low to survive on.  "Over the last two years, 200,000 people have left the country, and a lot of households remain deeply in debt, unable to pay," says economist Alf Vanags. "Huge numbers of people are at risk of poverty when they otherwise wouldn't have been."  Also the people seemingly have virtually no effective trade unions, so no one other than the government to fight their corner.  And it is locked into do or die EU relationship.  

Default I say, forgive % of the mortgages or go 1:2 conversion so the relationship to earnings and loans is reasonable, and let the banks go bust.  They are mostly Nordic or Swedish anyway.  Then set up banking co-operatives:  they are always more successful (well there are some bad stories, but if managed to the spirit of co-operative financial services, they are the best model.  AND they are owned by the people, not the global institutions).  

And as with many things there is an unlikely precedent.  In the late 90's Asian crisis, the South Korean economy remained in the doldrums.  The government introduced through its banking system [local] credit cards for all, and I recall there were tax deductions for interest rates.  This policy was intended to encourage consumption to give the economy a boost.  And it did.  But of course it then went too far, and people could not repay the new debts - being a country of savers and few debts, they were not prepared for the discipline of debt.  So the debt recovery experts for the banks started to get heavy with the defaulters, there was mass outrage from the people, then there was mass defaults.  Effectively a credit card repayment strike across the country.  You guessed it.  The banks in the end had to write off massive losses. 

I mean, if 85% of Latvian mortgages are in Euros to external banks, what's the loss?  If you all go on strike, then some resolution will have to be reached. 

85% of mortgages in EURO is a significant systemic flaw.  Currency risks should always only sit with those that have the wherewithal to manage them.  That is not the general population.  Default Latvia I say.  Let go of the peg, and let the losses fall where they may.  And you will have a vibrant economy again real soon.

Which is of course the last thing the French / German doom mongers want.  Because you would then be competing for their business.