Latvia: Should You Care?

In the current field of grand economic strategy, against crisis and for recovery, Latvia looms small. This is a country with just two million residents, best known recently for a huge current account deficit – the excess of imports over exports peaked out around 25 percent of GDP.  Ordinarily, there is nothing here that should move the world economy.

Yet, there are some intriguing and somewhat disconcerting signs that point towards our common future – much like a close study of Iceland, back in October 2008, told us a great deal about what was to come.

First and foremost, we are looking at a creditor bailout-type situation.  Latvia is receiving large amounts of foreign financial assistance – from the IMF and the European Union – with the express purpose of making all payments due on its debts (mostly owed to West European banks; thank you, Sweden).  This is strikingly reminiscent of Latin America after 1982: above all else, protect the foreign banks.

Second, the bailout – at Latvia’s request – focuses on keeping the exchange rate peg.  The payments adjustment (exports up, imports down) must still come entirely from lower wages and prices.  This is an incredibly difficult task, which brings to mind Argentina’s struggles within its currency board in the 1990s.  If you make it very costly to change an exchange rate, you won’t devalue – until you absolutely have to, and then of course it is very costly.

Third, there is a fundamental contradiction in the approach favored by Latvia and the European Union.  They say they can’t consider devaluation, because so many households have borrowed so heavily through mortgages denominated in foreign currency.  But what happens to real debt payments as wages fall?  Is debt default being avoided or just deferred until the banks have got their money out – and the IMF has come in to the full extent possible?

My takeaway: we are still not ready for hard economic conversations anywhere in the world.  Wishful thinking prevails, in Europe as much as in the United States.  No one wants to start the difficult and messy task of restructuring – i.e., reducing – debt payments.  Everyone feels entitled to a bailout.  And the banks get one.

Or put it to your elected representative like this – we’re transferring Latvia’s debts from European banks onto the IMF, which is underwritten by our future tax dollars; then there will be default and devaluation for which no one is prepared.

Brussels, you’re doing a heck of a job.

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