This blog was early on giving a public cry on the Latvian economy. I have the Latvian crisis to thank for a lot of my readership – it was about 50 per day until I wrote a post about the looming economic crisis in the Baltics – and illustrated the lack of competitiveness of the Baltic economy by talking about the price of prostitutes. That single post raised my readership by over 1000 percent - and it has risen - albeit more slowly - ever since. The post even warranted my first mention in the mainstream media – in the Estonian business press.
I guess it was subject matter. With some cynicism I suggested that sex tourism was the main Latvian export – and if you wanted to know about the domestic competitiveness then you should look at the price of prostitutes. The technocratic economists want to talk about “real effective exchange rates” and I just want to talk about the cost of getting laid. Will the insanely clever PhD students out there (Claus you know I am talking about you) try to model that.
Anyway if you really are interested in this I suggest you read the original post here… It is (my opinion) one of the best posts on this blog – so I hope you will not think I am wasting your time.
That said – the situation was that the Scandinavian banks – most notably Swedbank – had been funding the Latvian (and other Baltic) current account. This was a fixed exchange rate but in an uncompetitive economy that was not accompanied by the monetary crunch that the theory would suggest because the Scandy banks (especially Swedbank) were acting as the Latvian central bank and borrowing in Euro and lending in Lats. Locals told me that much of the lending was in Euro not Lats but the effect was the same. The Latvian current account deficit was sustainable as long as Swedbank was guaranteeing it – and Swedbank kept its credibility.
Unfortunately in a financial crisis – and with management as inept as Swedbank – it is rather tricky to maintain credibility. When trust in Swedbank eroded either (a) the Lat was about to get devalued massively – smashing up Swedbank either on currency risk or by making it impossible for Latvians to repay their Euro debt or (b) monetary policy – being a fixed exchange rate and an uncompetitive economy was about to re-assert itself and cause a great-depression level event in Latvia. When Swedbank could not sterlise the current account deficit the Latvian central bank would be forced to do it causing a monetary crunch of massive proportions.
I argued that the other Baltic states were more sustainable than Latvia – Estonia being bad and Lithuania being about as unsustainable as the United States.
Well – if you haven’t been following events – they are playing out rather like my blog post. Latvia has required an IMF bailout. Estonia is in a rather nasty recession. Lithuania is muddling on. The order predicted in my original post.
But – not in the scenario of the original post – the IMF has not required a devaluation of the Lat. Apparently the pressure from the Scandinavian banks was large – and the Scandy governments (presumably political play-things of their banks) are large contributors to the bailout. They have chosen a bailout with huge domestic contraction but a fixed peg. The last time the IMF tried that was Argentina and it was eventually a disaster with the peso peg being abandoned anyway.
There are plenty of raised eyebrows about the decision to keep the peg (see Krugman for instance) but the political economy is obvious…
First – abandonment of the peg is the most rapid way of showing the insolvency of the Scandy banks – and the Scandinavian governments are big contributors to the bailouts and – seemingly – political pawns of their banks.
The second reason for not abandoning the peg in Latvia is that it would take about 15 seconds to decide the peg is doomed in Estonia as well – and maybe – because a trilogy is three tragedies performed in quick succession – in Lithuania as well.
Anyway several people I admire (most notably a Fistful of Euros, Alpha Sources and also Krugman) have pointed out the obvious – that the monetary contraction that will happen will result in much lost production and loan failures anyway. The monetary contraction however comes from the loss of credibility of the real Latvian Central Bank – Swedbank. Once a real central bank has to give out its foreign exchange it will cause a crunch of gargantuan proportions.
So – score this for Bronte Capital. I admit my failures on this blog – and it is Christmas so I should indulge my successes.
As for how the bailout will work – I am with Edward Hugh of Fistful of Euros. It is Argentina mark 2.
And do I need evidence? Well I have spent 15 minutes searching around on the web – and the prostitutes still cost too much (though their price seems to be declining). If someone with first-hand experience wants to correct me then pop something (anonymously if you wish) in the comments.
John Hempton
I have resisted pouring more scorn on the totally inept Swedbank – but I should remind people that they purchased a bank in the Ukraine early last year for USD735 million. The bank had only 10 million of earnings – and most the 735 million was debt assumed.
They did this just in time for economic output to fall as much in the Ukraine as it did in the Great Depression in the US.
Next time Swedbank management wants to blow half a billion I have a bridge to sell them in Sydney. Their title will be just as good as their claim on the Ukraine!
This wouldn’t matter – but Swedbank was funding the Ukrainian current account deficit as well as the Latvian one – and when they stop the crash will be rather nasty.
