Tuesday, May 12, 2009

The hookers no longer cost too much: geopolitics and the price of prostitutes in the Baltic States

There is a article about me and about the Bronte Capital blog in the Sydney Morning Herald today. It mentions that I diagnosed the economic problems in Eastern Europe by analysing the price of hookers. That is true as far as it goes – though the original post was more nuanced than that.

The blog however owes a thank you to the (now suffering) people of Latvia. Before I mentioned their forthcoming problems I had about 50 readers. A post about the price of prostitutes got me my first 1000 reader day and my first mention in the main stream media (the Estonian business press).

For those that are new the argument was as follows:

  • Latvia and to a lesser extent Estonia and Lithuania had a massive and unsustainable current account deficit. That means they bought more from the rest of the world than they sold (just like America buys far more from China et al than they sell). The current account deficits (relative to GDP) was however much bigger in Latvia.
  • In a floating exchange rate regime this would usually be remedied by the currency falling dramatically, increasing the competitiveness of exports (and increasing the price of imports). The market provides a solution. With America this can't happen because the Chinese fix their currency against the US dollar. In the Baltic States the currency is fixed against the Euro.
  • Normally to fix the exchange rate a central banker needs to buy the currency that is tending weaker. They buy it and remove it from circulation. In so doing the reduce the money supply in the weaker currency causing interest rates to rise and a mild monetary deflation (increasing the competitiveness of local industry versus foreign competition) and hence over time remedying the current account deficit.
  • Unfortunately this monetary deflation causes a recession in the country with the naturally weaker currency. Ultimately that makes fixed rates unpopular in countries with chronic relative economic under-performance – because the populace doesn't like more or less continuous mild recessions. Some countries dealt with this through periodic competitive devaluations (Spain, Italy). Other just gave up on fixed exchange rates (UK). Generally the world has tended towards permanently fixed exchanges (Europe inside the Eurozone) or floating exchange rates (eg Australia).
  • Now there is one exception to the idea that the country with a fixed exchange rate and a lack of competitiveness has a sort-of-perpetual monetary squeeze and low-level recession. And that is if somebody cheaply finances your current account deficit ad-infinitum. Then you can have the nice strong currency and spend it and not have any domestic price pressure. Unfortunately you also wind up owing your foreign benefactors just way too much money.
  • The party has to end. And it can end quite sharply when the foreign benefactor becomes less willing to lend to you.
When that happens you are going to get a really big recession. If this sounds like the once seemingly endless willingness for foreigners to fund American spendthrift consumers you are right.

But in Latvia the situation was (at least) three times as unsustainable as the US. And ultmately Latvia has less credibility in repaying those loans than say the US.

When it ended in America we got a big recession.

In Latvia it ended when the Swedish banks providing the funding (Swedbank and SEB) themselves got into trouble. Latvia is experiencing something more akin to a depression. Latvian GDP has now dropped almost 20% - about the same proportionate drop as America in the Great Depression. And it is going to get worse still. This is really truly ugly – and the street riots I predicted in the original post have unfortunately happened in all the Baltic States. The governments (and the people can feed themselves) because of foreign aid – mostly through IMF packages funded by the Scandinavian governments.

Well what has all this got to do with the price of hookers?

At least partly for effect I noted that one of the most important (perhaps the most important) export industries in Latvia has been tourism. And it is not any type of tourism – it has traditionally been sex tourism. Latvians are beautiful Scandinavian people (if you like that Northern European look). They also have a more Scandinavian sexual morality and they were relatively poor. This meant that Ryanair put on discount flights and filled them with salivating Irish and English lads. Swill beer on the Friday flight over. Party all weekend, soil the plane on the way home. You could not walk around Riga as a single English guy and not be thought of as a Ryanair sex tourist.

The only problem is that the ridiculous exchange rate made the hookers very expensive.

Ryanair canceled the Shannon/Riga flight (and the Irish lads now go to Prague). The London Riga flights are less full. There are plenty of complaints on the web about over-priced bars and rip-offs in Riga. The oldest and one of the most dependable of professions was – due the ridiculous exchange rate situation – just priced out of existence.

Still markets are correcting in the end. Now that there is a Great Depression in Latvia there is price deflation. Lots of it.

The faster the deflation happens the faster Latvia will again become competitive. [Hint to the IMF – just float the currency and deal with the consequences of the new exchange rate rather than try to defend the old rate.]

Anyway the problem is that most industries have contractual arrangements which fix prices. Wages are very hard to flex downwards. Rents are fixed over sustained periods and the like. All of this means that people go bust rather than reduce prices – simply because prices are sticky.

Well – most prices. The contractual terms of prostitution are short (an hour, a night) and entry to the industry is unconstrained. That means that the prices are very flexible. Extraordinarily flexible.

The price – looking at websites I will not link for decency's sake – has fallen by at least two thirds in the past year – and the advertised price (for a non-English speaking young woman) is LVL30 – or less than 60 US dollars. I am sure the rip-offs are still there – but anecdotal evidence suggests the hookers no longer cost too much.

The first question is how far do other prices have to fall – and how bad will it get in Latvia before it improves.

I did say this was ultimately about geopolitics. The Baltic States all have sizable Russian Minorities. Russia under Putin is very concerned about the state in which those minorities live – and has been prepared to take military action to protect what it perceives as the interest of the Russian people. [Read Georgia/South Ossetia.]

Now I am not going to opine on the validity of the Russian claims. Tensions run very high on all sides.

I will note the Russian-Estonian relation riots in Estonia in particular have been lethal in the past (see the story of the Bronze Soldier).

And I will leave you with a somber note. In Latvia the hookers did cost too much. They don't any more – but most things still do – and there is no easy fix. However what is a classic text-book macroeconomic problem fast risks becoming a geopolitical one. And whilst there are big difficulties bailing out the Baltic economies one of them is not the size of the check you will need to write. These places are small and the checks disappear in a US or even European Budget.

And there are big difficulties allowing the Baltics to drown in their economic problems. Geopolitically a bailout looks like the cheap option.



Anonymous said...

Wow great pick-up

And here was I trying to gauge the economy by looking up to sales price of white toyota camry's on ebay (looking for an interational homogenious product)


Anonymous said...


The Bronze Soldier riot in Estonia has nothing to do with the depression riot. The real economic riots are still ahead for Estonia, you can just trust me on that.

The Bronze soldier riot was the same thing you would expect if say Australian government burned down some Baptist church in Australia and publicly peed on it. This would hurt lots of Baptists believers feelings and you would have get an Australian riot. Bronze soldier targeted Russian population and the purpose was to divide Estonian and Russian population among the looming economic crisis to force people to ignore economic problems and concentrate on the statue. It was also an attempt to revise the significance of the outcome of the World War II. Again, all this is to shift the attention from the economic problems. This is not quiet the same as depression riot, where people are angry because they are hungry and out of work.

Just want to make that remark to improve the perspective of that event. Lithuania and Latvia riots are real depression riots. Again, Estonia's riots are still down the pike.

The rest of the story is 100% accurate. I really enjoy reading your blog posts on Baltic Sates. Keep up the good work!

John Hempton said...

To Anon - I knew the Bronze soldier riots were about Russian Estonian relations. They pre-date the crisis - but I admit the post was ambiguous and have changed it to clear this up.

Anonymous said...

how expensive are hookers in sydney? quite expensive it seems.

as far as i know there were more 'riots' in australia than in east europe so far. holden, vroom, vroom.

the baltics had a few snowball fights and all the cubicle analysts fell on their backs. get real.

MW said...

Geopolitically, a bailout of Iceland was also a cheap option (the Russians were going to 'buy Iceland' to use it as an airbase, remember?), and that didn't happen.

Atticus said...

There is one piece missing in your picture. With Irish and British economies now in shambles, Irish and English lads will probably not get any financing for their overseas trips. Good times on borrowed money are coming to an end apparently...

z... ! ...z said...

I believe it was Michael Pettis (http://mpettis.com/) who pointed out the US has financed China's leveraged overcapacity by running huge trade deficits.

You write the party has to end, and this is true. But, one has to wonder the true extent of the cost to the Chinese in continuing to supress the US dollar, and note their rhetorical efforts to talk it down and reduce the cost.

Having lost control of US consumption, what options do the Chinese have? Quite a different situation from Latvia I would say.

Anonymous said...


Thanks for your blog, very interesting. I have read that the Latvian government already has started closing schools, hospitals etc. to reach a lower budget deficit. However, since the the economy contracts so fast even that is not enough. How much time do you think Latvia has before a total collapse?

Anonymous said...


Thanks for your post. How much time do you think Latvia still has before a total collapse?

Mara said...

Being Latvian, this latest article won't improve our punchline status one bit...
The riots were actually pretty peaceful until the cops got antsy at the end and started getting heavy with some drunk latvian guys (like there aren't LOADS of those on any given day). Then the violence erupted. We're actually pretty mellow folks. But once you've lost your job, food prices increased and you're up for moving back into your parents' one bedroom flat, tensions can, understandably, escalate.

The unfathomable part was the government's nodding acceptance to borrow from the IMF to pay for bad private loans given out by mostly swedish banks (for vastly overpriced real estate). Some of the loans were to locals, some other nationalities that wanted 2nd homes in Latvia. My understanding is that most of the mortgages were full recourse, but certainly not guaranteed by the govt. The real options for the govt would be to:
1. Allow the banks to repossess and auction the properties regardless of local or external ownership
2. Only allow repo on foreign owned properties
3. Allow no repossessions and nationalize the properties.

Of course, if I were in charge of "financial diplomacy" I would also include doing radical things like joining the SCO, getting off the euro and onto gold or renminbi, but only after I froze assets of the swedish banks and told them to go f*ck themselves for being so stupid in the first place. I would also outlaw mortgages being denominated in foreign currencies and/or payments tied to forex fluctuations, since agreeing to such terms is similar to prostitution, except it costs you, lasts for 15-30 years and does not come with lubricant. Of course, the above sentiment guarantees that I will not be burdened with accepting a nomination for any diplomatic post whatsoever.

John Hempton said...


Thanks for the comment - and actually I agree with you. It was absurd that the Latvian government borrowed money essentially to bail out the Swedish banks (and there is thus no more reason to be short Swedbank).

A little diplomacy and you could do better than you suggest - partially defaulting...

The problems were inflicted by bad policy AND bad Swedish banking.

Anonymous said...

Give me at least one website where I can verify the price (and pictures, phone numbers) myself. Any hotels in convenient areas that have gotten cheaper too?

Anonymous said...

On the relative prices of prositutes: In grad school, we used to call this PPPP (Pussy Purchasing Power Parity)

rahuldeodhar said...

It did predict a crisis. early warning deinitely.


General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.