Friday, December 26, 2008

Hookers that still cost too much – some comments on the IMF and Latvia

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.

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. 


Edward Hugh said...

Hello John,

Just to wish you the seasons greetings. And say keep up the good work.

Best wishes,


CV said...

Hi John,

Thanks for the plug and the kind words.

As I have mentioned before; you are bang on in connection to the link with the scandinavian banks (this is THE key here). One can only speculate on the political yug-of-war which has been going on behind the curtain.

Ultimately though, this is a very bad decision for two reasons basically.

Firstly, The Baltics are part of the rest of the CEE and as we can see in Ukraine not to mention Russia they are already devaluing like their life depended on it (which it does I guess). In this light the Baltics will simply end up even further down the ladder since they will be uncompetitive relative to their peers.

Secondly, there is the Euro itself. Clearly, the zone has its share of problems but if the USD is now set to crumble under the weight of QE, then the ensuing, if short lived, rally of the Euro (against the JPY too I guess) could quite simply end up breaking the whole edifice with a big bang.


Anonymous said...

It is a criminal offence in Latvia to mention in public the possibility of a devaluation of the Lat and the Latvian Secret Police are busy searching for and arresting those who have negative opinions about the Latvian economy. You may have been under an illusion that the EU was founded on democracy. I advise you to avoid visiting Latvia as you could be arrested at the airport. I would also advise you to look out for suspicious individuals tracking oyu in your neighbourhood, but I suspect the airfares would blow their budget.

Anonymous said...

NEWSFLASH regarding Estonia...
This one goes to the clown-president Ilves:

Estonian President Toomas Hendrik Ilves said yesterday that he was too optimistic about the economy a year ago

Last year on new-years eve prez blamed bad people (read bloggers) for bad mouthing the economy.

Now comes the preparation for devaluation:

Estonia is in talks with banks on financing

The government today approved the draft from the Ministry of Finance that makes the state faster when guaranteeing financial stability.

As a side speculation note: Estonian law used to require the parliament to vote on devaluation in three public readings, guess that took care of that need.

And the final one is in Estonian, sorry BBN did not post it in English, no devaluation with strings attached. And the strings attached are impossible in recession/depression environment Estonia is in. You can bet the devaluation is now in the cards:

Estomian president talks about devaluation

Fasten your seat belts gents. It will be an awesome 2009!

John Haskell said...

John- somewhat off topic but wondering if you wanted to update your WaMu/Sheila Bair call in the light of the fact that meth was a recognized aid to loan underwriting and their unofficial motto seems to have been "a thin file is a good file." Thanks.

Anonymous said...

Here's what Björn Wahlroos, the CEO of banking concern Sampo, and arguably the top name of finance in Finland, told the Swedish press (as translated by some reader of

"Q: What is your view on the general economic situation of the Baltics?

- It is a tough situation because of a single reason. All of them have overvalued currencies, in varying degrees. For those of us who lived through year 1991 in Finland, a trip to the Baltics is a deja vu. It is completely absurd that people believe there's benefit for anyone in maintaining an overvalued currency. It is the surest way to throttle all economic activity in those countries, they lose totally their competitiveness vs. foreign countries, now that the domestic price level is higher than it should be."

Sampo (part of Den Danske Bank) is the third biggest bank in Estonia.

Anonymous said...


I think you have missed one importatnt / funny interview.

Minister of Finance of the Republic of Latvia Mr Atis Slakteris to Bloomberg (before IMF decision) ( link video: ). Bloomberg removed video after Ministry of Finance asked!?

The key phrase is "nothing special slakteris". Just do a google search.

Best wishes,
A little worried citizen of Latvia.

MM said...


Whores in Riga are overpriced indeed, and the level of service is really poor. But this is not third world country. And don't blame Swedish or any other Scandinavian banks for that, - sex tourism was not funded from capital inflows from abroad, but tourist inflows from Britain.

You (and all other observers you quote) seem to forget that all of the country's foreign debt is in EUR, not just business and private sector, but the government too. What recovery would you project in a defaulted state? Second, you seem to underestimate external effect - not just Estonia and Liathuania, but some much more indebted euro area countries like Greece and Italy.

Baltic countries underwent much larger economic contraction during early nineties than it will take to adjust for excessive curreent account deficit now. With so high mobility of labor and so small population of the Baltic countries, it will just take half a year. You really CAN NOT compare Argentina, which had 36 m. inhabitants with the Baltics, which in total have 7 m.

It seems that you like symbolic comparisons. So consider this one. What is Latvia? It is just a night club for British and Russian tourists. What is a current account of a night club? Off course it is negative! And off course, this negative is very large!

Anonymous said...

Recently Svenska Dagbladet published an interview with Christoph Rosenberg, who is an IMF chief in East Europe.

Some quotes translated from the article:

"Saviour of Latvia

The Swedish government did not want Latvia to devalue. The reason: Baltics are too important for Swedish banks. The government was also worried that the market would punish them..."

"– I have had a lot of contact with both Swedish banks and the Swedish government. The Swedish Government was a driving force in getting other countries into this agreement..."

"Q: Do you have any advice for the Swedish banks?

- As a part of agreement we asked that the banks would make a clear statement they are going to keep the same (level of) credit expansion as in November 2008. What we did not want, was that they would leave the markets like the Japanese banks did during the crisis in Asia, he says and stresses that it is important the foreign banks meet their subsidiaries' financing needs in the afflicted countries. ..."

So, if we take him by his words, it was the Swedish banks & government, who are main reason Latvia did not devalue their currency. On the other hand, a week ago Mr. Rosenberg published this writing in defense of their 'non-devaluation', giving a slightly different set of reasons:

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