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Thursday, January 29, 2009

Message To Ilmars Rimsevics


"devaluation is a poison" and that "only pseudo-economists suggest Latvia devalue".

In this regard, it might be appropriate to consider the analogy with a pile of sand presented by the science journalist Mark Buchanan in his book Ubiquity: Why Catastrophes Happen. As a child, almost everybody has been building sand castles. We remember quite well that initially every single grain of sand which is added to the pile makes it bigger. In time, however, a certain point is reached, where the next grain causes a landslide instead of adding to the size of our edifice. Moreover, it is important to note that it is next to impossible to predict either which particular grain of sand will cause the landslide or how great and significant it will be. The author has a theory that this unpredictability is related to the instability that is unavoidable in the development process of any system. According to this theory then, even the most important events do not have special or extraordinary causes. These events can result from any, even the most insignificant of causes: a mere grain of sand that under different circumstances would probably be totally inconsequential and harmless.
Opening Remarks by the Governor of the Bank of Latvia Ilmars Rimsevics, Conference hosted by the Bank of Latvia - Latvia on Its Way to Prosperity: Growth Potential and Development Prospects, October 18, 2006.

I have one simple question. Given the latter, how can you be so sure of the former?

More opinions today.

Baltic Business News quotes economic analysts Hardo Pajula to the effect that the EEK has already effectively devalued, sinceit has lost its value since if a person loses half of income, "it’s the same as devaluation" (is this so hard to see, Edward).

“Devaluation is worsening of everyone’s standard of living at once and we have no escape from that in the near future. EEK has devalued for many of us since their incomes are smaller. Currently the devaluation moves from an individual to individual,” Pajula said.

Also Erkki Raasuke, Swedbank Baltic CEO has warned that "if the state cannot make the necessary cuts we’ll all go bankrupt".

“If Estonia can’t go necessary cuts, we’ll go bankrupt. There are examples to take and one should mostly look at Iceland. Problems are different, but it still should be terrifying enough to discipline us,” Raasuke said. “One option is devaluation here and not with all its destructive after-effects. Then we have that option politicians currently try to do – through deflation, decreasing the costs. Here the first question is discipline – are we capable of doing it? If we hesitate, we should pick the first option,” Raasuke said.

Please feel free to paste more "pseudo economic" opinions in comments if you find any.

Are Baltic labour markets really so "nimble", Maive Rute, SMEs’ competitiveness director at European Commission doesn't seem to think so:

“The relative inflexibility of the labour market is an issue that decreases the entrepreneurs’ readiness to create jobs and that especially affects the potential investors, who are interested in the attractiveness of the area. Our current legislations are rather inflexible compared to that of the EUs,” said Rute about the Commissions’ recommendations at that time.

Also Latvia's president Valdis Zatlers said on Tuesday that the country may fall deeper into recession than the 5 percent downturn currently forecast. If this is correct, then Latvia's situation would seem to be more critical with every passing day. Latvia's problems as a result of Parex (and related items) seem to be much more serious than Estonia's (ie it would be technically easier for Estonia to devalue), and the threat of credit downgrades and government debt which may be pushed over 60% of GDP put the eurozone 2012 exit strategy increasingly at risk. I think instead of talking about pseudo economists it would be better to come up with some practical solutions which have some hope of success. I think it reasonable to ask everyone to make sacrifices in a situation like this, but only sacrifices for a programme that can bring results.


Anonymous said...

> Baltic Business News quotes economic
> analysts Hardo Pajula to the effect
> that the EEK has already effectively
> devalued, sinceit has lost its value
> since if a person loses half of
> income, "it’s the same as devaluation"

This is indeed the case and this is why wage reductions actually have the same effect as devaluation.

However, devaluation will cause the collapse of Swedbank. This is politically unacceptable. I suspect this is why the Latvian body politic are pushing devaluation as being evil, lunatic, ridiculous, etc. (Also remember, this is the nation where people are being arrested and briefly jailed for publically talking about devaluation).

The problem is that wage reductions are simply harder for individuals to bear than devaluation. The abrupt drop in pay is much more objectionable than the less obvious and more gradual changes induced by devaluation.

The Latvian said...

European Commission provides forecast data on Latvia in its latest report (http://ec.europa.eu/economy_finance/pdf/2009/interimforecastjanuary/interim_forecast_jan_2009_en.pdf). On Page 32 there is summary table which states that Real Unit Labor costs will fall only by .7-.8 percent. My understanding that the whole idea about current measures was to increase competiteviness of the country and labor costs are significant part of the equation. So why this all suffering just to maintain almost flat real labor costs and as a result have large unemployment in country?

Does not it mean that EU is lending money for Latvia but admitting that the reforms are not going to work?! Or am I missing something?

Anonymous said...

"I think instead of talking about pseudo economists it would be better to come up with some practical solutions which have some hope of success."

I wonder if Mr.Rimsevics read this. :)
However that may be, he told in an interview today that they are going to repair the facade of Bank of Latvia building in the near future and that it will heat up economics ("otherwise by not spending money it will get frozen" he said).

They are also going to buy a new Audi A8 car. Rimsevics commented this by saying "If people won't buy anything, everything stops".

I wonder if we can call this the first practical solution offered for the improvement of current situation. :)

Miacek said...

Today, an Estonian economist called Andres Arrak claimed devaluation in Estonia would be useless, as ''we import most of our raw materials'' and he compared devaluation with ''pissing in one's trousers''.


Edward Hugh said...

Hello everyone,

I'm a bit busy at the moment, but I am enjoying the comments in the background. But

''we import most of our raw materials'' and he compared devaluation with ''pissing in one's trousers''.

I will try and answer this in a coming post, but basically it depends on whether you are trying to increase or decrease your current account deficit, or, I suppose, following his metaphor, which way the wind is blowing :)

Basically if you want to reduce the CA deficit because no one will lend to you, you need to reduce imports not encourage them. If the imports are for re-export, its doesn't it seems to me, matter what price you pay for them, since they effectively go out at the same price plus any value you add. Estonia is a price taker in this sense.

Of course, if you want cheap raw materials for domestic consumption, then that is another problem, but you need to pay for these, hence we get back to exports.

Basically, the argument is what to do about the bank bailout, and especially the Parex (Iceland type) case. Christof, me, and virtually everyone else who knows something about CA corrections knows that if it wasn't for Parex etc Latvia would be a lot better off devaluing. I still feel it is, since I don't agree that the whole cost of Parex should be simply passed over to Latvian public debt.

There is very little evidence of something like they are proposing working. This is what the IMF say in the report.

"Cross-country evidence indicates that there have been a number of episodes of important real exchange rate depreciation under currency pegs. However, in many of these cases, the real depreciation was achieved with help from outside forces, such as high inflation in trading partners or being pegged to a country that was not a dominant trading partner. The table below show countries with currency pegs that underwent real depreciations of 15 percent or more while preserving their pegs.”

They also provide a list of the countries who have run this kind of policy as follows:

Côte d’Ivoire 1981-1984
Dominican Republic 1983-1984
Hong Kong SAR 4/ 1986-1987
Netherlands 1987-1989
Oman 1983-1988
Panama 1986-1995
Peru 1986
Saudi Arabia 2002-2006
Venezuela 1983-1987

Basically I know nothing at all about these programmes, but am not overwhelmingly convinced that any of them are that relevant to the problem we have to hand.

Finally, I have intentinally not been using the "A" word, but it is interesting how, as things hotted up, all the economists who defended the peg started insulting the others as they were losing ground. Cavallo famously said that the only people who questioned the advisability of maintaining the peg were a group of "paranoid" US economists. Shortly afterwards Rodriguez Saá, announced in the parliament that they were going to "take the bull by the horns".

Edward Hugh said...


Just to mention this. The Baltic countries do not only need to think about each other, the main rivals for the export markets of the future have to be in the CEE. I simply can't see how all the peg defenders can be so complacent about exports, they are going to be vital, in all three countries.

Meanwhile the Hyrvnia, Czack Koruna, Ruble, Zloty, Leu and Forint all continue their downward path. Here is some stuff about the forint. Incidentally, I'm not saying that any of this is easy. There is no easy path, but somehow or another you have to restore competitiveness. Productivity imrovements alone won't do it, since the gap is just to big.


Hungary’s forint fell to a record against the euro, extending its biggest monthly loss since the introduction of the common currency, on evidence the economic slowdown that triggered an international bailout is worsening.

The forint lost as much as 2.8 percent after the nation’s statistics office said unemployment rose to the highest in nine months and producer-price growth slowed more than forecast. The currency dropped 11 percent against the euro this month, the worst performer in eastern Europe, heading toward a key level of 300.

“There’s every possibility that the forint will break through 300 per euro in the next few days,” said Jon Harrison, an emerging-markets currency strategist at Dresdner Kleinwort in London. “Hungary is a small, open economy affected by the slowdown in the euro zone, there is some political risk and concern whether it’s able to maintain the IMF conditionality.”

In exchange for the IMF-led loan Hungary agreed to accelerate budget deficit cuts. Finance Minister Janos Veres pledged to meet the government’s target for the budget deficit this year, even at the cost of spending cuts, according to analysts at the nation’s largest lender OTP Bank Nyrt.

The forint, which weakened with the Czech koruna and Polish zloty, was at 297.98 per euro by 5:27 p.m. in Budapest, after sliding to a record 299.25. It lost 3 percent this week.

Since the beginning of this year, it lost 11 percent against the Swiss franc, which is popular for foreign-currency mortgage loans in Hungary because of lower borrowing costs. Weakening forint means increasing debt burden for households.

The Polish zloty depreciated 1.3 percent to 4.4526 against the euro, after falling to 4.4716, the lowest level since August 2004. It has lost 6.8 percent this year.

The currency was hurt by speculation the slowdown in eastern Europe’s biggest economy may deepen and the central bank will lower interest rates further to cushion the slump.

A rate reduction is “possible” in February and expansion may slow to between 1 and 2 percent this year from 4.8 percent in 2008, central banker Andrzej Slawinski told Polsat News channel today.

The Czech koruna weakened 0.9 percent to 27.922 against the euro. The Romanian leu lost 1.1 percent to 4.2957 per euro and the Turkish lira declined 0.7 percent to 1.6490 versus the dollar.

Edward Hugh said...


"They are also going to buy a new Audi A8 car. Rimsevics commented this by saying "If people won't buy anything, everything stops". I wonder if we can call this the first practical solution offered for the improvement of current situation. :)"

They seem to be following the Russian example here, I just read this:

Russia’s government plans to boost domestic car demand with an order of 42.5 billion rubles ($1.2 billion) that will upgrade at least 12 percent of the federal car fleet, Trade and Industry Minister Viktor Khristenko said. The government intends to provide aid to the automotive and construction industries to help revive metals sales, Khristenko said today in the lower chamber of parliament.

Anonymous said...

"They seem to be following the Russian example here, I just read this:"

The problem is - Audi cars are not made in Latvia. :)

Edward Hugh said...


"The problem is - Audi cars are not made in Latvia. :)"

But, humour aside, isn't this just the point, people say "why devalue, we haven't got anything to sell anyway", but the thing is why haven't you got anything to sell, and why were you living from ridiculous Ponzi's like Parex. I mean the whole model is whacked. It isn't that devaluation is hard, the problem is your whole model is done and over, and you have to virtually go back and start from scratch.

The first priority must be rewriting those bankruptcy laws and getting moving on the "restructuring". The problem here isn't the nordic banks, the problem is, who would stand to lose most if Parex debt was "restructured" away and out of sight?

Obviously Estonia doesn't have these problems, so could go straight ahead and devalue as far as I can see, but where would that leave Latvia???

Anonymous said...

"Obviously Estonia doesn't have these problems, so could go straight ahead and devalue as far as I can see, but where would that leave Latvia???"

Does it mean you start to doubt devaluation is the best solution for Latvia?

Edward Hugh said...


"Does it mean you start to doubt devaluation is the best solution for Latvia?"

Sorry, no, this is not my meaning at all. What I am getting at is that if the real problem about devaluation in Latvia is that 47% of the banks are domestically owned (only 0.8% in Estonia), and that these banks have made huge losses from financial offshoring, but that in Estonia this problem doesn't exist, then there is nothing really to stand in the way of Estonia devaluing tomorrow (even on Cristoph Rosenberg's view, this is my meaning). Basically defaults on domestic loans are the same whether you go for devaluation, or whether you deflate. The big advantage is that at the present time you don't produce Audi cars (or something similar to pay off your debts), nor without devaluation will you ever start to do this, since no one will invest in a country where everything is so expensive.

But if Estonia do decide they want to make some Audi cars (or similar) and go ahead and devalue, then where does that decision leave Latvia in the sense that Latvia's currency would be much more exensive and people would simply buy things in Estonia.

I have no doubt that devaluation is the best path for Latvia, although as I keep saying, you need some bankruptcy experts to decide what to do about all the Parex toxic debt.

I mean, I have no doubt Latvia will eventually devalue, the only real question is when. After a year of political turmoil, or now?

Latvian abroad said...

Two questions:
1. Why is Parex situation a reason against devaluating? I suspect that a large fraction of Parex assets is outside Latvia (they were very inactive in domestic mortgage lending, compared to Scandinavian banks) and, then, a devaluation should not hurt them so much.
2. We have had quite a lot of pay cuts recently. Some government institutions have cut salaries by 35%. I suspect the rising unemployment is pushing the private sector salaries by a lot, as well. Do we still need the devaluation on top of 35% pay cuts?

Edward Hugh said...

Hello LA,

I hope you are well. As usual you ask some very interesting questions. Remember when we exchanged views 18 months or so ago, at the start of all this, when they were all saying, don't worry, we will have a soft landing. Now they are saying "don't worry, we don't need to devalue, deflation will work", even though specialists in international economics and CA deficit corrections during financial crises are all very sceptical. But basically this whole question of export competitiveness is what we were discussing back then. So this situation was perfectly foreseeable (I mean I forsaw it near perfectly, I think), and was thus not inevitable. ie something could have been done to avoid all this, but no one was willing to listen. Loooking one more time at the local debates I think we are now about to see a repeat performance.

"Why is Parex situation a reason against devaluating? I suspect that a large fraction of Parex assets is outside Latvia"

Well, both assets and liabilities. This is the problem. Also the syndicated loans they took out to finance the assets they acquired. The thing is the loans in theory became due for immediate repayment on the change of ownership of the bank (it really is worth reading the whole IMF report to see the arguments used, and then my reply to Christoph to get a reference point), whilst many of the assets are either "bad" or with a very low quotation at the present time (for example equities). Hence you need the IMF loan to finance the difference. This is Latvia's *biggest* problem IMHO, and also why Estonia has a much easier choice about devaluation. But Latvians all working hard to pay off debst for 20 years for some bad decisions by a few people at Parex doesn't seem like a very good solution either. And as I say, the Parex bailout, plus a very strong contraction may push you over the 60% debt to GDP limit, and thus make euro adoption impossible. This is much more of an obstacle than devaluation, since after you devalue you reset the clock: look at Poland and Hungary now.

This was in Bloomberg yesterday:

Parex Banka AS has agreed with syndicated lenders it owes about $1 billion to discuss a revised repayment plan, Parex Chief Executive Officer Nils Melngailis said in an interview with Latvijas Neatkariga Televizija program’s 900 Seconds. The bank’s lenders “understand the situation in Latvia and are ready to be accommodating,” Melngailis said. Parex, the country’s second biggest bank, wants to put off repayment of the loans until an investor can buy the bank, he added. Parex owes two syndicated loans due in February and July for a combined 775 million euros ($997 million).

As you can see, these loans are in euros.

"Do we still need the devaluation on top of 35% pay cuts?"

Look, I am realising now there is some basic misunderstanding here. You don't just need wage cuts, you need PRICE cuts too. Obviously for some politicians it is easier to argue for wage cuts than the equivalent price ones. Basically competitiveness is about getting prices down, not simply making people poorer, which only collapses the economy further.

The problem is you may need to drop your price level by something like 20% (the forint is down 11% this year, and they had nothing like the inflation you had), but as people keep pointing out many of your exports have a very high import content (ie they are items only processed in Latvia) and you cannot influence the price of your imports (although, eg if these are metals and come from either Ukraine or Russia, there prices are well down already).

Basically I think there is a good argument for some kind of loose indexation of wages and prices downwards, with a hefty kick start on the wages front. So say you start with a 15% general cut this year, and then go down in 2010 by the quantity the price level drops in 2009 etc, otherwise there is simply no incentive to bring some (eg government administered) prices down.

But the thing is, I wouldn't be doing any of this. I would simply float the currency - possibly via an initial period of widening the band to 15% as initially proposed by the IMF - and make the correction a much more fluid one.

One day or another people will wake up, Latvia needs to export, and it needs to make domestic output price competitive so as to reduce imports, otherwise the only way to reduce imports is by reducing living standards pure and simple - which seems to be the most favoured strategy at the present time, but even this doesn't work, since here there is only economic contraction and more contraction till you get to be so poor that investors find you attractive again.

But how having a totally demoralised population can be good for productivity is a complete mystery to me. I guess alcoholism must be on the rise right now, I noticed that suicides are.

Anonymous said...

What do you say to 50% devaluation?

political instability in Latvia should lead to a change in government by mid-2009 the latest. by then it could be easier for a new government, be it newly elected or technocrat appointed by a national unity coalition, to denounce the previous euro-peg policy and go for devaluation.

see also this article by Bloomberg and Leta:

Latvia may lead 50% devaluation in Baltic Currencies, BBH says
February 13, 2009

RIGA, Feb 13 (LETA--BLOOMBERG) - Latvia's weakening economy may force the nation to relax its management of the lats, spurring all three Baltic currencies to break their pegs by mid-year and fall as much as 50 percent to the euro, Brown Brothers Harriman & Co. says.

"Latvia stands out as the weakest of the three because its external debt is very high and it's got a big current-account deficit," said Win Thin, New York-based senior currency strategist at the oldest privately-owned U.S. bank. "The contagion between the three is so strong that if Latvia broke the others wouldn't be able to resist."

Brown Brothers Harriman & Co. (BBH) is a large USA private bank which was formed in 1931. Brown Brothers Harriman provides financial services to a variety of mutual funds, hedge funds, asset managers, financial institutions, and insurance companies.

Latvia, Estonia and Lithuania are "under pressure" to follow Russia and Kazakhstan in reducing their currency management and allowing devaluation, Nouriel Roubini, the New York University professor who forecast the U.S. recession, said last week.

Latvia's economy shrank 10.5 percent in the fourth quarter, the steepest drop in the European Union and the country's biggest since quarterly annual records began in 1995, according to preliminary data. The nation has to fund a 92.5 million lati (168 million dollars) current-account deficit while credit markets around the world remain frozen.

Lithuania is heading into a two-year recession with gross domestic product forecast to decline 4.9 percent this year, the nation's central bank said last week. Estonia's economy contracted an annual 3.5 percent in the third quarter, the weakest in the 27-member European Union after Latvia, and may shrink 8.9 percent this year, according to its central bank.

Dwindling reserves may force the Baltic currencies devaluation, according to Thin. Latvia's reserves have dropped 27 percent to 4.7 billion dollars since July, according to data from its central bank as of Jan. 31. Estonia's declined 5 percent to 3.9 billion dollars in the second half of last year, and Lithuania's slumped 13 percent to 6.3 billion dollars, International Monetary Fund data show.

"They're going to run out of reserves and funds at some point and they'll look to contain the reserves bleed," Thin said in an interview.

Latvia is the most indebted among east European nation's with external debt equivalent to 130 percent gross domestic product. Estonia is 108 percent and Lithuania is 70 percent, according to Brown Brothers data. Russian debt by comparison is just is just 34 percent of GDP.

"You can't rely on external funding in a global environment like this," Thin said. "The longer this crisis drags on the higher the likelihood that their pegs will collapse."

Latvia buys and sells foreign-currency reserves to prevent the lats from fluctuating more than 1 percent either side of 0.702804 per euro. It was little changed at 0.7064 per euro by 2:55 p.m. in Riga.

Latvia's currency gained 0.2 percent against the euro this year, while Russia's ruble slumped 15 percent against the dollar, and the Kazakh tenge was devalued 21 percent last week. Belarus' ruble management weakened 21 percent. A 50 percent decline would leave the lats at about 1.4 per euro based on yesterday's closing price.

The Estonian kroon is kept around 15.6466 per euro, while the litas stays at about 3.4528 per euro. This type of management regime is often called a currency board.

The IMF is allowing Latvia to keep its peg while receiving 7.5 billion euros ($9.6 billion) in assistance. The Washington- based fund demanded Ukraine move toward a more flexible exchange- rate regime for the hryvnia when it offered the nation 16.4 billion dollars.

"The IMF has taken a hit to their reputation" by allowing Latvia to retain its fixed currency regime, Thin said.

LETA Bloomberg

131040 EET Feb 2009

Flavian said...

Yes, you are a pseudo-economist.

Latvia ought to raise its official interest rates as much as needed in order to maintain a fixed exchange rate and allow a healthy deflation to purge out the excesses of the boom.

The only thing which is mistaken is that the Lats is tied to the inflation-euro instead of gold.

You oversee the healthy effects of recessions and deflations.