Wednesday, 17 June 2009

Euro Problems for Latvia

Latvia is in the EU and wants to join the Euro just like Mandy wants the UK to join. To this end the Latvian government has pegged its currency to the Euro prior to entry just like we tried to shadow the DM and stay in ERM limits in Lawson's day. Latvia is now in dire straits economically, a 20% drop in GDP this year for the same reasons we were in a slump in the early 90s until we were forced out of the ERM in 1992.

Latvia however is also in a political bind. Out of its population of 2.4 million over 28% are Russians with another 6% Ukrainian and Belarusian. It elects 8 Euro MEPs and 3 of these are strongly pro Moscow. The Euro peg is partly to keep Latvia firmly in the EU and out of Putin's hands but its not working.

Paul Krugman, Nobel Laureate in Economics wrote in Dec 2008,

"The most acute problems are on Europe’s periphery, where many smaller economies are experiencing crises strongly reminiscent of past crises in Latin America and Asia: Latvia is the new Argentina "

Argentina was pegged to the dollar and endured a similar slump in 2001 and resolved it, in the IMF approved way, by exiting the peg, letting the peso float, cutting public spending by 30%, redenominating its debt from dollars into pesos and foreign creditors lost 70%. Public spending was cut by 20% and the government fell after 3 days of rioting with many people killed.

Latvia is also cutting its public spending, firing 30% of its teachers, cutting police, doctors and nurses pay by 20% and dismantling its welfare state. The central bank lost 10% of its reserves in 2 weeks (sounds familiar). Unemployment is now 17%. The IMF advised Latvia to ditch the Euro peg last year but Brussels said No! Why? Well it is dominoes. If Latvia leaves the peg so might others like Bulgaria which abuts Greece the sickest man in the Euro. Euroland banks would of course be big losers as per the Argentinian experience. Also those UK nationals,who egged on by TV property programmes tales of easy money, bought flats and houses in Latvia. They will lose considerably and should remember excess returns come with excess risk.

There will be civil unrest and and an aggrieved police force will not be too motivated to quell the riots. Enter the Russian dimension. Its not just the EU that can have a beneficial crisis! The Euro peg is driving Latvia into the arms of Russia with the possibility of a military confronation.

It is ironic that the EU, set up to avoid another European war, might well precipitate one through its imperial ambitions. Europe extends to the Urals!

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