- The global financial and economic crisis has hit the
small Baltic country Latvia harder than any single country with the possible
exception of Iceland. As part of its attempt to join the European Monetary
Union the country has fixed its currency the Lats to the Euro. The result
has been to make a bad situation catastrophic. How the situation develops
will have direct bearing on the fate of many emerging countries of eastern
Europe. It marks the death of the radical experiment with Thatcherism in
- On the surface the crisis the country is experiencing
the result of a borrowing binge among consumers which got out of control
and now must be reigned in by tough government austerity measures. In reality,
it is a tale of greed of foreign bankers, a failed economic reform and
a political system that is fixated on Euro entry as the Holy Grail for
- Events in Latvia over the past two years signal the death
of the radical neo/liberal Thatcher economic shock therapy imposed after
the dissolution of the Soviet Union when the West, led by Washington, mandated
that the IMF dictate terms of economic transformation for the former Soviet
- On the one side are western banks, above all Swedish
banks which more of less colonized Latvia after 1990 as their 'sphere of
influence.' They are allied with the IMF and the EU, though of late the
latter two are themselves in a deep policy split.
- On the other side is a growing grass roots popular protest
which since January has led major marches against the government, and which
has just elected to Parliament an ethnic Russian party for the first time
since 1990, with ethnic Latvian support, as a signal of the depth of protest
to the freewheeling plunder era of the past two decades. Until the
present crisis, Latvia was praised in western financial markets as the
'poster child' of free market success in the region. It was growth based
on easy credit, a real estate bubble and consumer debt. The success was
only for a tiny elite of bankers and local oligarchs as now is clear.
- The IMF at war with EU
- At the moment all eyes are on what the IMF and the EU
will do in terms of emergency financial support to the country. Much of
the present crisis has to do with the Governments fixation on holding the
currency peg to the euro rigid in hopes it will be able to enter the Euro
zone in four years. The only ones that gain advantage from the currency
peg are those with Lats-denominated paper assets. It makes little sense
ultimately, because the deflation of the economy required to maintain the
peg will result in the paper assets defaulting anyway, except for government
- As always the IMF is demanding savage austerity from
the Government as precondition for its loan. To meet the demands the Government
adopted a package of measures last month that include a huge wage and pension
- An average Latvian earns around Euro 400 a month. Slashing
wages results in more deflation as consumers buy even less and business
bankruptcies climb. The IMF medicine is simple, but deflation something
the US and EU countries are desperate to avoid at all costs. Eager to shift
blame for the growing fiasco, IMF officials claim they demanded the savage
austerity package on the urging of Latvia's neighbors.
- According to informed EU banking sources, the EU and
the IMF are in a bitter internal fight over Latvian aid terms. In December
Latvia got a ¤7.5 billion emergency "stabilization" aid
from an international group including the EU and the IMF, some 34% of total
- The cost for Latvians has been more than Shylock's "pound
of flesh." The donors demanded savage cuts in public sector wages
of 20%, in pensions of 20% and 70% cuts for those pensioners still working.
- These drastic fiscal cuts are being euphemistically termed
"internal devaluation" by IMF technocrats. During the world Depression
of the 1930's they were called what they are-wage and price deflation.
- In Riga joining the Euro is regarded by the Government
as the magic "cure all" for their problems. The examples of Slovenia,
which joined the Eurozone in early 2007 and today has the worst economic
crisis outside the Baltic in the EU, shows there is no magic in Eurozone
- Despite the fact the Parliament agreed in March to draconian
budget cuts of $1 billion (¤.7 billion) this year and each of the
next three, the IMF has refused to release its ¤200 million loan
tranche pending "review." Now breaking reports from Latvia are
that the Government has just refused the IMF demand to cut pensions as
pre-condition for receiving the ¤200 million rescue money.
- The IMF according to Latvian sources familiar with the
demands, is demanding higher real estate taxes in a country where real
estate prices are in free fall. Swedbank, the largest lender in Latvia,
just reported that fully 54% of all its mortgage loans in Latvia are "under
water" meaning the value of the bank's loans outstanding is larger
than the current market value of the houses that make up the collateral
on the mortgage loans. Tendency: worsening real estate prices. Hardly an
ideal climate to add new property taxes and force even more Latvians to
default on home mortgages.
- The demands of the EU for its release of ¤1.2
billion end of July are that the Government must use 50% of that to help
the lending banks. And the Government had to impose ¤0.7 billion
of cuts to get that ¤1.2 billion, a net "gain" of a paltry
¤500 million. But when costs of the Budget austerity and wage cuts
on total economic growth are factored in, the "rescue" is actually
an economic kiss of death for Latvia.
- The behind-the-scenes battle between IMF and EU are clearly
over the Latvian plans to join the Euro, something the Riga Government
falsely believes will be its salvation. The EU is demanding Latvia retain
a rigid peg to the Euro in the pre-Euro period to show its "discipline."
It has declared it will keep the Lats in a narrow band of 1% plus-minus.
However ERM rules allow an applicant to fluctuate 15% plus-minus. It is
also desperate to force inflation down via deflationary budget cuts to
hold to the EMS Euro Maastricht demands.
- The IMF refusal to release its share of the rescue loan
according to informed reports, is part of a Washington-backed effort to
break the peg and thereby force other fixed-peg pre-Euro EU members-Estonia,
Lithuania and Bulgaria-as well to devalue and forget the Euro dream. Former
chief economist at the International Monetary Fund Ken Rogoff hinted as
much when he recently stated in an interview that,"Latvia should devalue
the Lats to avoid a worsening of its economic crisis. The IMF made the
wrong decision when it allowed Latvia to keep its currency peg"
- Economic disaster
- Already the country is one of the worst hit in the EU
by the two year old global crisis, and among emerging markets second only
to Ukraine. Landmark property developments such as the twin Panorama Plaza
towers on the road between Riga and the airport stand all but empty and
shopping malls are ghost towns.
- The Government debt is now 64% of GDP and official unemployment
stands at 16%. In the first three months of this year GDP fell a dramatic
18%. By contrast, during the easy money lending binge in 2005-2007 the
Latvian economy was booming at China-style growth rate of 10% a year, all
on borrowed Euros.
- Now that casino has closed, a victim of the global crisis.
House prices fell by one-third last year, business insolvencies are up
and banks are repossessing more mortgaged properties and leased cars. In
Riga the average price of an apartment has dropped 68% since the crisis
first began in August 2007.
- The economy is in a free-fall. Latvian foreign trade
is down year-on-year by 38%--no green shoot here. Exports are down year-year
for January-May by 28% and imports by 40%. Industrial output is down year-on-year
by 19%. Retail sales are down by 24%.
- Much like Iceland, in Latvia 90 per cent of all loans
are in a foreign currency, the euro.
- The Government of Prime Minister Valdis Dombrovskis argues
that devaluation could bankrupt tens of thousands of companies and individuals.
But the price of avoiding devaluation by imposing the IMF's "internal
devaluation" will now do the same if not worse, causing huge economic,
social and political strains. Dombrovskis admits his main challenge now
is "to preserve the social peace." That's an understatement.
- If the Latvian Domino Falls
- At this point, with social unrest in Latvia erupting
in mass political protests and unrest growing with each new austerity demand
on the Government to maintain the Lats fixed peg to the Euro, it is almost
certain that the Government will crack and be forced to devalue. At that
point, depending on how rationally Brussels reacts-something rarely seen
these days-the other dominos across eastern Europe will likely fall.
- If a Latvian currency devaluation is orderly and systematic,
it may, even at this late date, be a containable process. That would mean
the EU Commission would have to admit the Maastricht Treaty conditions
are not immutable fixed laws of the universe and to stop playing politics.
In short, they need to adopt an exit strategy for Latvia.
- That seems highly unlikely given EU demands so far. If
Latvia is left to fester, and the country falls into a growing political
anarchy, containment will be much more difficult and panic will likely
set in. That will impact the plans of Lithuania and Estonia as well as
- For Bulgaria the problem is not one of sustaining the
Euro peg, but of restoring competitiveness and economic growth, and this
is much more difficult without a formal devaluation. If Bulgaria falls
off the cliff trying to hold the peg, it will likely have seismic shock
effects across most of South Eastern Europe.
- * F. William Engdahl is author of Full Spectrum Dominance:
Totalitarian Democracy in the New World Order. He may be contacted via
his website, HYPERLINK "http://www.engdahl.oilgeopolitics.net"