Riga 2009, Buenos Aires 2001
by Charles Lemos, Wed Jan 14, 2009 at 02:12:47 PM EST
Chalk up another in a string of neo-liberal economic failures. Caught in the global financial crisis to a degree perhaps only surpassed by Iceland, the normally tranquil small Baltic republic of Latvia erupted in violence overnight. Thousands of people massed in the Latvian capital, Riga, demanding snap elections and the resignation of the government in the face of a deepening economic crisis. The resentments quickly turned into a riot. Twenty-five people were injured and 106 were arrested.
Latvia's fall is, indeed, a hard one. Credit growth had reached an astounding 78% in 2007. Riga property prices more than doubled since early 2005, driving prices in the old city above levels found in Berlin. Over 85% of all household and corporate debt in Latvia was contracted in foreign currencies, a proportion similar to Argentine dollar debt before the collapse of the peso peg in 2001. The current account deficit was 26% of GDP in the fourth quarter, the world's highest. All thanks to lax regulations on the free flow of capital, one of the cornerstones of neo-liberal economic thought.
"The situation in Latvia bears a striking similarity to that in Iceland last year, only we would argue that Latvia is more exposed," said Tim Ash, an economist at Bear Stearns warned in a report published in February 2008. Consider the moment now one of full exposure. Ah, the joys of the free flow of the capital. Riga 2009 is Buenos Aires 2001.
Discontent has been brewing since the country slid into recession and the government had to seek a £7.5 billion (approx $10.4 billion USD) rescue from the International Monetary Fund and European Union this past Fall. The Latvian economy shrank 4.2% in the third quarter of 2008 compared with the same period in 2007 and official data showed the country as suffering the sharpest recession in the EU. That's rather remarkable given the economic downturn in Iceland, Spain, Ireland and Belgium. According to the Latvia Central Bank, the economy is expected to shrink at least 5% and perhaps as much as 8% this year after the credit crunch stopped a consumer boom coupled with collapse of the country's currency, the lats.
On November 8 of last year, the Latvian government was forced to rescue Parex by taking a 51% share -- Parex is Latvia's largest local bank and the country's second-biggest after Swedish-owned Swedbank -- for the symbolic sum of two lats (2.85 euros, 3.65 dollars). Then again, you're essentially buying liabilities, not assets.
The move came after the Parex had lost 108 million lats in deposits. Parex's boss blamed an exodus of customers attracted by Swedish state guarantees for Nordic rivals such as Swedbank and SEB, the country's third-ranked bank. The government said it had acted to ward off a wider financial sector crisis in the Baltic state.
Since then, the situation has only gotten worse. Unemployment is running in the low teens, more than triple where it was a year ago. Additionally, Latvia's Parliament also approved linked belt-tightening measures, notably deep budget cuts that slash state employees' pay by up to 15%. This is, of course, the major worry facing global policy makers -- how to tackle the deflationary pressure on wages (just as a reminder Governor Schwarzenegger just cut the wages of California state employees 10%).
Back in May 2007, the Fitch Rating Agency said this in a report:
"Cheap and plentiful capital inflows have fueled the economic boom Eastern Europe. This begs the question how well the region will cope in the event of a marked increase in risk aversion and tighteneing liquidity."
Cross out Eastern Europe and substitute United States and the same is true. How well can the US cope in the event of a marked increase in risk aversion and tigtheneing liquity? Probably better than Latvia or Iceland but all I can say is be nice to your Chinese lenders, you owe them $40,000 per US household.
It's time for a more circumscribed approach. That is, markets work best when rules and regulations are in place to moderate the tendency to excess. The day will come when the world will no longer willingly finance our penchant for militarism no matter how noble the cause nor our unrestrained consumerism. And that day is fast approaching.