Latvia's Collapse Threatens Europe

Latvia's currency - the lats- is on the verge of being devalued as the nation's economic collapse threatens to break its peg to the Euro. The Baltic nation's GDP contracted 18% annualized in the first quarter, and pressure is building to allow the lats to fall to stimulate the export sector.

A Latvian devaluation could spread panic in Eastern Europe as investors flee nations that may debase the value of their holdings. In addition to fellow Baltics Lithuania and Estonia - Poland, Hungary, and Bulgaria could be next. It is unknown how far this could spread, but it should be noted that the 1997 Asian financial crisis began when Thailand was forced to abandon its peg to the dollar.

Most immediately concerned is Sweden's financial sector, which invested mightily in the Baltic economies during the boom times. The iShares MSCI Sweeden Index Fund (EWD), the US traded ETF that tracks Sweden's broad market is down 8% on the week on the backs of steep declines in Sweeden's big financial names, which make up about a fifth of the index. The SPDR Emerging Europe Fund (GUR) and the Market Vectors Russia (RSX) are off by similar measures on contagion fears. Broader European funds such as the iShares MSCI EMU Index Fund (EZU) are off about 5%, despite the American markets being up on the week.

Observers are urging the IMF and the EU to come to Latvia's rescue, but the two institutions are demanding stiff terms. Latvia yesterday cut its budget by 10% of total GDP to meet IMF bailout requirements, but it is uncertain of even this will be enough to stave off a fierce devaluation and the regional panic that may result.

Comments

[milkguy:]

This is one big bs... . Latvia wins nothing from devaluation, as any positive effects are counterbalanced by the rise in loan service costs (practically all private sector debt is denominated in euros). In addition, Latvia's current account is now firmly positive. They have no other way, but to cut costs heavily, both in public and private sector. If GDP falls back to 2002 level, then associated costs must do the same. Sure, it may be difficult to imagine an across-the-board 30% pay cut to ALL public employees in America or W Europe, but that's ultimately the only way to regain competitiveness.

Moreover, devaluation pundits, I believe that in the long term devaluation is the worst solution - basically it punishes the prudent (savers) to bail out the reckless (debtors). In the long term we need savings and capital investment for sustainable growth.

Jun 10 03:53 AM

[Dave Wrixon:]

This is a bit like saying a crisis on Rhode Island would bring down the US. Having said that Obama is teetering so close to the edge anything is possible.

Jun 10 04:23 AM

[Roger Knights:]

100 dominoes on the wall,
100 dominoes;
If one of those dominoes happens to fall ...

Jun 10 05:00 AM

[Gtarras:]

"Most immediately concerned is Sweden's financial sector, which invested mightily in the Baltic economies during the boom times. "!!!!!!

"Latvia's Collapse Threatens Europe!"

Long on hype, short on numbers. A collapse of Springfield, MA will bring down the US economy!!! Hows that for a headline??

Jun 10 10:23 AM

[ETF Grind:]

Thailand.

1997.


On Jun 10 10:23 AM Gtarras wrote:

> "Most immediately concerned is Sweden's financial sector, which invested
> mightily in the Baltic economies during the boom times. "!!!!!!<br/>
>
> "Latvia's Collapse Threatens Europe!"
>
> Long on hype, short on numbers. A collapse of Springfield, MA will
> bring down the US economy!!! Hows that for a headline??

Jun 10 10:50 AM

[ETF Grind:]

And Sweden was just bailed out by the EU yesterday.

Jun 10 10:50 AM

[Glen L.:]

You can't compare Latvia to a town or small state in the U.S. For one thing, those entities don't print their own money. As the author points out, Latvia is just one of many countries with interconnected default scenarios. The EU is a house of cards made from fiat currencies, and the whole thing can fall.

Jun 10 12:10 PM

[cameroni:]

The EU and the Euro are still experiments. The institutions and policies that evolved and are in place now represent Europe's most noble attempts to head off conflict in the future and strengthen trade by building a community around currency, law and common objectives. The idea was partly conceived as a means to distribute losses and share gains. But in tough times not all countries want to take the losses. That is where we are at today.

Europe is still dealing with a second world war hangover, bad politics, resentments, an impossible conflict of cultures and a multitude of languages. Can the Union see past all of this and tough it out when real money is on the line? When Germany for example does not have the economic clout to silence objectors countries by buying cooperation?

The risk to European unity is that if any of the countries revert to their own self interests (like they are now) and place them above the union then a domino effect can take place putting all at risk.

The US with it's common culture, established two-party government, single language, currency, tv programming, food, media, sports and other institutions recognized across all states and boundaries will never understand European unity problems.

Jun 13 11:29 PM

[optionsgirl:]

ETF Grind: Thank you for your article. The EU is in danger of imploding, one country at a time. The US is in danger of imploding, one state at a time. Will it be immediate? No.
Can it be averted?

They apparently are not reading ( or comprehending) what Chancellor of Germany Angela Merkel has been saying, loud and clear.

You keep up the good work, despite your detractors. They can deny the importance of Latvia. By the time they realize what you have been saying- and take a look at the other Eastern European countries, Ireland, Spain, etc., it may be too late.
Watch out below.

Jun 15 06:24 PM