The euro zone, slow-motion crashes and Latvia

June 7, 2012

Spending time with top European policymakers at the moment is scary and slightly nauseating, like the final, slow-motion moments before a car accident, when you can see precisely both how you will probably crash and what it would take, if only you could force your paralyzed muscles into action, to swerve to safety.

That’s why Christine Lagarde, the formidable French chief of the International Monetary Fund, told me this week that she wants to lock Europe’s dithering leaders in a room and leave them there until they figure things out.

“If I was able to do one thing, I would lock them in a room, take the key and let them come up with a comprehensive plan,” Lagarde said, when I asked what her fantasy scenario was for Europe. “I’m sure they can make it. I know the fundamentals are solid. The numbers on an aggregate basis are good. And, as I said, we have to take the key because they cannot escape unless and until they’ve firmed up the plan. But they can do it.”

Lagarde’s dream is frustrating and encouraging in equal measure because she is right: There is a clear, credible and widely accepted path to safety for Europe. But that car crash may still happen, because no one has the power to lock Europe’s leaders in a room, and, absent that forcing mechanism, they may not muster the will or the sense of urgency to act in time.

The sticking point is not policy. Speaking on a panel with Lagarde, Jörg Asmussen, a member of the European Central Bank’s executive board and a former official at the German Ministry of Finance, outlined what Europe needs to do.

“It’s very simple,” Asmussen said. “We need a more integrated monetary union, because the monetary area that we have now is incomplete. And we have to complement it in a way to make it more stable. One point is a fiscal union. The second one is a financial market union with three key elements: a resolution regime; second element, a deposit guarantee insurance; and third, we need a centralized supervision for the large 25 banks in Europe.”

“We need a democratically legitimized political union,” he added. “We need to start this speedily.”

That’s a plan the overwhelming majority of European leaders would agree to in principle. The problem is putting it into practice.

As Olli Rehn, the European commissioner for economic and monetary affairs, jokingly explained on the same panel: “Prime Minister Jean-Claude Juncker” of Luxembourg, the chairman of euro zone finance ministers, “put it quite well some years ago by saying that we all know what needs to be done, but we do not know how to get re-elected after that.”

Rehn’s wry comment is a reminder of the real tragedy at the heart of Europe’s troubles today: An idealistic political experiment, founded above all on the principles of democracy, peace and social inclusion, is failing because elites are unable to sell their vision to the public they were meant to serve.

Part of the problem is that the European idea, which really is a gauzy, high-concept confection, long ago devolved into a profoundly uninspiring affair of EU directives, painstakingly translated into 23 languages, and the Brussels apparatchiks, remote from the everyday life of their nations, doing the translating.

That’s where Riga, the venue for the conversation between Lagarde, Asmussen and Rehn, comes into play. The 2008 financial crisis was devastating for this country of just over 2 million. Like some of the euro zone states that today teeter on the brink, Latvia gorged itself on easy money during the credit boom of the first decade of this century. When capital abruptly flew to the world’s havens – a category that most certainly did not include the Latvian currency – Riga was pushed to the brink.

One option – which many contemporary observers thought was inevitable – was devaluation. Latvia, after all, enjoys a freedom that Greece, Ireland, Italy, Portugal and Spain do not. It controls its own currency, and printing money would have been an expedient way of both reducing its debt and instantly bolstering the country’s global competitiveness.

But Latvia chose the tougher route of internal devaluation. The country stuck with its currency peg to the euro, and instead rebuilt the confidence of the international capital markets by slashing government spending and domestic wages and prices. Over the course of the program, the Latvian government’s combination of spending cuts and tax increases amounted to 15 percent of gross domestic product.

That hurt. In the first year, unemployment jumped to more than 20 percent, and the economy shrank 18 percent. Nearly four years later, Latvia, whose overhauls were supported by funding from the IMF and the European Union, is harvesting the payoff. The economy grew 5.5 percent in 2011, the currency is stable and unemployment has subsided, to 13 percent.

“I want to congratulate Latvia for the recent successful completion of their balance of payments program which has been conducted together with the EU and the IMF and also for the successful return to the markets and the rather positive data on growth,” Rehn said. “And Latvia has shown that this kind of economic assessment is possible without currency devaluation.”

The harsh Latvian plan worked because the whole country was committed to it. And that commitment, including the painful peg to the euro, is rooted in the overarching national mission that has driven and united this small Baltic state since the collapse of the Soviet Union – to escape the legacy of communism and Russian rule and to build a modern, democratic, capitalist nation. Latvians believe they can achieve that goal by joining the European Union and eventually the euro zone.

The people on Europe’s periphery still believe in the Union’s great historical purpose. Unless the Europeans at the continent’s center regain that faith, their leaders will be unable to summon the political will to swerve out of that slow-motion car crash.


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If you ask Latvians about the years of austerity, you won’t find that same self-satisfied, smug, gloating evidenced by the author.

It’s clear that severe austerity:
1. Doesn’t work
2. Is politically impractical

The solution is, as will be practiced in the EU, a combination of stimulus and slow budget balancing that will, over time, solve the crisis.

For those impatient columnists screaming for action NOW! – Keep your shirt on. Good things take time, but patience is not an American virtue.

Posted by Francophile | Report as abusive

A monetary union is an opening for disaster. If there is joint liability for debts and supporting the currency, the nations without fiscal self-responsibility will be cheating the nations with it.

It is happening now, Germany is bailing out the rest of the EU.

Posted by ALLSOLUTIONS | Report as abusive

“The harsh Latvian plan worked because the whole country was committed to it”. NOT.

Neoliberalism thrives in Latvia because of ethnic divisions between the Latvian majority and the 30% Russian minority, which is partially disenfranchised. 14% of the population are long term residents denied citizenship, through draconian naturalization laws — hardly a beacon of freedom and democracy.

Take a look at the population and birthrates in Latvia. At the current rates, there won’t be any Latvians in a century. Unemployment may be down to 13%, but that is likely because those with professional skills are packing up and leaving.

The commentary also does not address the points made by Prof. Michael Hudson bout the nearly tax free treatment of real estate and capital gain and a 50% tax rate on labor.

Obviously what happened in Latvia was capitalism left to run wild, fueled by western banks with hot money. Real estate boomed, the industrial sector was decimated. What remain is a sad case and it is ridiculous to hold the Baltic states up as some shining success story.

Neoliberalism is a failure. Latvia is a poster child.

(disclosure: I have Lithuanian relatives experiencing the same benefits of neoliberalism. The young have evacuated and taken their skills elsewhere, then pensioners live marginally, many in prime working age are unemployed or working menial jobs in spite of university education).

Posted by upstater | Report as abusive

Per Paul Krugman:
Simon Wren-Lewis, writing about Latvia, is more caustic:

An extraordinary success story: after an 18% decline in GDP in 2009, and flat GDP in 2010, we now have 5.5% growth in 2011. But surely I’m being economical with my quotes here. Isn’t the 5.5% growth last year just the beginning, with the economy achieving a new dynamism? Mr. Asmussen does not provide any additional evidence on this. Perhaps wisely, as the IMF are predicting 2% growth this year, and 2.5% next year. So the 5.5% growth last year is all we have.

The complete article is here: why-cannot-other-european-countries.html

Posted by A.deWitt | Report as abusive

Thank you for the story of Latvia’s crisis. I visited the country last summer and liked it very much. Great beaches. Although I had heard about the great economical and political crisis in 2008, I was not aware of the fact that they did not devalue the Lat and rather chose austerity.

Unluckily it seems that not all countries are able to pull this through, rather devaluing, or as Euro members, believing in dreams and European (ie German) support. I really would like to know what the secret plans for Greece are like – I fear “democracy” is a word which does not occur in them, for some time at least.

In the longer term, the paper currencies of Europe and the U.S. will burn anyway. They seem to be strong, seen from the perspective of the now defaulting Mediterranean countries, but in fact the crisis has lit the fuse for their last firework.

Posted by dingodoggie | Report as abusive

indeed is much easier to manage a small independent state that the whole EU with different languages and traditions.

Devaluation has been the secret weapon of each single EU countries before the Euro.

Posted by robb1 | Report as abusive

it is simpler than you state

for example

germany has agreed in supporting eurobonds, but there has to be fiscal integration and supervision of the budgets devised by politicians within each country of the eurozone: there will also need to be closer integration of the banking system at the eu level

reuters has reported that the french do not support this intrusion, yet argue for eurobonds (a non-sequiter)

reuters has reported that england opposes any controls on its investment and speculative finance institutions in london

locking them in a room achieves nothing – it is a soundbyte

at least the germans understand something – it takes a slow-moving car wreck to galvanise political action within europe

similarly the self-inflicted harm in greece, only a fool would continue to bail-out corrupt greek politicians, to idle and greedy to build a proper state infrastructure and administration

chrystia would not support war and force to achieve agreement,

but the slow moving car crash is in fact the rod of fiscal discipline across the back of political hacks in the form of higher premiums in the bond market, impending bank failures …

don’t spare the rod

Posted by scythe | Report as abusive

Any sort of fiscal union has to go through vote at citizens level. And there it will fail because a big part of EU citizens do not like the EU, proven in many past national votes (France, Netherlands, Ireland). So if you put it to vote you risk the entire EU project. If you don’t put it to vote and try to pass it through national parliaments than the anti-EU sentiment will be even more on the rise because population will feel the EU as anti-democratic. Its a vicious circle that points to a certain end. The big guys know it, they only hope to delay it.

Posted by Qeds | Report as abusive

The questions are how much economic independence will powerful nations agree to forfiet for a union; and how much austerity and guidance will the struggling nations be willing to endure to deserve inclusion?

While frustrating to the United States mentality, we
should remember we fought a major civil war and continue to struggle with regional and political differences. And, we started as one nation with one language.

If Germany and Spain can connect. The EU may fly.

Posted by BluePelican | Report as abusive

Chrystia is right that Latvia moved to join the EU in order to escape its history of Russian and Soviet domination (at least the 2/3 of the population that is ethnic Latvian). However, her economic analysis is misleading. The austerity without real growth policy of the Latvian government, including it policy of artificially pegging the Lat to the Euro, has been a failure. Officially, unemployment has dropped to 13 percent. But the reason for this is that Latvia has undergone a demographic collapse. Literally 100,000’s of young Latvians have fled the country, most going to Western Europe where things are bad but not as bad as in Latvia. In 1991 the population was 2.7 million. Last spring according to the most recent census the population dropped to 2 million, but is probably lower because of continuing emigration (and dubious census statistics). Many people left before the current austerity policy was implemented, but in recent years austerity has been the prime driver of emigration. Moreover, the demographic profile of the country is skewed toward the very old, which means the population collapse will continue. Any country in the world can lower its unemployment rate by driving out a large percentage of its working age population. Worse, this economic policy has done little to develop Latvia’s industry and agriculture, meaning the country’s future remains bleak.

Posted by Dan85 | Report as abusive

Latvia is already part of the EU. Unless the author knows something we don’t know?

“Latvians believe they can achieve that goal by joining the European Union and eventually the euro zone.”

Posted by Fionnghlas | Report as abusive

Isn’t it a sad day when someone points to a 13 percent unemployment rate as proof of the success of a nation’s fiscal and monetary program?

The problem with Europe is that its leaders have come to confuse the words mediocre and good.

Posted by LoveJoyOne | Report as abusive

Even as the idea of a (centralized) United States of Europe was taking off a few decades ago — and long before the Eurozone — a brand new area of science (epigenetics) was rapidly developing. This not only explains why the dour, hard-working disciplined personalities of the Baltic periphery are so different from the laid-back, less disciplined personalities of the Mediterranean periphery, but also why there can never be a coherent and widely-shared ‘European-ness’ until the Eurozone citizens, like Americans, move around between regions so much more freely and, as it were, ‘merge’ their cultural differences. We know now from revolutionary discoveries following on from the Human Genome Project that psychological differences are heritable. All those subtle personality propensities which make one culture (say, German) so different from another (say, Greek) can persist. Epigenetic inheritance is not so permanent as that of genes themselves but they can continue for generations if background environments (of which climate is extremely important) remains the same. It is possible to envisage a successful northern bloc of the Eurozone (in which Latvia would be included), and an equally successful bloc (though with a different way of life) in the south but there are simply too many cultural disparities for the present arrangement to continue for much longer.

Posted by Keithhudson | Report as abusive

The Latvia analogy is irrelevant in the big picture of the Euro’s inherent flaws. The Euro was specifically created to profit the few exporting EU countries at the expense & economic destruction of the rest. Fraud in its grandest form.

Posted by GMavros | Report as abusive

If the Eu had less leaders of Christine Lagarde’s caliber there might have not been as much damage.

Posted by GMavros | Report as abusive

The reason that the delegates to the U.S. Constitutional Convention were able to achieve compromise is that James Madison locked the windows in Constitution Hall in Philadelphia during the summer of 1787.

The Europeans just don’t get it.

Posted by Jim1648 | Report as abusive

Chrystia, Latvia indeed made bravely through the crisis and you correctly identified that was politically possible due to the fear of Russia. Latvians (and to not forget there is huge Russian minority there) want to be in EUrope at any price, at any price indeed as the data are showing. In this context you do not mention the heaviest price paid for the crisis, the price which is not financial. This is massive emigration of young people, thoug not visible on the EU scale it is really of collosal proportions if one takes the size of the country.

Posted by wirk | Report as abusive

Latvia is in fact an excellent example of the complete failure of the policy of internal devaluation, a.k.a. austerity recipe. Latvia is, sadly, a dying country/nation.
The problem with the austerity cure is that it kills the patient. 13% unemployment is ACTUALLY a catastrophic number, especially given the fact that it was “achieved” only after an emigration exodus of biblical proportions – the unemployment figure would be much higher, if hundreds of thousands had not voted with their feet and left the country. Even as it is, it just suggests an economy unable to create jobs and chronically lacking aggregate demand.
Also, the much advertised 5.5% GDP growth (after a 18% collapse) are but a temporary blip – growth figures for 2012 and on are much lower and declining.
And a note to the author – Latvia is operating under a currency peg, which means that they are not in control of their currency, they simply cannot “just devalue” their currency. A currency peg is an extremely STUPID and HARMFUL arrangement that leaves them with no room for fiscal stimulus and catastrophic internal devaluation as an only “choice”. A choice that is destroying the country and the nation before our very eyes.

Posted by DLT | Report as abusive

Latvia, compared to other East European states, is not a success story but rather a disaster story. The IMF-EU austerity programme made Latvia into one of the poorest Eastern EU member states.

Posted by Radek.kow1 | Report as abusive

This is a great article well written. However, using Latvia as an example of people pulling together is showing me that they still feared their past with the Soviet Communist. Latvia is not Greece or Italy or Spain or Portugal. It’s comparing a family of one child with a family with eight children. A lot harder to bring 8 kids together and lock them up in one room and make them co-operate with their parents than having a one child co-operatelive on the cusp of a new era in economic cycles. Nothing can be done in terms of stopping the crash in Europe or US or China or India, and most of the world countries.

Reason is very simple, democracy does not work in the long term, politicians are fighting each others to get elected and they’re willing to do anything to get elected just read what’s written in this article above. That’s the problem, how do we elected people to serve us to our best long term interest and serve the interest and the future stability of a nation vs serving the largest block of voters to get elected in the short term, at the expense of the future growth and earning and tax liabilities of a nation. Democracy as we are practicing it today has been around very short time. Just find out when in the US for example gave the right for everyone to vote, women, minorities, etc.

Read what’s in the news everyday, Obama still can win because of the Hispanic voting block in key state, that’s it right there. Short term goal to get elected and be in power.

Eventually all countries are heading the place where Greece is right now.

If Germany comes in and print more money to bail Greece and Italy and Spain, they will add more debt on their country and the rest of the European countries. If they don’t they will see Greece and other nation defaulting and creating a large political vacuum that is being taken advatange of by the far left or far right etc.. more uncaring people taking over.

Adding more debt will put them closer tot he Greek situation.

The US is not far away as well, no matter who they elect, is Obama stays they get closer, another person will delay the eventual change few more years.

I believe the next ten to twenty years things will not be the same in every country.

A new Era will emerge based on more honest and caring leaders that want to really fix the problem and not get re-elected or get elected in the first place.

They measure debt by GDP percentage, a very deceiving measure. You borrow 10 to create 2 in GDP, what happened to the 8?

US Debt is about 6 to 7 times our collected tax revenues, our ability to pay. I never heard of anyone able to pay debt that is 6 to 7 their yearly salary, and still able to buy a house and raise a family and save for his retirement and saving for his kids education and marriages. Try, please someone on this board do the math, to help all of us understand. an income of 100k per year, 600k in revolving credit at 2 percent, a mortgage of about 2k per month and utilities, … I forgot that this person is allowed to spend 3% more than his or her earning per year, so you need to add that 3% additional debt to accumulate each year. I really want someone else to calculate this formula and post it here.

no place to hide, even Gold is not a safe heaven, when the problem is global, all the Indians and Chineses will net gold sellers.

Only your hard labor to produce basics goods like food, and medical care will be first priority.

A new Era will emerge after this large train crash and all of us will suffer the consequences of not taking politics seriously. we as citizens are to blame, we elected and agreed with them to borrow and spend on us.

If these leaders are so bright and capable how come we have had more bad policies than good successful policies. Just take each decision in every country and you will that more than 70 percent of policies are a failure that leads to more failures, and they are able to compensate via more borrowing and more spending.

Nobel Lauerates that are talking about more spending to fix the problem, in theory yes, it will work, if all people are equals in skills and intelligence. that’s one of the issue that economist does bother to delve into, the quality of each individual and what motivate them.

Posted by phoenixnews | Report as abusive

What´s clear now is that foreign lenders mistrust about “europe” as we know it continues to thrive by the inability of the political leadership to explain their own people some basic facts of life:
1. Even if northern europeans (people and leaders) are regretting now the former adhesion to euro of “mediterrean countries” they cannot simply throw away this by the window and rebuild a new “reliable” and restricted currency without a transition period.
2. Of course this will probably be accompanied by another set of new currencies (for instance, Portugal and Spain are now so inextricably integrated that is virtually impossible to maintain peacefully two different currencies in the Iberian Peninsula).
3. Apart from geostrategic issues arising from this eventual split between north and south, an important economic question should be adressed: are northern rich countries aware that a solidarity failure in a grave moment such as this, even if there is some “moral reasons” to “punish” “lazy” countries coult shatter not only the “Idea of Europe” but also a natural internal market to north european industry.

Posted by southmed | Report as abusive

The US has a monetary and fiscal union yet there are cities and maybe soon to be states that are going bankrupt. 800 billion stimulus only delayed the reality that the money is not there.

Posted by whyknot | Report as abusive