“I will not vote in today's European election. Instead, I am doing something much more interesting and relevant to the future of Europe and Britain. I am travelling to Riga [for a speaking engagement]. Why is this trip to Latvia more important than voting? Because, believe it or not, the future of Europe could be decided by this tiny Baltic state.
…
What does [Latvia] have to do with the future of Europe? …
Europe is now in the middle of a perfect storm - a confluence of three separate, but interconnected economic crises which threaten far greater devastation than Britain or America have suffered from the credit crunch: the collapse of German industry and employment, the impending bankruptcy of Central European homeowners and businesses; and the threat of government debt defaults from loss of monetary control by the Irish Republic, Greece and Portugal …
Latvia, partly because it has followed an Argentine-style policy of “fixing” its exchange rate and encouraging its citizens to borrow in euros and Swiss francs, is now in the front line of the battle between governments and financial markets - and a humiliating devaluation looks increasingly likely. Last weekend a former Swedish finance ministry official brought in by the Government as an adviser admitted that devaluation was no longer a matter of “if” but of “when and how”. If Latvia does devalue, then the two other Baltic states will almost certainly be forced to follow and the panic will probably move to Romania and Hungary. Beyond that, the contagion is likely to spread to the weakest members of the eurozone - Ireland, Greece, Portugal and probably Austria.
If the crisis expands, other EU governments - and especially Germany's - will face an existential question. Do they commit hundreds of billions of euros to guarantee the debts of fellow EU countries? Or do they allow government defaults and devaluations that may ultimately break up the single currency and further cripple German industry, as well as the country's domestic banks?
Publicly, German politicians have insisted that any bailouts or guarantees are out of the question. Germany has vociferously blocked proposals from Italy, Spain and the European Commission for the EU … to issue bonds … to support the governments with weaker credit. …
Last October [, however,] a previously unused regulation was discovered, allowing the creation of a €25 billion “balance of payments facility” and authorising the EU to borrow substantial sums … This facility was doubled again to €50 billion in March. If Latvia's financial problems turn into a full-scale crisis, these guarantees and cross-subsidies between EU governments will increase to hundreds of billions in the months ahead … .
This policy of “fiscal federalism”, long advocated by France and high-debt countries such as Italy, Spain and Greece, has been fiercely opposed by Germany and Britain. …
How could German politicians accept such a policy, having repeatedly sworn to oppose it …? And how can they pervert democracy by telling their electorates that they are doing one thing, while advocating the exact opposite within the EU?
… Germans focus on the letter of the law when they cannot bear to think about the spirit of the rules they are applying … . The new EU borrowing, for example, is legally an “off-budget” and “back-to-back” arrangement, which allows Germany to maintain the legal fiction that it is not guaranteeing the debts of Latvia et al. The EU's bond prospectus to investors, however, makes quite clear where the financial burden truly lies: “From an investor's point of view the bond is fully guaranteed by the EU budget and, ultimately, by the EU Member States.”
And so the juggernaut of euro-federalism rolls on; but viewed from an increasingly liberal central Europe, there is a great consolation: the history of euro-federalism keeps being repeated but, as Marx once said, what began as tragedy tends to end in farce.”
Anatole Kaletsky, “The great bailout - Europe's best-kept secret”, The Times of London (4 June 2009).
http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article6426565.ece
Anatole Kaletsky (1952-) is Principal Economic Commentator of The Times of London.
In a recent government auction Latvia failed to sell a single bill in its attempts to find $100 million in financing support for its crumbling currency and economy. Its currency is probably overvalued by a factor of one-third and its GDP is expected to shrink 15 per cent this year. House prices have fallen 50 per cent, and in response to bailout terms imposed by the European Commission and the IMF a third of its teachers are being laid off and public sector salaries are being cut by 35 per cent. One reason why it can’t sell its paper at auction is foreign creditors don’t believe it will really follow through and implement these draconian cuts in spending.
Latvia is not the only East European country in deep financial trouble. It is estimated that Western banks have loaned $1 ¾ trillion to this region. In the midst of a severe recession, these countries need to roll over $400 billion in foreign debts this year. With output and employment dropping sharply in many of these countries, their budget deficits rising rapidly, and their currencies under extreme pressure, it is difficult to see why private lenders (or even international agencies) would want to bail out these countries. As Kaletsky points out, however, failure to bail them out could bring down the private banking system of many West European countries. Hence, the dilemma before Germany.
Like it or not, the well of global capital from which these debts -- and the growing debts of the U.S. and many other countries – is running dry. In the U.S., President Obama’s stimulus package alone, if allowed to run its course in the years ahead, would add $6 trillion to the U.S. debt load. Note that this tremendous increase in debt owed by the U.S. government does not include all the bailout costs of the banks, Fannie and Freddie, the auto industry, the states and localities now set to default on their debt, or the rising costs associated with an ageing population. Other countries are also in trouble, and will be running to the IMF and the international development banks for help. The realization that all these bailouts are not possible is no doubt why long-term interest rates are on the rise despite the Fed’s effort to hold them down.
It is not only that the policy course we are on is not sustainable that gives one pause. It is that those in charge of setting the course do not seem to realize that it is unsustainable, and rather than changing their policies continue down a dead-end path to economic decline.
A Tdj by Doug Walker.
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