The FT has a nice piece on Latvia this morning. To my mind the most interesting sentence in it was the following:
IMF officials have indicated that the organisation was divided over the wisdom of defending the lat’s peg but was finally persuaded by pressure from Riga’s EU partners as well as the Latvian government’s own refusal to contemplate devaluation.
If there is one thing we have learned about international currency markets in the past couple of decades, it is that fixed exchange rates and internationally mobile capital don’t sit well together. A European response to this general lesson has been to go for full monetary integration — EMU — rather than stick with unstable intermediate arrangements such as the EMS.
There are logical consequences for how we deal with Latvia. If the country’s EU partners don’t want it to devalue, they should offer it immediate EMU membership. If they don’t do this, then we can probably leave aside the normative point that Latvia ought in its own interests devalue, since as a positive matter it will almost certainly be forced to be. As this article points out, a forced devaluation would have repercussions far beyond Latvia. It would be nice to avert a crisis before the fact rather than after it, for once.
7 replies on “Baltic trilemmas”
The EU might try to intimidate (!) the FX market. After all, it is not as if it is the bond market! They could say that the application has been made, and the peg will be defended by them.
I look forward to seeing why they will not do this….
Remember Iceland!
AFAIR some 200k mortgages in Latvia are €denominated, which was done in anticipation of € entry.
Develuation would be bad news for them, so an emergency bail-in would make more sense.
The thing to do would be devalue by a few percent from the peg as part of a bail-in to the euro. This would allow the benefit of devaluing without opening fears of further devaluation. Loan denomination is an issue but with very low interest rates it would be managable.
Main problem is that the ecb would then have to do the same thing for a number of countries. And you can only do this trick once.
I agree Antoin, devaluation followed by membership would be optimal IMO. I didn’t mention that since I wanted mainly to point out the inconsistency of saying (a) don’t devalue (b) stay out of EMU. @Brian: Lex yesterday had an interesting comment about how it would supposedly be legal to convert all those debts to lats before unilaterally devaluing. I’m not a lawyer so don’t know if that is true.
f I lend you 100,000 euros in euros, I expect to get paid back that plus interest at the agreed rate. I have what the European lawyers call a ‘legitimate expectation’ and I depend on what they call ‘legal certainty’. (http://books.google.ie/books?id=ZrlsnC-zhyUC&pg=PA223&lpg=PA223&dq=legitimate+expectation+EU&source=bl&ots=b9liDO7Yhn&sig=hi6PIaWKEPUrYhfBzsJ1v4zF358&hl=en&ei=41A6SoCnIty7jAfSzbiBDg&sa=X&oi=book_result&ct=result&resnum=7#PPA224,M1) .
II’m not a lawyer and I don’t play one on the ‘net, but as legitimate expectations go, the expectation of repayment of a debt in full, in the expected currency is probably about as legitimate as you can get.
If it was only Latvia, everybody could get together and kick in the difference between the full and devalued amount, or more likely, put in place a support scheme for the people carrying this debt. The amount of money is just not that much (say, 200k mortgages of 60k, 3 percent devaluation is a loss of 360m, which is small beer, less than what it costs to keep an Irish bank solvent for a month). Remember too, that these debtors will also benefit from the economic uplift that the devaluation would bring and have benefited up to now from lower interest rates.
The problem is that if you tried to do this across Eastern Europe, it could start getting expensive and messy.
Anyway, if I were Jean Claude Trichet and if I were planning on doing this, I would probably not mention it to the man from the FT.
Here is the link to that FT comment (although I confess I am prejudiced against any outfit styling themselves a ‘research boutique’):
http://www.ft.com/cms/s/2/a9b779dc-5405-11de-a58d-00144feabdc0.html
Well, they are proposing to compensate the parties or negotiate somehow, and it was to save all the parties, not just the Latvians. There might be some chance then, as opposed to doing it unilaterally (EU law seems to be approving of large meetings and high-minded plans).
Other than that, it’s the same thinking and the same problems – the ECB could do it, but what if everyone else then wanted to pile in?
40 percent, which they are talking about, is some devaluation. It’s hard to believe that on one hand there are people (Latvian government ministers) who say there should be no devaluation at all and on the other hand, there are people (working for an international business newspaper) who consider that a 40 percent devaluation might be on the cards. That is a very wide range of opinion.