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Saturday, March 7, 2009

Why You Need Devaluation - An Open Letter To The People Of Estonia

The macroeconomic data coming out of Estonia in recent weeks are truly shocking even in the context of the ten percent annual drop in GDP for 2009 that most observers are now forecasting. Perhaps the most evocative number of all is not the 27% year on year drop in industrial output registered in January, but the announcement this week that Estonia’s registered unemployment rate rose to a record 7.4 percent during the first week in March, with a total of 47,774 job-seekers registering with the unemployment offices, up 3,019 in a week. Of course, for many outsiders these are not large numbers, but then Estonia is not a large country. Still this was the highest number since the Labor Market Board started disemminating data in 1993 (although not as measured by Eurostat, which uses a different methodology). The level was up from 7.1 percent at the end of February and 6 percent in January, although the important thing is not the volume of unemployment, but the rate of its increase.

At the same time it is estimated that nearly 250,000 Estonians are currently living in homes whose market value is insufficient to cover the outstanding mortgage loans which their owners have taken out, making "exposure risk" a growing problem for the country's banks. During the boom, house sale transactions were commonly financed with a 90% loan to value (LtV) ratio. This is a very dubious practice at the best of time, but in the face of a sharp fall in both house values and wages it becomes well nigh disastrous.

Once boasting one of Europe's fastest-growing real estate markets, property prices in Estonia fell by a whopping 23% in 2008 (following an 18% increase in 2007) according to data in the latest edition of the Royal Institution of Chartered Surveyors European Housing Review. The RICS tracked 2008 year-on-year house price inflation in 18 West and East European countries, and found that Estonia's fall was the most substantial in the entire group.

Take, for example, a 50 sq metre apartment bought in the spring of 2007 for a price of around EEK 1.3 mln. This apartment is currently worth around EEK 790,000, but the outstanding loan balance is of the order of EEK 1.1 mln. Should the once proud owners of that lovely appartment now find themselves among those unfortunate enough to be queueing up outside the offices of the Estonian Labour Board and need to sell it, then even assuming they could find a buyer they would not only lose their home, but they would still end up owing the bank EEK 300,000 under Estonia's "full recourse" lending laws (which are of course very different from those operating in the United States). With an average net monthly salary in the region of EEK 10,000 this means that the unfortunate ex-property owners would in all probability end up with a debt worth more than two years their total income.

Of course, in this climate buyers are likely to be scarce, and it is more probable that the banks themselves end up with a substantial direct interest in Estonia's property market. And this would only add to the problem they are already having with overdue loans, which are rising and reached 3.6 percent of total credit in January, according to the most recent data from the central bank which now forecasts bad loans will hit 6 percent before the year is out. Of course, as is by now well know, more than 95 percent of Estonian banking assets are held by Nordic banks, and despite the fact that the banks don't cease to reassure us that their Baltic operations form a “key part” of their business and that they have a “long-term commitment” to Estonia, this doesn't stop them getting downgrades. Swedebank, for example, had its credit rating cut to A1 from Aa3 by Moody’s Investors Service last month, citing the risk of a “substantial increase in impairments” (read loan defaults and deteriorating asset quality) from the bank's Baltic operations.

Meantime output and employment simply keep on falling, with Estonia's industrial production dropping by the most in at least 14 years in January - 26.8 percent year on year, the most since 1995 (following a 22.4 percent slump in December).

Of course, as output drops and people are sent home to remain inactive, the one thing Estonia does have at the moment is a lot of loan offers. Thus the central bank recently announced that they will be able to borrow as much as 10 billion Swedish kroner against Estonian krooni from their Swedish counterpart in an attempt to boost confidence in Estonia's financial markets. As Riksbank Governor Stefan Ingves said in the statement “The financial systems in Estonia and Sweden are closely linked”. But what Estonia needs is not more loans, and more debt, and people lying around idle, it needs work, and output, and exports to pay off all that debt which has been accumulated. And it is just at this central point that the current solutions are being tested and found wanting.

The Price and Wage Correction Is Too Slow

In order to understand what is wrong with the path on which Estonia has set itself we need to bear fully in mind that the problem is that the country (or its households) have become excessively indebted in relation to the economy's competitiveness, and the consequent ability to pay. Estonia has a current account deficit, and this does not help things, but Estonia's problem is not, in the longer run, a simple balance of payments and financial crisis one (against which external loans can of course help), but a problem of competitiveness and the ability to pay off debt.

And even despite the recent sharp fall - almost all of which is produced by a fall in imports and a reduction in living standards - Estonia's current account deficit was still running at slightly over 9 percent of gross domestic product in 2008 (following the 18.1 percent shortfall achieved in 2007).

Estonian central bank data show an estimated current account defict for last December of 943 million kroons, down from a revised 1.87 billion kroons for November, and from around 3.5 billion kroons in December 2007, but since exports were down 6% year on year in December, it is obvious that the reason for the contraction in the deficit is the 17% drop in imports. Ouch!

Now, as I say, basically the problem here is to restore competitiveness and, although not everyone will be prepared to agree with me, I would argue that the only solution for Estonia is to export its way out of trouble. Given the problems the banking system is having and is about to have, it would be sheer fantasy-land (and very foolish) to imagine we are going to see a return at any point in the forseeable future to consumer credit driven growth (we are talking everywhere about more, not less, regulation), so as Estonians work hard (once they finally get a job again) to pay off their debts and try to save for their increasingly uncertain old age, the only really valid way to try to go for growth is by exporting. Saying that this is not possible, well... this is simply defeatism before you start, and I don't imagine the Estonian character that way somehow, not after so many years of fighting to gain a hard won independence.

So if you want to export, you have one benchmark to work againt - Germany. And if we look at the chart below, we will see the extent of the competitveness gap which has opened up since 1999. Now Reel Effective Exchange Rates (REERs) are a nice measure of competitiveness, since REERs attempt to assess a country's price or cost competitiveness relative to its principal competitors in international markets. Since changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends the specific REERs used by Eurostat for its Sustainable Development Indicators have been deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness, and as we can see Estonia's index has risen sharply against Germany's in recent years.

Well, just in case anyone thinks that the comparison with Germany is not an appropriate one in Estonia's case, here (see below) is the equivalent chart for Finland, which shows an equally strong loss, and let us remember that the worst year in this sense (2008) is still not included, since Eurostat have not processed the data yet.

And of course, I am only looking at eurozone comparisons here, we won't enter at this point into the embarassing fact that Sweden and the UK have both devalued sharply in rcent months, as have Eastern EU rivals, Romania, Poland, Hungary and the Czech Republic, as well as non EU rivals like Ukraine and Russia. Really hanging on to the peg blindly in these circumstances is not only foolish, it is ridiculous, and I hardly see how following a ridiculous policy (which for sure won't work) is going to enhance your credibility, which is what the decision not to devalue was all about in the first place. It won't even shield the Nordic banks from the slew of incoming defaults.

Now, "plan A" is supposed to involve a very sharp downward adjustment in prices and wages, something of the order of 20% during 2009 and 2010. (Incidentally, talk of a V shaped recovery is misleading here, since the V shaped recovery only comes with a one-off devaluation, say getting the 20% out of the way all at once, and doing it over two years can only bring a U shaped process, as you simply spin the same thing out over two years, think about it, the issue isn't that hard to see). Anyway, over two years it is, so how are we getting on? Well up to December last year (which is the latest data we have) not very well, since average hourly wages (the key number here) were still up 9.9% in the last quarter of last year, and so this is really another 10% or so to add to the 20% we were just talking about above (based on the 2007 REER). True, hourly wages did peak in Q2 at 78.26 kroon, and were down to 75.58 kroon in Q4 (or by 3.4% in six months), but this was only really taking back some of the excess from H1 2008, and the real hard work is still to come.

But if we move away from wages and take a look at prices, we find the situation is not much better, since while Estonia’s inflation rate fell in February to its lowest level in more than three and a half years it was still running at an annual rate of 3.4%. We need to see average price declines in the region of 10% in both 2009 and 2010, and not only am I not convinced we are going to see that, none of the major bank analysts or multilateral organisations are currently forecasting anything like this. Or are we going to run our correction from now till 2015 (and have something which looks more like an L-shaped correction)?

Of course, as many will point out, the price index has been falling in recent months (see chart below), but the question is: is it falling fast enough?

What we really need to think about here is not the general index, however, but the so called "core" index (the one that excludes volatile items like energy, food, alchohol and tobacco). Now as we can see in the chart below this index has stabilised, and has even started falling slightly, but if we keep in mind the rule of thumb idea of a 20% decline, and note that the core level peaked at 118.37 in December, then for the correction to have any hope of working we would need to be looking at a reading in the region of 95 come December 2010.

And the situation may be even more complicated than we imagine, since the Eurozone itself may fall into deflation, and if so every percentage point drop in the Eurozone index will need to be matched by an extra percentage point drop in the Estonian one. Unfortunately your leaders and advisers are a long way from explaining this harsh reality to you.

But there is reason to fear that this may actually be what happens, since if we look at Eurozone headline HICP inflation on an annualised basis, we will find that it fell more than expected in January - to 1.1 per cent, according to Eurostat data - down quite dramatically from the peak of 2.7 per cent hit in March last year. This was the lowest level we have seen since July 1999, and a sharp drop from the 1.6 percent rate registered in December. On a month-to-month basis, prices were down 0.8 percent. The "core" inflation rate - that is consumer inflation without the volatile elements of food, energy, alcohol and tobacco - we find it still stood at 1.6%, since the biggest impact on headline inflation comes from the decline in food and energy costs. But if we look at the monthly movement in the core index, we find that it dropped by a very large 1.3% (see chart below).

Now if we come to look at the core inflation rate over the last six months, we find that the index has only risen 0.1% (or an annual rate of 0.2%). This gives us a much more accurate reading on where inflation actually is at this point in time, and where it is headed. The chart below shows the six month lagged annualised rate for the last twelve months, and the sharp drop in January is evident. If things continue like this, then the eurozone as a whole is headed straight into deflation, for sure.

Retail Sales Dropping Sharply

Basically, to get economic growth, and thus to be able to pay down debts, you need one of three things: an increase in government demand, and increase in export demand, or an increase in private domestic demand. Now the first two of these are categorically excluded in the present situation (especially since the government is cutting, and not increasing, public spending as part of the crisis response package (the so called "plan A" strategy). However, private domestic demand is falling like a stone at the moment. According to the latest data from Statistics Estonia, retail sales were down 10% year on year in January (at constant prices).

As we can see in the chart below, Estonian retail sales peaked in February 2008, since which time they have been steadily falling.

So what are the chances that domestic demand can make a recovery? Well, according to some, quite substantial. According to a recent report from UBS bank on Eastern Europe Lending:

We retain our firm view that convergence is a ‘sure thing’ for those economies already in the EU – it is just a question of time before levels of GDP per capital approach those of the established members. If convergence is perhaps a thirty or forty year process, the most advanced are perhaps half way through (Poland introduced its free market reforms on 1 January 1990). The uncomfortable period we are entering is one where local growth goes from above-trend to sharply below. It may well take a number of years before nominal GDP (in Euro) recovers the levels of summer 2008, but we believe markets can be forward-looking when outcomes are predictable.

So the issue is convergence, and the justification for "plan A" is essentially based on this idea, as UBS analysts

Why does convergence matter so much? Because equity markets – and therefore companies – are essentially about growth. And convergence drives excess growth. The new EU members offer legal systems becoming increasingly like those in old EU states, with labour productivity comparable and labour costs a fraction of those back home – particularly following recent currency declines. Margins on banking products are typically higher than in ‘old’ Europe and levels of penetration much lower.

These arguments were a staple of a thousand corporate presentations through the good times and we suspect will be little mentioned except where necessary over the next twelve or eighteen months. But we believe them to remain essential to an understanding of likely outcomes in the region: they raise the bar for all stakeholders faced with a challenge of whether to prioritise the long-term or the immediate. It is an active debate what the Ukraine will look like several years hence; we believe it is not for the EU members: they will look more like the old EU states, in form and substance.
So we are putting all our money on the "convergence" bet, but just how realistic is this? Unfortunately, not very, since one key argument it simply fails to take into account is the effect of demographic processes. Basically, the whole of Eastern Europe has one large and little discussed problem, birth rates fell dramatically, but life expectancy did not rise: Latvia and Estonia are not only (along with Slovakia) the EU countries with the lowest per capita income, they are also those with the lowest life expectancy. Male life expectancy in Estonia is just 67.16, and for Latvia it is 66.68, compared to 76.11 for Germany, and 77.13 for Italy. Let's not beat about the bush here, this means that each adult working male can contribute roughly ten years work less to paying down the country's debts, and of course, extending the working age to 70 (25% of the Japanese population still work at 75) impossible. This is why the whole idea of "convergence" is a non-starter. And again, you don't need to be an economics PhD from MIT to see this.

In the real world Estonia's population is currently shrinking, which, with fertility around the 1.4 Tfr range is hardly surprising.

The birthrate has been rising (slightlly) in recent years, but as Afoe's Doug Muir explains in this post here, this is more than likely going to unwind during the recession.

Interesting Fact #1: birthrates tend to drop during recessions, and the drop tends to correlate with both the severity of the recession and the speed of its onset. The current recession is looking to be a bad one, and it happened pretty quickly, so we can reasonably expect a sharp drop in birth rates. Makes sense, right? Babies are expensive; more to the point, babies limit your options. They make it harder to move to a different city, change careers, stop working for a while. When times are hard and uncertain, babies become a luxury. For individuals and families, a recession is a good time to put childbearing on hold.

Interesting Fact #2: all across Communist Eastern Europe, birth rates declined slowly through the 1970s and ’80s… and then crashed after 1990, dropping to very low levels and staying there through most of the decade. In some countries they bounced back a bit, in others not, but in almost all cases there’s a big “birth gap” from about 1991 until at least 1997, and often later.

Put these two facts together, and there’s a problem.

Indeed Statistics Latvia have already reported a 25% year-on-year drop in births in January 2009 (from 2310 in Jan 2008 to 1860 in Jan 2009), and looking at the Estonian Statistics we find that in January 2008 there were 1493 births and in January 2009 there were 1232. Again about a 20% drop year on year. Of course, one month's data don't prove anything, but since, as Doug points out, this is what the theory predicts, we should all be taking it seriously, and it should be taken into consideration when we talk about which kind of "correction" we want. It is no good saving the stream of external funding coming into your banks if you "meltdown" your population as you do it.

Unfortunately I haven't noticed one single European leader who is seeing fit to even mention this issue - or the other, pending, one that when the recovery does come, if the Baltic countries are still stuck struggling with their pegs, the additional haemorrage out will be in young people looking for money to send home to their ageing and impoverished relatives, thus giving the whole demographic thing another turn of the screw.

The future already looks bleak enough in human capital terms, as this recent report from Statistics Estonia makes evident:

According to the Statistics Estonia, at the beginning of academic year 2008/2009, 154,481 pupils were acquiring general education, 27,239 vocational education and 68,399 students were acquiring higher education. The decrease in the total number of pupils is influenced by the number of pupils acquiring general education, which has decreased during the last decade. The decrease in the number of pupils in general education is related to the decrease in the number of births, which began at the end of the 80s and lasted till the end of the 90s. At the end of the 90s more than 220,000 pupils were acquiring general education, thus the number of pupils in general education has decreased by about a third during the last decade. In academic year 2008/2009, 147,519 full-time and 6,962 part-time pupils were acquiring general education. In autumn 2008, 12,426 children started school, which is over a third less than ten years ago.

So Is There A "Plan B"?

Well, of course there is, and everyone, no matter which side of the argument they are on, knows only too well what this is: devaluation. Of course of devaluation of the Baltic/Latvian pegs contains implied sovereign liabilities, and these need to be thought about. You cannoy do this alone, but you are members of the EU and you can ask for help with the process. But if you don't start to ask for the help, then naturally you aren't going to get it.

Technically the pegs can be maintained. The question which faces Estonians is quite simply which alternative – keeping or changing the peg – implies the greatest cost. The main stakeholder here is the EU, and you should be leveraging that for all you are worth. The capital erosion for Western European lenders would not be insignificant if you (and others) simply sink.

Naturally small open European economies like Latvia and Estonia can only hope to gain very minimal monetary autonomy outside currency board type arrangements, so the only realistic exit strategy is devaluation and Eurozone membership, as I explain in this post (and this one).

Of course this change in EU policy won't arrive tomorrow (but it might come next week, or the week after). It's just that you have to push for it. Stopping work and going home (as unemployed) while your country borrows more and more money is not going to bring the future you all so badly want. There is another path, choose it!


Anonymous said...

You writing that government "is cutting, and not increasing, public spending as part of the crisis response package (the so called "plan A" strategy)."

Actually, even after cutting budget government deficit is still at least 3% of GDP and it is financed by spending reserves what were invested abroad. Also some demand is created by European Union support money (up to 4% of GDP, I guess). All together there is some 17 billion kroons or 6-7% of GDP additional demand from government side.

Edward Hugh said...


"Actually, even after cutting budget government deficit is still at least 3% of GDP and it is financed by spending reserves what were invested abroad."

Yep, but this is simply to maintain existing spending, as the economy contracts, rather than a specific stimulus programme. The EU funds are rather different I agree. But I'm not talking about now, or even 2010. I am talking about the 2010 - 2015 horizon. That is when you will be dependent on exports, and that is when it will be important to have relative prices ready to attract greenfield site investment and relly get exports moving. My fear is that you will arrive at the end of 2010 and still not be ready to start putting people back to work. The CA deficit may be much smaller, but that will only be because living standards will be a lot lower, not because you have restored competitiveness.

Foreign resident of Estonia said...

I wonder if you could address a little more clearly what the political and economic consequences of devaluation would be for Estonia. You're saying it's the lesser of two evils - so how would going that route impact the country?

(Oh, and thanks for your blog!...)

Anonymous said...

What will happen to Skype?

Hynek Filip said...

One interesting piece of evidence from the Czech Republic: as is widely known, the koruna lost about 25% of its value against the euro (and more against the dollar) in just a few monts. And, voila, the popularity/support ratings of the government went quite sharply up (up, not down).

So far, the government was quite succesful in explaining that we need to cut back, save more, borrow less and generally prepare for harder times.

By the way, the Czech government had one fine idea, which is proving extremely successful:

an official "Council of the Wise" was created and staffed with the most respected (as well as the most publicly known) economic experts available. So far, the plans drafted by this council - and implemented by the government - have been fundamentally sound.

However, the greatest advantage of such a scheme is that the government has a relatively free hand to implement unpopular measures. It simply suffices to claim that "The Experts have told us".

You can still be angry that your income is down and the taxes up, but the Experts have spoken and there is nothing you can do about it.

Raul (Estonia) said...

It would be mistake to simply disagree with your analysis. To find someone from outside of Estonia, who is willing to work on the topic and to contribute his insight, is very rewarding. Most of the publications keep the "all-the-same-balkan" type of approach, putting sometimes South Africa into Eastern Europe, etc. So I find your blog extremely valuable and I know a lot of people in Estonia, who follow it on regular basis.

There are some serious points, why Estonia is reluctant to go to the devaluation path.

1. Export vs long term debt

Estonian export in 2008 was about 132bln kroons (EUR 8.4bln). In 2007 (2008 data not yet available) total long term debt of businesses was 124bln kroons (EUR 7.9bln). We are talking about the similar numbers here. Most of the long term debt is fixed in EUR. For export businesses devaluation would mean not only increase in export opportunities, but also immediate and painful increase in their debts. This is one of the reasons we do not see heavy pressure towards devaluation from export industries. As soon as they face serious troubles with refinancing, we may see another story.

2. Home loans

You described that "it is estimated that nearly 250,000 Estonians are currently living in homes whose market value is insufficient to cover the outstanding mortgage loans which their owners have taken out". While I disagree with this number, majority of the valid mortgages were taken pre-boom, and are covered, I must agree with the delicacy of the situation. But I fail to see, how could devaluation help those people? If more than 80% of mortgages are in fixed in Euros, devaluation would increase monthly payments and generate foreclosures, driving real estate prices even more through the bottom, etc. This is one of the reasons homeowners are not eager to agree with devaluation.

3. Politics

With local elections upcoming in 2009, you can sleep well with your Kroon deposits until autumn (or at least until Latvia devaluates). Devaluation would be political suicide and with Tallinn's city government in stake, no politician dares to speak about devaluation until then.

4. History and emotions

Estonian Kroon is one of the symbols of independance, its stability one of the symbols of our stability. Giving up the peg would mean that we didn't make it. Sure, this may sound silly, but it works. And the good point is that we have a focus. Keeping the peg until Euro comes, is religious goal in good sense. It unites people and gives hope for better future (whatever this may be). Generations over 30 have seen crisises and living standards much worse than today's. People are tough and ready to cope with anything, as long as they have hope.

So devaluation would probably give positive boost to export, if exporting industry survives debt increases. Unfortunately, devaluation would not be the end of the crisis. It would take lot of work to regain normal situation and with adverse efect to people's motivation, devaluation would probably make recovery more painful and longer than problems associated with peg.

Anonymous said...

Aare (Estonia)

I would disagree with Raul.
Main points: having lived and worked in industrial company in Latvia now for three years and following, seeing chrises locally globally and can say following:

home loans, loans overall, etc - all these are irrational arguments, meaning they are political.

But in time of crises one should be rational.

In Estonia, if you look at news and/or analyses in media, I am sure that this country is living in some kind of dream world, and/or as elections are coming, all media, politicans are avoiding subject dealing of crises. Our prime minister simply and openly calles people disagreeing with him "idiots".

So this blog might be right, devaluation is needed, EU in their latest decisions did f...k Baltics and other Eastern European countries, but the fact is that in a democracy as we have in Estonia, some subjects in open and academical discussions are considered as banned, or not discussable. At the moment it is so called quiet period in crises discussion, there is no open (academic) discussions in Estonia.

And even if there were, nothing wouldnt be done, as goverment is incapable of deciding. As it will be elections, it is "status quo" period, an nobody wants to brake it.

So academically, in reality it would be interesting to calculate, forsee how quickly Baltics as a group of countries, or separtely will be forced to insolvency or devaluation.

Nutt ja Hala said...

Sweden has devalued (floating rate) its currency and they are as f*ucked as we are:
use google translator.
industrial production down 23% in january.

Estonia needs exports,but not cheap outsource jobs, but high value added products. such products sell at higher prices and input resources/prices don't really matter (no real difference is your margin 200% or 220%).

by devaluing we just encourage cheap outsourcing. and this will not get us forward. but by not devaluing we take longer recession and pain, but as we all know, lack of money is source of ingenuity.

of course we can argue that there is not enough intellectual capital in Estonia and until we manage to develope those high value added export articles we need to live too.

but I'd rather take longer pain than cheap outsource.

Anonymous said...

I would rather believe Jim Rogers : "They think that if you drive down the value of your money, it makes you more competitive, now that has never worked in history in the long term."

Edward Hugh said...

Hi everyone, thanks for the comments.

"I wonder if you could address a little more clearly what the political and economic consequences of devaluation would be for Estonia. You're saying it's the lesser of two evils - so how would going that route impact the country?"

Well look, I think at this point in the game Estonia would be unwise to simply go ahead and devalue tomorrow, since you need the support of "stakeholders" like the EU.

What I think is needed is a common front between Latvia, Estonia, Lithuania and Bulgaria to push the EU into facilitating the process of euro entry. I mean you do all very much need to stay in this together.

Basically large changes are going to have to come in the EU structure during the next twelve months or this crisis really will turn into a depression.

But the first, and necessary move for this is a recognition that the present path won't work, that's what I think is lacking at the moment, not unilateral action.

The respective governments and economic advisers shoudld stop arguing that you can resolve without more support than simply liquidity providing loans and advancing EU grants.

So you do need a political campaign, I agree with this, and you do need to be streetwise in the way you do it. But convincing all the Estonian people you don't need devaluation, and then later in the year, or next year, telling them that you do, that can really damage morale and confidence. And your future now looks so complicated and so difficult that you could really do without the added diffivulty of dropping morale even further with a thoroughly unannounced U turn.

And there U turn will come, IMHO, since there is simply no way you can realistically hope to enter ERM2 with your current exhange rate.

Edward Hugh said...

"Sweden has devalued (floating rate) its currency and they are as f*ucked as we are:
use google translator.
industrial production down 23% in january."

Sweden is not in anything like the trouble you are, I'm sorry, it's just like that.

Sweden is another elderly export dependent economy, and obviously they are having a hard time of it right now, but this isn't a football match, we shouldn't simply cheer when someone scores a goal against Germany or Japan.

The thing is Sweden has a current account surplus, that why their banks are losing so much of that money they leant you. Sweden is down, but it is far from out, and when the recovery comes swedish industry is likely to be in a position to take a lot more advantage of it than Estonia's is.

"Estonia needs exports,but not cheap outsource jobs, but high value added products. such products sell at higher prices and input resources/prices don't really matter (no real difference is your margin 200% or 220%). "

I think you are living in a fantasy world about all this. Everyone now wants in on this market, and the competition is going to be fierce, and the margins much thinner than you imagine.

On top of which you have a lot of people over 50 with low educational levels who need employment, otherwise they have to be supported on state benefits. Germany now does a huge amount of low value work. There really is little alternative in an ageing society.

Anyway, as I said, this isn't a lottery, or a football match, this is the real world, so we will be able to see. This blog isn't going away, so stick around and lets see who is right. I give it two more quarters, and then if the wage and price data haven't shown a very dramatic change your position will fold.

If Bulgaria or Latvia don't fold first. That's why you need a common position.

And just what evel of unemployment can your political system stand, 20%, 25%, everyone has their breaking point. And what default rate can the Nordic banks withstand, obviously the potential defaults are the same whichever way you go, but with an export lead discovery there is the prospect of people being able to start paying again at some point.

"but I'd rather take longer pain than cheap outsource."

Well, this is just it, you aren't the only one voting here, and just how long will all those unemployed be able to hang out, one year, two years, three years....

Hynek Filip said...

To Nutt ja Hala:

You are one hundred per cent right in saying that Estonia needs to export high value added products.

But, at the moment, Estonia does not have many such products, so it will need to develop them. And to develop such products, you need human capital, that is clever people. A very scarce and quite mobile resource indeed.

Now, it would seem to me that at the moment, Estonia is going straight off the cliff and without devaluation, the economy will collapse in a matter of months.

Do you believe that those people who have brains will voluntarily choose to stay in a collapsed economy? Most of them will take the first flight to Zurich, Dubai or Singapore. Who will then develop the high value added products?

You know, I would not be making this comment if most of the Czech cities were not flooded with Ukrainian workers, who since 1998/9 left Ukraine in search for decent living. Although many of them have university degrees, they take whatever jobs we can offer, especially in construction.

It is simply so bad over there that you may be a rocket scientist, but you still rather build metro tunnels in Prague than stay in Kiiv.

I do not believe that at the end of the day Estonia will end up at the bottom of the pit right next to Ukraine. However, if it keeps the current course, it most certainly will.

Nutt ja Hala said...

Edward, Hynek,
Estonians are very well educated. We scored 5th place in PISA test. Estonia has very high rate of people with university degree. but in business world this means nothing. well educated people are good workers, but they tend not to take risk and do business (owners).

by meaning high value added products, I'm not meaning another iPod killer or laptop of some sort. I mean stuff that nobody else does, or very little. currently I have only one example, Skype.

and in my mind, such products come from peoples ingenuity, not from good education. and people ready to take risk. if business is good, nobody takes additional risks, but if you have nothing to loose, you take leap of faith.

Nutt ja Hala said...

Entrepreneur Requirement: Be a college drop out!

Hynek Filip said...

My point would be that enterpreneurial spirit is rewarded only in a functioning economy, and that a functioning economy can not work with lasting massive imbalances (such as, in the Estonian case, a staggering current account deficit and overvalued currency).

Actually, we have found ourselves in a very similar situation back in 1996-8. At that time, the Czech currency was overvalued, the industry unable to compete and the banks were on life support provided by the Ministry of Finance.

The crisis took about five years to resolve, and the key measures that ultimately proved succesful were as follows:

a) real wage cuts
b) currency devaluation
c) fire sale of all banks to Western investors
d) state-supported massive inflow of primarily German foreign direct investment resulting in complete overhaul of the industrial base
e) significant reduction of direct taxes
f) radical modernisation of the legal system, largely following German laws
g) modernisation of power generation, especially the nuclear power plants

In any case, it took us five years to get unemployment back to below ten per cent and gdp growth to more than three.

Nutt ja Hala said...

btw Edward, you have any positions that will increase in value when estonia defaults or devalues kroon?

Edward Hugh said...

Hi Nutt,

"btw Edward, you have any positions that will increase in value when estonia defaults or devalues kroon?"

Frankly Nutt this is a silly question? If I were an investor and I backed my views with my money, would that be wrong??? We live in a free market economy.

As it happens I am a theoretical economist, not an investor, and I have no positions on anything, except my own human capital.

I even rent my flat, and sold the last home I owned in the early 2000s, since it was obvious all this was coming after they introduced the euro in Spain.

The only thing I have a position on is cash. In the present environment I keep as much of the little money I have as possible in cash. But I'm not an investor.

I don't even accept money for giving economic advice so I can avoid the silly question you just asked altogher. If I ever have a tomb, I would like someone to carve on it "he never accepted a penny for offering an economic opinion".

I earn my living - my needs are few - in other ways, and somehow I feel better this way. Still, each to his or her own.

Foreign resident of Estonia said...

Hi Edward -

Actually, I wasn't challenging your view. I was just asking: What would happen in Estonia after devaluation? I understand that imports then become expensive for locals, but tourism is buoyed because foreign visitors find their money stretches farther. And adoption of the euro would, I assume, be set back. But other than these obvious ones, I'd like to know the likely ramifications.


Edward Hugh said...

Hello Foreign Resident,

"Actually, I wasn't challenging your view."

Sorry, yes I realise that. I am just so busy at the moment.

"You're saying it's the lesser of two evils - so how would going that route impact the country?"

Well basically I am sayin that there is only one route, devaluation, or devaluation, since I think what they are doing now won't work, and eventually they will have to devalue. This could happen becuase Latvia devalues, it could happen because Lithuania devalues, or it could devalue because the poitical unity needed to continue along the present path fails.

Basically, I doubt they can turn prices round quickly enough to be able to get exports up fast enough to stop the rot.

I mean the economy is contracting every month, more and more people are becoming undemployed, and more and more people are going to start to default on their mortgages, especially as their mortgages go under water.

Look, there are just so many difficulties with this no devaluation view that it is hard to list them all, I would be eher all month.

But think of this, if they don't change the banruptcy law away from full recovery, then a lot of young people will have no option but to leave, as Hynek points out, since they will lose their homes (but then who will live in them, will the banks just let them lie empty, remember the population here is falling) and they will still be paying.

Under these conditions, it is simply better to pack the bags and go to Australia or something and start again.

So the first argument in favour of devaluation is that it can give people back hope, hope that one day the economy can start growing again, and that living standards can start to rise again.

Then it can stop the rot in employment, not only by making the possibility of jobs selling products elsewhere, but by making it less attractive to buy imports, and more price attractive to buy home produce (think food).

The thing is, what just isn't sinking in is that there is no growth going to come until exports start to move. We can wait years, but we won't see it. Domestic demand just will not be a driver. I simply do not know how many times I have to say this. As far as I am concerned this is simply a given.

I think the best thing would be devaluation, and Eurozone entry, but we have to persuade Brussels and Frankfurtfirst.

However, as the crisis is developing, I do feel that solution may not be as far away as it seems, since a huge crisis is a wonderful way of concentrating people's minds - as we saw with Hank Paulson and George Bush.

Basically, they can't just go out and say we will devalue tomorrow, or the speculation will be unbearable. But neither should they be telling people that Estonia can't export and all these silly ideas that are going the rounds, since people will become very confused later.

My policy proposal is that the three Baltic leaders should be collaborating with Bulgaria to put reasonably public (but responsible) pressure on the Commission and the ECB. These countries naturall fall together due to their peg type arrangements, and their relatively small size.

I agree with the Economist that we need a two tier solution for the East, with the floaters coming into an accelerated ERM2 chamber.

Not doing anything is ridiculous, since the situation WILL turn critical, and then everything will need to be done in a hurry.

I hope that helps, I'm not sure just what else you want me to say. I don't have a crystal ball, but I do know that by fighting and trying to break out of the encirclement they have a better possibility than just sitting there and waiting for the roof to fall in on them.

Allan said...

Statistics Estonia published today the preliminary foreign trade figures for January - exports of goods was down 29% and imports of goods 37% compared to previous year. Biggest drop so far as I can remember.

I agree that kroon is overvalued and this makes it much harder to export. Many important partner countries (Sweden, Russia, Byelorussia, US) have weakened their currencies against euro and this makes our products more expensive.

The problem still is that most of the loans to companies and private individuals are euro based. So with the devaluation the income drops and the loans will be still the same and therefore harder to serve. It would be nice to convert all the loans into kroons before devaluation but I think this is not possible. At least the banks and their Swedish owners would not be happy about that.

TT said...

Devaluation, in my opinion, is no option for Estonia. Other measures should be considered by the government.

The fact is that most of the wages have over the past few months decrased. Some incomes have decrased up to 70%. People, who were doing well a year ago are already struggeling with their loans.

I this instance it is needless to say that almost 90% of loans granted by banks are Euro based. Devaluation of kroon by 20% would in fact increase those loans by 20%.

Another thing that should be kept in mind that most of the consumer products in Estonian market are imported, therefore there would be a 20% increase in these prices as well. Domestic producers would have to increase their prices as well, since the gas prices would increase 20%.

People, who's incomes have already decraeased up to 70%, would have to add to that the extra 20% due to devaluation, and an extra due to the increases in prices.

After devaluation the economy would be, it is not nice to say, but so fucked up, that no household would be able to stand the expences.

Most of those 250 000 people are well educated and hard working, whose intelligence would influence and assist the Estonian economy in the long run. These people would migrate certainly, because they do have what it takes to cope abroad, leaving behind average workers, who are not able to sustain the economy.

TT said...

I forgot to mention that the figure which represents the cost of products and competitivness in export markets is hihg because ineffective management of recources and hihg expectation of net profit. I have witnessed many annual reports, where the net profit is between 50-80%, sometimes even exeeding the last. As I recall, in busines 101 they teach that up to 11% of net income is ethical.

Even now some businesses expect same net profits, which is one of the reasons of lay-offs - the work is left for the coworkers without increase in salary.

Anonymous said...

Some good news from Lithuania (http://www.baltic-course.com/eng/analytics/?doc=11025):

"Statistics Lithuania reports that according to non-final data obtained from customs declarations and Intrastat reporting data, exports in January 2009 totalled LTL 3.2 billion in terms of commodity value, while imports to Lithuania equalled LTL 3.3 billion. The foreign trade deficit of Lithuania made LTL 0.1 billion and was by 95.5% lower than during the same period in 2008. Data on trade with EU countries were adjusted after VAT declarations’ data had been received. "

Edward Hugh said...

Hi anonymous,

"Some good news from Lithuania"

Well it depends what you call good news, since Baltic Course also report this:

"In January 2009 against January 2008, exports and imports decreased by, respectively, 14.6 and 40.6%;"

In other words the trade deficit is being closed by a huge drop in imports (read drop in living standards).

Obviously you can close a trade deficit by having zero imports and zero exports, the real question is at what level of output and employment.

Lithuanian living standards just fell off a cliff, if you call that good news I'm not sure what "good" means anymore.

As I say, there are two ways to do this, one is by reducing imports and increasing exports (which is consistent with maintaining employment), and the other is by tanking the economy so you don't get imports because you can't afford them - incidentally, do all those products people buy when they do the shopping trip across the frontier to Poland count in the import stats?

This is all so sad. First the fact that it is happening at all, and then second the fact that people don't seem to understand that they are playing with fire. But, oh well, if you insist, but after you gentlemen..................

Who Dares Wins (or loses).

Edward Hugh said...

If you all like experiments, and don't mind giving yourself up in the interests of science, there is an experiment I have long been wanting to run.

Maybe Newton's whole theory of gravity was wrong, or at least the Baltic countries may be a kind of Bermuda Triangle where the normal rules of space and time don't operate. So what I would like are say, ten volunteers, among those brave and hardy folk for whom no sacrifice is too much in the interests of science, who would be perpared to jump off the top of a high building, willing themselves to go upwards, I mean, surely it can't be true that apples, always and everywhere drop from the branches of trees.

And meanwhile, what are all those people going to do after one year of unemployment, when they have only 59 euros a month to live on?

Tough people, that's for sure, "Hard, like Steve Gerard" as my former scouse fellow townsfolk were cheering when Real Madrid succumbed 4-0.

Edward Hugh said...

Hello TT, Raul, Allan, everybody.

Sorry I haven't responded to your comments directly, this really has been one hell of a week.

I am trying to follow a lot of economies simultaneously, and as you can imagine there is a lot to study. Today I was looking at China, and commenting on Estonia, from the biggest to one of the smallest, I suppose.

Anyway, what I want to say is that over the weekend I will try and find the time for a serious and reflective post where I try to address the arguments you have presented. So keep an eye out, and thanks again for commenting, whether you agree or disagree with me.


Hynek Filip said...

Let me put forth one more idea, again based on Czech experience with devaluation.

It is now quite universally accepted that in the summer of 08 the koruna was massively overvalued. Then it fell some 50% against the dollar and about 30% vis-a-vis the euro.

The government let the koruna fall without any sign of intervention.

Moreover, the Czech state does not bail out banks, does not print money and our trade balance has turned positive.

And look what: the investors did notice. All of a sudden, the depreciation stopped and the koruna claimed back about half of the losses.

Although there may be many factors in play, I would suggest that the markets will in principle reward those states whose policies are not completely absurd. We have quite nice currency reserves and our economy is not the weakest on the planet, but we do not throw money out of the window and let the markets decide what the koruna is worth. At the end of the day, the markets will decide if our government is sane or not.

As it seems, the government of Estonia decided (for political reasons) to stick to the peg. No matter how hard I try, I can not find many voices supporting this policy (Mr Almunia does not count). So the whole world seems to think that the Estonians lost their senses.

It seems that the whole world believes that the devaluation is inevitable and that the solution is to let the kroon float.

If that is true, the kroon will devalue. However, if the government admits that the devaluation is necessary and that market forces should decide how much a kroon is worth, the world will again have some trust in Estonian economic policy. Which will, in turn, mean that the investors will have more trust in the currency, and that the currency will go up. In other words, devaluation need not mean that the kroon will go down like a lead balloon, but devaluation will almost always be seen a step out of the DreamLand and into reality.

TT said...

Hynek Filip, Estonia is living in reality, not in somekind of Dreamland or world.

Keep in mind, that no government should put solely economy before it's citizens in the long run, because citizens are it's economy - the buying power of the citizens menas, through taxes, sustainability and growth.

Estonia has witnessed the "power" of foreign investments, which started some 8 years ago. An economy needs long term investments, not short term speculative investments, to sustain it's economic stability.

Most of the investments made to Estonia over the past 7-8 years were short term speculative investments, which aided to the real estate boom, increasing the costs of real estate in some cases over 10 times. An appartment which was sold for 120 000 EEK in 2001, was valued 1,2 MEEK in the middle of 2007.

The average gross-income increased during that period from approximately 4 000 kroons to approximately 12 000 kroons. Keep in mind, that these figures are average. In 2007 the statistics about wages revealed that only around 15% of gross incomes were the avrage of 12 000 or above. Some 40% recieved up to 9 000, and some 45% up to 5 000 (approximate numbers). In general, it was stated that the average income of an household was around 10 000 kroons. If you divide the population roughly by 3, you get that there are approximately 400 000 workers, of which 60 000 eraned the average salary - the household net income was greater than 10 000. The number of mortgages in Estonia, however is around 250 000.

Up until the summer of 2008, the real estate prices were in some cases even higher than i.e. Finland.

I personally have started to call these "investors" "garbage investors", since their goal is not to produce anything, adding extra value, or creating jobs, but by creating a high demand for products (i.e. real estate) increase the price in short term, and sell shortly after. The speculative investments started to pour out the money in the middle of 2007.

Devaluation of kroon would give such investors just another opportunity to gain, what I like to refer to as "unethical money". But Estonia does not need short-term investments & capital, which does not create new jobs, and in the long run does "travel" back across the border. For economic growth and stability Estonia needs long-term investments, which generates new jobs, and in turn keeps the investments within the country.

The devaluation of kroon would give long-term investor (i.e. a VC) the sign that the economy is unstable and that there are high risks involved in investing, since the devaluation also attracts short-term investors who'se intention is to gain quick profits, thus creating the risk of high inflation.

I believe, that kroon is not overvalued, since it maintains the trust of the people, and of those few investors still in business in Estonia. Short-term investors, however do not invest in Estonia, since they are waiting for the devaluation, and therefore it is practically impossible to attract long-term investors, since they fear the devaluation.

Now, the devaluation does not put a stop to the increase in unemployment, since it attracts only short-term investments, which goal is purely fast gain from the situation. True that devaluation would cut the cost of the domestic products, but because most of the domestic products use imported components, and loans administered in Euros, the "price cut" would be short-term. Eventually devaluation would create a % cut in the income, and % increase in prices - simply a €1 for a litre of oil, remains €1 for a litre of oil even after the devaluation of national currency.

At this point I shoul clarify one more detail. Most of the companies that are "domestic" companies, and are considered the "engines of economy" are in fact held by companies in the Nordcic countries. Their goal is solely net-profit, thus in recent years reinvesting considerably small amounts of money back in the local economy. Most of the foreign held companies have strict rules about net profits (the amounts), and therefore their actions considering labor strategy and investments are driven from these strict rules.

Only persons/corporations gaining from devaluation in the short-run are the banks, and short-term investors. The devaluation would hit the average citizen so hard that would not be able to "stand up" for years to come (to put it nicely).

Devaluation would not resolve unempolyment problems, since the cost of production would increase, and therefore would eliminate the efect of the devaluation fairly quickly.

It is always easy to make statements based on statistical data, however statistical data does not describe the economy and the mechanisms, and processes within as a whole, and at the present time.

Excel-analysts should live in the economy to understand it's real nature, before making any suggestions for any solutions!

Anonymous said...


I'm an investor. I wait for devaluation to invest. I stop my investment project when I saw the unsustanaible growth in salaries that gives really really bad habits.
I was already concerned the scarcity of the human capital but then adjusting my investment goals to this.
Another concern was the lack of infrastructures (including social ones) that ruins productivity.
Devaluation will just finish killing speculators as they didn't borrow in kroon (more likely with pounds and they are right now laughing). In case of devaluation, don't worry they wont come back after that! And I repeat real eastate foreign speculators have left in 2007 for the laters.
While exporter can always default if debt renegociation fails (anyway they are defaulting with deflation...) and go bankrupt to restart.

Anonymous said...

and well, this is a time to market issue. I can not postpone investments to hypotetical euro adoption. In a very few months from now, I'll propably select another location.

Foreign resident of Estonia said...

Hello Edward Hugh -

Forgive me, but I was hoping for an answer to the question "What will be the result of devaluation in Estonia?"

The one clue you left was in this graph:

"Then it can stop the rot in employment, not only by making the possibility of jobs selling products elsewhere, but by making it less attractive to buy imports, and more price attractive to buy home produce (think food)."

OK, fair enough.

Raul in the comments had more:

* "Most of the long term debt is fixed in EUR. For export businesses devaluation would mean not only increase in export opportunities, but also immediate and painful increase in their debts."

* "If more than 80% of mortgages are in fixed in Euros, devaluation would increase monthly payments and generate foreclosures, driving real estate prices even more through the bottom, etc."

THIS is the kind of information I think many of us would like to know. What would the practical effects of devaluation in Estonia be? (and you may disagree with Raul, obviously!)

thanks again...

Blue Monk said...

Foreign resident of Estonia,

as for devaluation and its implication on household debt, I think one possible option would be for state to take over a part of that debt. Lets say devaluation starts with big jump of 20% and state takes over 20% of household debt. State debt is minimal in Estonia and state caused all this mess with fixed exchange rate, which was under its warranty.
What next? Maybe a transition to free float after a period of well in advanced scheduled and public small devaluations, of lets say 0.5% per month for next one or two years and then switch to free floating.
So the mitigation might be loss sharing between households and state and clear way how to get to a sustainable exchange rate.

Raul (Estonia) said...

Blue Monk said: state caused all this mess with fixed exchange rate

C'mon guys, lets be serious! Current situation in Estonia is caused by withdrawal of short- and midterm investments (as correctly pointed out by TT), and this withdrawal is not caused by "state", but by global crisis. While I have certain (modest) degree of respect** towards our government, I very much doubt they were bright enough to cause this crisis. We are talking about around $50 trillion wiped off the value of global financial assets last year and about $2 billion lost from Estonian GDP in 2009. See the difference?

One might argue quite correctly (as some in Estonia and abroad have done), that currency peg combined with high inflation were an engine for high capital inflow, causing the present situation. So? What was another option? Lets not talk about what we are seeing now, but about what we all saw like 4-5 years ago. No respectable analysis was available until 2006, pointing out possible overheating problems in Eastern Europe. And I am quite positive that without global crisis, the problems would have been solved without anything similar to today's mess.

Basically it was government's duty to get those investments, not mistake. Of course, now we are wise and say that government made grave mistake, preferring economic growth to lower inflation in 2006 and thus losing the chance to join Euro. But even today we can not be 100% sure that we would have been in better position with Euro today. Likely, though.

It was possible to foresee the problems, but even today we are unable to make any sound forecasts even for 2010. Even in 2008's spring didn't Soros foresee the extent of the crisis. Even in 2008's autumn didn't Buffet foresee the depth of the crisis.

And the honorable author of this open letter, we are all commenting here (also published in Estonian newspaper, btw), is making prediction that Estonia will fail miserably without devaluation. As seen from inside, there are good chances, that he is wrong.

As long as we have chance to join Euro in next two years, there will be no devaluation in Estonia. Latvia, being in weakest situation, still will very likely not devaluate without acceptance from EU, especially from Scandinavia and from 2 other Baltic countries.

Let me tell you what will happen next in Estonia:

1. Estonia makes another budget cut before summer, to ensure the compliance with Maastricht criteria.
2. In autumn 2009 outlook is positive for both Lithuania and Estonia, both have good chances to fit within Maastricht.
3. EC and ECB will give green light to Lithuania and Estonia by the end of 2009 to join the eurozone in 1st of July 2010. Latvia does not qualify.
4. Latvia devaluates immediately after the decision. Lithuania and Estonia still stick to the peg.
5. Lithuania and Estonia will adapt Euro 01.07.2010, exchange rate very similar to today's is kept with adaption (- few technical %)
6. Life goes on.

** PS. I am not involved with politics, nor with any governmental stuff.

Edward Hugh said...

Hi everyone,

Look, I really am sorry, but I am very pushed for time, it isn't that I am trying to duck questions. I have spent the day looking at Slovenia and Slovakia, and I recommend you read the post I have just put up on a Fistful of Euros. Now, I will try and deal in detail with all the main argument threads that have been raised in some sort of post over the weekend.


Blue Monk:

"I think one possible option would be for state to take over a part of that debt."

Well, you are on the right lines here. Basically there are three stakeholders, the banks, the state and the householders, the costs should be shared between them.

Obviously, ( Obviously,Obviously,Obviously,Obviously,....) there is going to have to be large scale debt restructuring here, whichever way you go - ie with or without devaluation. Now, I was talking to someone involved in the Mexican Tequilla crisis today (there were a lot of dollar denominated housing loans), and he explained to me that the problem was really resolved by the banks renegotiating with the houseowners, on an individual basis. The criteria was stream of income. That is they applied a multiplier on your monthly income, and then you paid that monthly quantity, regardless of what the value of the loan was, and regardless of whether the loan was in dollars or pesos. I see no reason why a similar solution won't be applied in the Baltics, after all the banks don't want to end up with all those houses, they are not property developers, and anyway, there will be no buyers.

Another solution is being proposed in Hungary. I quote from Portfolio Hungary today:


Hungary's government is seeking a solution to convert foreign currency-based housing loans to forint loans, local daily Népszabadság reported on Friday. The basic idea is that the state would also pitch in on the costs of conversion and the IMF could also stand in. The notion was originally conceived by Viktor Orbán, President of Hungary's main centre-right opposition party Fidesz.

“The need to convert foreign currency loans to forint loans is rather obvious; the Finance Ministry has been discussing it for weeks," Socialist Prime Minister Ferenc Gyurcsány reacted to Orbán's proposal.

The question is who will bear the costs. According to Orbán's concept, the costs of conversion would be split between the state, the client and the bank.

The PM said he still had no answer to the question whether a major overhaul of other systems could possibly generate the necessary funds to put this idea into practice.

According to Népszabadság, there is a package in the making that would offer a solution to the yet unanswered issues. The paper said there is a proposal to convert foreign currency-based housing loans to forint loans and a put a cap on monthly instalments temporarily. The related costs would be borne by the state, the bank and the borrower, but the state would assume the lion's share.

The backbone to this plan would be money lying in private pension funds, but there would need to be a limit to tap these, otherwise the deficit of these funds would become excessive.


Basically, in Hungary's case this may well all end up in sovereign default, since their deficit is already around 65% GDP, and rising as the economy contracts. But Estonia isn't in that situation, and there is a way to do this, if there is a will.

Of course, if everyone is saying they are just fine, and you don't need devaluation, then no one is going to look for a solution, that's why I think all these comments are short shighted and counter productive.

Naturally, anyone talking about recycling money from pension funds fills me with the fear of god, and makes me think immediately of Argentina, where, incidentally enough, those economists who said that breaking the peg was inevitable were also systematically insulted and called "excel" or "pseudo economists". The more of this sort of noise we get (ie in Latvia) the nearer I think that devaluation actually is.

Blue Monk said...


Estonia is responsible for its own mess for combination of fix exchange rate and unsound policies. The global boom amplified the problems, the global bust takes Estonia down if nothing is done. Other country's errors cannot be used as excuse. Life always goes on, the question is what it looks like.

Blue Monk said...

"Naturally, anyone talking about recycling money from pension funds fills me with the fear of god"

I'm from Hungary, government cannot touch that money, without breaching constitution. I think it is proposal for debtors to be allowed to use their pension funds savings, only if the debtor wants to do it with consequence of reduced pension.
I don't believe this proposal will a a big deal, it is mainly politics.

Edward Hugh said...

Hi Foreign Resident:

"What will be the result of devaluation in Estonia?"

Well basically, this depends on the rest of the policy mix you put together. I have never made any secret of the fact that I think Estonia's position is very difficult, so there is no panacea, or easy way.

What I do think is that devaluation gives you a chance to fight back, and in any even you should feel better fighting, than simply waiting, and sitting and taking it on the cheek. 2 years sitting at home waiting can be very demoralising for anyone, especially if you are trying to live for the second year on 59 euros a month - I am saying absolutely clearly that I see no possibility of any kind of recovery in 2010 (especially given the global environment) just by sitting there.

Now, if you devalue, you recover monetary policy, and you then need to keep a tight reign on inflation, but frankly, and again if we look at Hungary, they have devalued 25% and they still only have 3% inflation (and falling) so this may not be such a massive problem. The thing is you need a better monetary policy once the recovery starts, so you don't simply get the inflation again.

But basically, you should be able to foster domestic industries as an alternative to exporst in some things - I know, Estonia is so small it is hard to see how to do this, you obviously need to be very open as an economy, and practice good old Ricardian comparative advantage.

So you need to specialise to some extent in new activities, and this is really up to the ministry of industry, or whatever, to formulate projects. Then you need to sell Estonia to some new investors. Price is only part of this, but it is part. Remember, with the present crisis there are plenty of people offering, and few people wanting to invest in new productive activities, but they do exist, and you have to find them.

But if the price structure is right, and you can provide a base for some sort of exporting activity, then so much the better.

So the devalution is just a kind of stimulus, it is like a large subsidy to exporters, socialising the costs. It isn't perfect, nothing in this world is, but it is better than nothing. You can keep more people in work this way, and those people create wealth, rather than simply consuming government benefits.

Obviously, this year is already lost, this is why comparisons with what is happening now in Hungary or Ukraine are beside the point to some extent. The question is, when recovery starts, who will be in a position to take advantage of it.

Edward Hugh said...

Hi Raul and Foreign Resident (I'm not sure which).

* "If more than 80% of mortgages are in fixed in Euros, devaluation would increase monthly payments and generate foreclosures, driving real estate prices even more through the bottom, etc."

Look, and I don't know how many time this needs to be said, the two proposals are NEUTRAL on this, since the objective is to end up with the same level of relative prices, rapidly in the case of devaluation, or over two years in the case of internal price deflation.

The defaults are the same whether you have half the salary, or whether the cost of servicing repayments doubles, it is as simple as that.

By the same token, real estate prices are going to be driven to a very low level (and stay there) whichever policy you adopt. I see no difference on this count.

They are going to stay there because you have had a bubble, and the bubble has now burst, and after bubbles burst prices do not recover - at least not for a decade or more - look at Japan post 1992, or Germany post 1995.

Edward Hugh said...

Blue Monk:

"I think it is proposal for debtors to be allowed to use their pension funds savings, only if the debtor wants to do it with consequence of reduced pension."

OK, now I understand. They have to be mad to be proposing this, but looking at what has been going on in Hungary that doesn't surprise me. I mean, it is no solution for people to give up their pensions, since the state only has to provide for that in the end anyway, and back we are with default, as the state can't meet its liabilities.

Edward Hugh said...

Hi Raul,

"Current situation in Estonia is caused by withdrawal of short- and midterm investments (as correctly pointed out by TT),"

well thanks for this, since it clears up why there is so much confusion about the whole problem. Go back one stage, why was there a "withdrawal of short- and midterm investments", and even go back one step, why was there a global crisis? Because too many risky investments had been made, and they had not been managed well.

Why were the Baltics among the first hit, because you had had a bubble caused by a crazy monetary policy (peg to euro, and out of the roof inflation while interest rates didn't move).

I mean I will repat this - your monetary policy was CRAZY - and reminisent of the sort of currency policy operated in Russia and Ukraine. This is why inflation got out of control. People aregue that you want to maintain your credibility, but I don't know what credibility you have left, when you operated such a short sighted policy. Hynek has it right, no one outside can understand you.

Even when the IMF spelt it out, and told the government to apply a much larger budget surplus as virtually a desperate measure given the absurd situation you were in they were too little and too late.

And now you want to say you (Estonia's citizens) and your government have no responsibility. And even a lot of Estonians have no better way of debating than being rude to those who disagree. C'mon, all this feels like me to be more like the old USSR than the modern Europe you want to join.

In Latvia they even use the state security police to interview dissident economists. There are a lot of things to put straight here.

"We are talking about around $50 trillion wiped off the value of global financial assets last year and about $2 billion lost from Estonian GDP in 2009. See the difference?"

Noone is blaming you for the global crisis, we are holding you responsible for your own one. I think the first step to progress is to recognise the validity of this.

"Of course, now we are wise and say that government made grave mistake, preferring economic growth to lower inflation in 2006 and thus losing the chance to join Euro."

This is not just a mistake, it is a whole way of thinking, like the currency "corridor" (sorry peg) and the laxity on wage rises. This is soooooo Russia/Ukraine, it is what those who were running things were brought on. This isn't new, it is very very old, and very very stupid.

Blue Monk said...

"I mean, it is no solution for people to give up their pensions"

Yes it sounds like madness, but it is not that bad, cause pension structure in Hungary is that compulsory private pension fund is so called "second pillar", the first pillar is payed by state anyway. There is a "third pillar", voluntary private pension fund, but it is used only by wealthy who hardly need any bailout. In this proposal if someone uses his funds, it might affect his pension by reducing it by 10-20%. So it is not horrible, but it also means that it can help only marginally. Like the already introduced scheme for people who lost their job since September, who can have state help for two years, but later on they have to repay that help.

Edward Hugh said...

Here's a really quite intelligent comment about what is happening in Russia now from a commenter on my Russian blog. Notice any similarity? I think the key point is the need for "security" (the corridor" - too many old NKVD agents running things in Russia) and the idea that inflation doesn't matter. The Germans see all this very differently, which is why you are having such a hard time getting into the eurozone.


I think they were always like this as far as I can remember and I was following them from the days of Perestroyka. I was actually still there in the beginning. Anyway, they were always somehow doing this combination of failing to tackle inflation properly and not letting rouble to devalue.

In fact, it took them so long to get the connection between inflation and money printing that I am not even sure that they comprehend it properly now. I don't mean Kudrin, but people around him. So this was the situation from the beginning, even though it might be less obvious during the first years when the economy was a wreck and nothing held for long including the rouble.

I think their way of mismanaging the economy locks them in a very predictable cycle. Lets say in 1998 they defaulted, rouble collapsed and almost immediately the industry started grow. Then the oil and commodities booms have arrived. Then they locked rouble in this corridor, failed to tackle inflation, inflated their bubble with imports driven consumption getting out of hand.

This time it will be pretty much a replay of the same story. At some point rouble will collapse, this will give their manufacturers and others the competitiveness they were missing, imports will slump, a lot of internal demand will be destroyed by devaluation. Then the oil market recovers and so it all starts again with the government steadily inflating the next bubble, until something happens and this one will explode too.

Edward Hugh said...


"EC and ECB will give green light to Lithuania and Estonia by the end of 2009 to join the eurozone in 1st of July 2010. Latvia does not qualify."

It is absolutely and totally politically excluded that Lituania and Estonia are admitted to the zone, and Latvia not. You really need to read the standby loan report from the IMF for Latvia. The only reason that Latvia wasn't admitted there and then was that this would have left Estonia and Lithuania out.

There will be ONE solution for all the Baltic countries, of this I am sure.

"EC and ECB will give green light to Lithuania and Estonia by the end of 2009 to join the eurozone in 1st of July 2010."

This is also impossible, they will never invite someone they consider to have an overvalued currency to join (they have had too much trouble with Portugal). You need a 20% reduction in your general price level (as measured by CPI), the earliest you could have that via internal deflation would be the end of 2010, even in the best of cases.

And remember the eurozone may itself be deflating, so you may need to do more. Living standards aren't only falling in the Baltics, and you need to drop yours vis-a-vis the rest.

Raul (Estonia) said...

Hi Edward, Blue Monk: Estonia is responsible for its own mess /.../ Other country's errors cannot be used as excuse. /.../ And now you want to say you (Estonia's citizens) and your government have no responsibility

Ouch :) I had no intention to claim that we have no responsibility. Sure we have exactly what you say - responsibility for our own mess. I just tried to point out that the global crisis coincided with local, and very likely the local crisis would have been survived without much noise.

Raul (Estonia) said...

Edward: It is absolutely and totally politically excluded that Lituania and Estonia are admitted to the zone, and Latvia not. You really need to read the standby loan report from the IMF for Latvia. The only reason that Latvia wasn't admitted there and then was that this would have left Estonia and Lithuania out.

Could you be more specific, where in the report this is said. I found nothing like you describe. Maybe I read wrong document? Joining is limited by Maastricht criteria and there is nothing about Baltic states being in special "3-together" admission status.

they will never invite someone they consider to have an overvalued currency to join

Again, joining is regulated by Maastricht's and the fact that currency is overvalued is not an objection. Devaluation would be.

TT said...

Edward Hugh, from your post and comments, it is clear, that you do not know the actual situation and the "business culture" in Estonia.

Yo claim, that banks are no real estate agents, who are interested in property. That is in fact true. Nevertheless property=money, and therefore the banks are in reality interested in the real estate. In February 2009 some banks created their own real estate companies to deal with the property after foreclosure.

The loan portfolio of all the banks in Estonia is around 240 billion EEK, of which lets say 20% is 48 billion EEK - this is around 50% of Estonias national Annual budget. Highly unlikely that that the government will rush to the aid with money they do not have.

Banks, on the other hand, are very interested in these mortgages, since they can make quite good profit on them.

Lets assume, that the kroon is devalued. Aproximately 80% of the home owners are not able to service the loans. The bank terminates the agreements, and "collects" the collateral. Since it is not the primary business for the banks to manage real estate, or any other property for that matter, they try to sell it as fast as possible, and with an attractive price.

This, however, in reality means, that they sell it for pennies. It is the common practice. Let's assume that kroon was devalued by 20%. A 100 000 EUR loan in kroons before the devaluation was around 1,5 MEEK, after devaluation 1,8 MEEK. The bank probably will sell the property for 300 - 400 000 EEK, which is around 50% less then the market value, and the client still owes the bank around 1,4 - 1,5 MEEK.

If anyone thinks this is stupid idea, it is reality. The Estonian Supreme Court has several rulings in very similar cases, where the decision is in the favor of, guess who, the bank.

Since emotionally and psychologically the people are pushed so far in the corner, there is no way to predict what are the real consequences of that. No long term investor will be interested in an economy which is unstable.

Also, I would like to point out, that I know several Finnish "investors", who are waitig for this to happen - devaluation, since they can then make "good deals" for the future.

Before making any comments about economy, we should think for a moment that economy is not just some numbers, but actual people, who have feelings, and might "respond" based on those feelings.

The rate of suicide has already increased in Estonia, the fear of tomorrow has created nervousness, and disbelief - all rationality has gone.

If this cenario is the end-goal, the I would have to agree, that devaluation is the best choice!

Edward Hugh said...

Hi Raul,

"Ouch :) I had no intention to claim that we have no responsibility."

Accepted, and happily so. I just think it is very important you don't take this discourse out of Estonia, since the facts don't fit. Latvia and Estonia started correcting in the spring of 2007, when changes were made to the documentation rules about getting mortgages, and credit attitudes were tightened at banks. Both these things could have been done, much, much earlier. Romania, Bulgraia, Poland and Slovakia were still having massive lending up to the end of the summer of 2008, and it was only really in October 2008 that the global credit crunch hit the CEE collectively, as it became seen as a high risk zone.

I mean basically, it is reasonably easy to argue with me, since I am sympathetic, and have no power, but over at the ECB and inside the German government you have another attitude. You are widely seen as suffering from a self inflicted boom-bust, and may I remind you that Germany has almost a veto over eurozone decisions (since they think that ultimately they pay for the broken plates) and that East Europeans still don't have free movement of labour in Germany.

Yeah sure.

Para 19: 19. "The macroeconomic framework is centered on maintaining Latvia’s quasicurrency
board at the current exchange rate parity"

You will find this:

"Given the fragile global funding environment, the spillover risks increase for other emerging European economies, especially in the Baltics and South-Eastern Europe."

This is in the list of reasons why they did not decide on Latvian devaluation. Now they can hardly deny Latvia the devaluation they needed becuase it would harm you (and Bulgaria) and then let you into the zone and throw Latvia to the wolves. At this level things just don't work like that. The way forward here is to get the Commission and the ECB to treat the East as one single issue, and find a comprehensive solution, which will be:

a) devaluation and immediate euro access for the four peggers

b) entry to ERM2 for the floaters, and accelerated euro membership (say one year).

Basically, I may be an "excel" economist (as someone said), and I may not have "much feel for the Estonian business culture" (TT), but I reckon those of us pushing this argument in Brussels and GFrankfurt will win, if only for the reason that too many Western banks go bust otherwise, and Germany will never come out of recession. Remember, Germany's customers in both the East and the South are completely on the floor right now, so Germany has as much interest as anyone in finding solutions.

Also notice this in the stand by report, the IMF wanted 15% devaluation.

The authorities and staff examined the merits of alternative exchange rate regimes. A widening of the exchange rate band to ±15 percent (as permitted under ERM2; currently Latvia has unilaterally adopted a ±1 percent band) would result in a larger initial output decline, since adverse balance sheet effects would reduce domestic demand. However, competitiveness would improve more quickly, reducing the current account deficit and fostering a more rapid economic recovery (Box 1). The case for changing the parity would be stronger if it could be accompanied by immediate euro adoption. Technically, this would address many of the risks described above, and give Latvia deeper access to capital markets. With its negligible public sector debt, the government would also find it easier to borrow in euros on international capital markets. However, the EU authorities have firmly ruled out this option, given its inconsistency with the Maastricht Treaty and the precedents it would set forother potential euro area entrants.

Raul (Estonia) said...

Hi Edward,

IMF report still doesn't mention anywhere that Latvia was not admitted to eurozone because "that this would have left Estonia and Lithuania out". The text you refer to deals with possible devaluation. and accelerated euro adoption. "Free" admission to eurozone is excluded: "/.../ changing the parity would be stronger if it could be accompanied by immediate euro adoption", but "EU authorities have firmly ruled out this option, given its inconsistency with the Maastricht Treaty and the precedents it would set for other potential euro area entrants."

So Latvia is denied quick euro adoption not because of Estonia and Lithuania, but because of Latvian failure to comply with Maastricht criteria.

Of course, I have to agree with you, keys to the decision are in Germany and perhaps in France also. Maastricht Treaty is only the framework, and even if Lithuania and Estonia will fulfill the criteria, Germany can still find reasons to veto the admission, if they want to. However this seems to be unlikely today and there are strong signs that Maastricht criteria will be the sole criteria for Lithuania and Estonia (it may be wishful thinking, though).

You reasoning in you last post is correct, admission to Estonia and Lithuania will leave Latvia to wolves. But there is also another side - leaving Estonia and Lithuania out because of Latvia will leave Estonia and Lithuania to wolves.

Basically there are two general ways of development: your way or my way (sounds nice, heh:). What you are seeing is basically devaluation throughout Baltics and hopes for Euro postponed until earliest 2013. The only way out of this scenario is my way, accelerated euro adoption in Lithuania and Estonia and devaluation in Latvia with hopes to adopt euro in 2011-2012.

I am fully aware that this may be wishful thinking. Being inside the problem I am not objective here. You can close your file on Estonia and take another topic, we can't (no offence here), estonians are emotionally involved and your outside view is definitely more clear.

On the other hand you do not have the full view from inside, which is nothing near the doomsday scenario (yet?) hyped in some foreign newspapers. But lets see what will happen, in 6 months we will be wiser. Some indicators to watch are (1) budget cuts before summer, (2) unemployment figures in August (employment law changes in July and we can expect rapid change in July-August, no rapid changes is very strong positive signal), (3) tax income figures, especially VAT, and of course (4) Latvian devaluation - if Latvia does not devaluate before July, there is very strong chance, that things will go my way.

Anyway, thank you for your sympathy, again, it is very positive to see that someone is wasting time to our problems.

Raul (Estonia) said...

Just one figure to back my comment on overhype - number of employed people has no significant changes (around 650000), the growth in unemployment rate (7.7% today) comes mostly from people registering more actively in Labour Market Department.

Edward Hugh said...

Hello Raul,

You are right to some extent, in that I am reading between the lines.

When I said:

"The only reason that Latvia wasn't admitted there and then was that this would have left Estonia and Lithuania out."

What I should have said (to be clearer, and less rhetorical) was that one of the considerations in deciding to maintain the Latvian peg was that if Latvia had devalued without eurozone entry, then they would have had all the other problems that the IMF identify.

(incidentally, I accept all these problems, since they will arise anyway)

So my argument is that the IMF - being aware of the need for Latvian devaluation (since there is just so little evidence that the kind of internal deflation we are talking about can work, and again, we are seeing this now in Latvia) would have pushed harder for it, if there had not been the contagion danger, reaching as far as Bulgaria. They would have pùshed harder for devaluation, and for the eurozone to treat Latvia as a special case, and this would have had much more possibility of success, if there had not been "three more" special cases just waiting to say "me too".

So now that Latvia is doing as the EU have stipulated they can hardly abandon Latvia when it doesn't work (as it won't). And they can hardly favour Estonia and Lithuania when Latvia has shown "responsibility" and solidarity by not devaluing, and the only thing they will have done wrong will have been to follow EU advice. It is only the ECB and the EU Commission who have their credibilities on the line in the Latvian and Hungarian cases, since you should not be punished for being "good students" even if you were very "naughty boys" before.

Basically, Latvia going bust is as much a problem for the EU and the ECB as it is for Latvia. If the EU can't help one very small country in difficulty, what can they do. Can you imagine the USA sitting back impotent as Vermont goes to wrack and ruin?

Simply put, Latvia and Hungary can't be allowed to default, no one in the EU can be allowed to default, as more will inevitably follow, as the Union's ability to offer protection becomes a worthless guarantee. All those countries inside the eurozone with large CA deficits are immediately at risk. You need to see the bigger picture here.

Ireland, Austria and Greece cannot be allowed to default. That is we need a much bigger, EU wide solution, to include the UK, Denmark and Sweden, who are all in difficulty in different ways.

"Anyway, thank you for your sympathy, again, it is very positive to see that someone is wasting time to our problems."

Thanks, I appreciate this, really. And thanks for helping me to put my argument better, since I will be posting on this.

Edward Hugh said...

Incidentally, here is the IMF list of countries with currency pegs that underwent real depreciations of 15 percent or more while preserving their pegs.

It doesn't exactly thrill me with enthusiasm.

Côte d'Ivoire 1981-1984
Dominican Republic 1983-1984
Hong Kong SAR 1986-1987
2002 - 2006
Netherlands 1987-1989
Oman 1983-1988
Peru 1986
Saudi Arabia 2002-2006
Venezuela 1983-1987

Edward Hugh said...

Raul (and others),

Vis a vis joining the eurozone. Can I also draw your attention to this post of mine on Slovakia's membership bid, and in particular to the part pasted below. Basically, it isn't simply a question of fulfilling a simple set of criteria - this is only the first (minimal) hurdle. You then need to convince on sustainability, and this is impossible during the "bust" part of a "boom-bust" cycle, and then you need to be invited.


On the surface it is easy to get the impression that what is now involved is a mere formality, with the ECB and the EU Commission coming under considerable political pressure to say yes after their recent cold-shouldering of Latvia and Lithuania, and given all the economic problems now being encountered in Hungary following the application of the Lisbon agenda inspired “austerity programme” isn’t someone somewhere badly in need of some sort of success story to inspire the others? This indeed is how most analysts and much of the popular economic press are treating the situation - almost as if what we were now looking at was already some sort of “done deal”.

But are we and is it? In recent days doubts have begun to surface. The most recent example perhaps took place last week when Pervenche Beres, chairwoman of the European Parliament’s committee for Economic and Monetary affairs, who was leading a “fact finding” delegation to Bratislava rather noticeably dropped-into her on the record press remarks the emphatic observation that the debate about Slovakia’s euro membership has now moved on from whether or not the country’s economy met the formal euro inflation criteria to the issue of the “sustainability” of Slovakia’s current inflation rate. That is to say the EU institutional structure is likely to look well beyond whether or not Slovakia’s inflation level as registered during the 12 months to April 2008 meets a set of rather formal criteria to the much more thorn-ridden issue of what might subsequently happen to the inflation rate if Slovakia is given the “go ahead” on May 7.

That Commissioner Beres point was not simply incidental was underlined by the fact that the very same point was re-iterated by the Economy and Finance Commission representative during questions at last week’s press briefing on the EU’s March inflation numbers. Indeed, despite the fact that Slovakia has for some time now been within the Maastricht inflation criteria, the EU Commission has repeatedly expressed concerns over the sustainability of the current state of affairs, and in doing this not furthest from their minds will be the rate of inflation which is currently to be found in neighbouring Slovenia (Slovenia it will be remembered was admitted to the eurozone in January 2007). In March 2008 Slovenia’s annual inflation rate was running at 6.6% - the highest in the eurozone - and rising. Indeed Slovenia’s inflation rate has now more than doubled in the year and a quarter since she adopted the euro.

Thus - and quoting Pervenche Beres - the discussion has now moved on from the nominal compliance with the Maastricht criteria - to issues associated with the ongoing sustainability of Slovakia’s present economic path, and these concerns about sustainability - taking their cue from what has happened in Slovenia - take us into a much larger arena, one which goes to the very heart of this problems of applicability for a one size fits all monetary policy to economies having the sort of structural characteristics which are currently being exhibited by the Eastern European EU accession members.

Edward Hugh said...


"Just one figure to back my comment on overhype - number of employed people has no significant changes (around 650000), the growth in unemployment rate (7.7% today) comes mostly from people registering more actively in Labour Market Department."

Sorry, can you spell this out a bit for me, why should people suddenly start signing on more actively, is there less work available in the informal economy? Why this change.

Anyway, the labour force survey (Eurostat compatible) is a much better indicator, but we only have this for January at the moment. Why are you so relaxed about your labour market shedding labour so fast?

I am imagining more like 20% unemployed by mid 2010, and the unemployment benefit running out for lots of these.

TT said...

Edward, I do not believe that Raul is so "relaxed" about the current situation in labour market. Raul is just commenting on the government officials, who have declared, that the the registration has increased among young people.

The most likely cause for this is that before the current situation university graduates were optimistic about finding a job, but in the current situation, believe not.

Registering with the Labor Market Department, allows the unemployed the access to government financed health services. Health is important always.

Edward Hugh said...


"The most likely cause for this is that before the current situation university graduates were optimistic about finding a job, but in the current situation, believe not."

Thank you for this clarification.

"Before making any comments about economy, we should think for a moment that economy is not just some numbers, but actual people, who have feelings, and might "respond" based on those feelings. The rate of suicide has already increased in Estonia, the fear of tomorrow has created nervousness, and disbelief"

I want to say that I am indeed very sorry for the situation you describe. I do think feelings matter, and even if it doesn't make a shred of difference, I do feel for you all.

Look, do you think I would spend so much of my time writing about Eastern Europe, if I wasn't really concerned about all this. I mean, I have I don't know how many blogs, I am not in this for money.

I am worried about Ukraine, Serbia, Macedonia etc. But what can we do, they aren't even in the EU, and in the Serbian case they didn't even want to be. Does that make me feel any better when I see what they are in for? People were killed, massacred, in Kosovo, should we be "hard hearted" about the Serbians. Obviously not, but we cannot help everyone, at least not all at once we can't.

So what I am arguing is that the EU needs to face up to its responsibilities to the populations of the East. That the leader of each country tries to say they are different from all the rest - apart from being comic - doesn't worry me at all.

That I am not a powerful and important individual doesn't worry me either. I just do what I can. I wouldn't feel right at night if I didn't.

"it is clear, that you do not know he actual situation and the "business culture" in Estonia."

You are right I don't, and in this sense I can't tell you what to do exactly. Look, someone somewhere called me an "excel" economist (maybe it was you), and in a way this is right.

But if you may have a cancer, do you just go and have a chat with your local doctor (who knows you well, and possibly has known your famility for years) or do you go through the scanner. I am a radiologist of economic systems, no more and no less. I am not a witch doctor. I know what I can and cannot do, but I can tell you some things about the structuarl characteristics of your situation that you won't discover having a chat in your local bar, or, dare I say it, reading the latest report from one of the able analysts of Swedbank. They are just not specialised in this type of problem.

"You claim, that banks are no real estate agents, who are interested in property. That is in fact true. Nevertheless property=money, and therefore the banks are in reality interested in the real estate. In February 2009 some banks created their own real estate companies to deal with the property after foreclosure."

Well, my point is they don't want to do this. Banks prefer to stay in the business of banking, which is what they know about, in the same way that governments really don't want to nationalise all the banks, even though they may have to, governments really don't know about running banks.

Basically they are trying to practise "hold to maturity" rather than "mark to market" and profit from a hypothetical rise in property values in the future.

But this credit and housing crisis isn't like previous ones in recent history. House prices in the boom/bust economies are unlikely to recover for many many years, and the bank balance sheet won't let them hold the properties that long. Banks want mortgages, not houses, since mortgages pay a stream of income, while houses are only non performing loans, with no income.

The same thing was happening in Spain, but now they are about to start "fire sales" as the banks can hold out no longer. This will also happen in the Baltics, and the best thing for the banks is to recognise reality, accept their share of the loses, and negotiate with householders while they are still in their homes and still in work, and with the government.

Those with the most immediate interest in debt restructuring and devaluation - even though they don't seem to realise it - are those very Nordic banks who were pressing to avoid it. As I say, 100,000 houses with people living in them and working and paying something are worth a lot more than 100,000 empty houses whose owners have long gone and which have been left to rot.

Raul (Estonia) said...

Short term labour market statistics can be found here. Employed persons quarterly (thousands):
2006 634.7 - 650.0 - 649.6 - 650.7
2007 647.0 - 658.6 - 662.1 - 653.8
2008 656.5 - 656.6 - 660.5 - 652.6

Last comment regarding no significant decrease in total number was made today (14.03) in radio by Thor-Sten Vertmann, head of Labour Market Department. Article in Eesti Päevaleht.

There are several possible reasons for increased official registration as unemployed. First, movement in labour market has much more friction, finding a new job is harder. People register themselves more actively, wanting to use every possibility. Younger people are also much more active. You have to be officially unemployed to get unemployment insurance and as expectations to future are uncertain, those who earlier expected to find a new job quickly, admit now that it could take much more time.

Hard to estimate black market influence, but as construction market is one of the biggest users of unofficial labour force, people losing their informal job there are certainly prime candidates for this increase. This opinion is backed with the fact that ratio of female/male work seekers has moved from 56/44 to 45/55.

I am not so relaxed about the figures, but so far the developments have matched moderate scenario, not the blackest one. No doubt, we will see the decrease in total number of employed persons also. As I said earlier, massive layoffs in July-August are possible and quite frightening. New employment law will make layoffs easier and cheaper and there might be number of businesses waiting for the new law to act.

20% by mid 2010 is possible, one of my friends even predicted this number by September 2009 (we made a bet and I have a bottle of Dom Perignon waiting for me in September:). Today's situation however suggests, that if we will not see the significant layoffs in summer, 20% is unlikely.

We have two options, massive layoffs or massive reduction of salaries. As far as I can tell you from my own experience - massive reductions in salaries are possible. 10-20% reduction has been standard already, achieved via decrease in workload and in hourly wage. Reduction in fuel prices, dropping euribor (estimated effect 7bln EEK in 2009) are making salary reductions a bit easier for people. Sure, this is probably short term effect, but still valuable.

Edward Hugh said...

Thanks for this last info Raul,

Just one small point:

"-20% reduction has been standard already, achieved via decrease in workload and in hourly wage."

Drop in working hours doesn't count, it is only a fall in unit labour costs that matters, ie the hourly wage, although some can be offset by increased productivity.

The problem is, that with everyone feeling so bad, productivity gains are normally few during crises. It is only when you trim down and have a much smaller workforce in any given bloc of plant that you can get good levels of productivity expansion after the recovery starts, since you ramp up output with the same workforce, and people start to feel better, the "feelgood effect".

That is why it is better to stop contracting and start expanding as soon as possible - the V shaped scenario.

TT said...

Yes, Edward, it was me, who referred to you as an excel-economist, but this was in no way meant as an insult, but only pointing out that it does not contain first hand experience in given market, which is essential, in my point of view, for thorough analysis. The statistics enables us to look at historical data for analysis of haow have we been doing, but for the purposes of predictions/forecasts without first hand experience, it is not that strong of an instrument, since at a decision made at any given time may and will make a dramatic change in the data, and therefore in the charts. Another point that I was trying to make with that statment is that that excel data can in fact include serious flaws, resulting in huge errors (I know that businesses have lost money for incorrect calculations).

Another thing that I am not really found of, is the Eurostat data. The electricity comparison chart indicates that the price of electicity is almost 3 times cheaper in Estonia, than in Finland, whereas in actual data, the price of Estonian electricity is 2 times more expensive then in Finland. In my work I deal with lot of Finns, and this topic has been of discussion.

I am in no position to comment on other countries, since I have not followed that closely economic situations, nor have I exhaustive reports on these countries. Nevertheless, I am most confident about my objectivity towards Estonia, since my profession requires almost absolute objectivity (keeping in mind that objectivity is subjective).

I agree, that I might miss something, or overlook something, but in my opinions I try to be as objective as I possibly can.

In terms of trusting the opinions of Nordic banks, I am always sceptical, since history has proven, that they do often make misteks in their analysis.

I personally believe, that government should have increased it's spending, rader then cutting it. The businesses are laying-off employees, in just few cases the actual work load has diminished (i.e. construction). In reality in most businesses people are laid-off, and the workload is devided among "surviving" collegues, meaning more work without an increase in salary. Another fact is that most of the incomes have been already decreased by 20-30% in average, in extreme cases up to 50-70%. I personally believe, that instead of letting people go, businessed should find ways and means to keep the people workin, since a person whith an income means buying power, means a customer. The lay-offs have resulted working people to cut off their expences, meaning even less buing power.

The problems with businesses and their difficulties lies in very poor management and very narrow future perspective. Most business leaders see as their only possibility to increase profits to increase the price of the product, or service, or by expanding locally. Lack of vision and long term perspectives, as well as high risk investments do contribute to the situation as well. On the other hand, I know few businesses, who have managed their risks rather conservatively over the past 5 years, and they are able to keep on going for the next 2-3 years, even if there is approximately 20-30% decrease in their field.

Hynek Filip said...

TT, as a business owner, I would like to make two points:

one, it is not the purpose of a private business to keep people employed. Its sole purpose is to make profits for its owners. If my businesses cease to be profitable, I will wind them down. However, I do know that businesses have good times as well as bad times, and that it is the task of the owners to do all they can to survive the bad times. So basically all you can ask of the Estonian business owners is that they do their best to keep their companies afloat.

two, you made one extremely important point in saying that you know some companies which have been well managed and thus can survive a few years of recession. This is it, the real reason for the present economic slump. Almost everybody behaved as if bad times ceased to exist, growth was guaranteed to last forever and future was rosy. Just a few prudent individuals and businessmen made provisions for a downturn. Unfortunately for the Baltics, it now seems that prudency has been very scarce over there (mind you, it has not been much better here in Prague).

TT said...

Hynek Filip, in general I agree with you, that the purpose of privately held business is to make profit for the owners. However keep in mind that you need customers for your products or services in order to make business, and therefore profit.

No customers=no money, even if you do not deal with private customers directly. Each business is interlinked with other businesses who deal in the end with private customers. When the private customers do not have purchasing power, meaning money, businesses start to lose their profits, therefore, it is inevitable to keep theunemployment level as low as possible.

Furthermore, the understanding of a modern business is more clearly shaping away from the understanding of "generating profits for owners". A modern understanding of a business is more like a social entity, whose has far more responsibilities than making just profits.

Keep in mind, that people, businesses and governments are closely interlinked, meaning that if the weakest of this links suffers difficulties, all others suffer difficulties. It is in every business "best" intersts to keep people employed, since it means profit.

Hynek Filip said...

TT, you may be right that the modern academic world believes that a business is something more than a profit making machine.

I am just afraid that the academics who contrive such wonderful theories have never made a penny in real life.

For me, my business is a profit making machine. I established it, put capital in it, made it succeed. Crisis or no crisis, it is making money, employing people and paying huge taxes. When it stops making money, to the dustbin it goes. It is not my task to worry about employment, my task is to stay in business.

You should not listen to social engineers that much, if you stuck to old fashioned capitalism, Estonia would be better off. When you start to think that businesses should have a long list of social responsibilities, those businesses will sooner or later die.

Or, you will have to subsidise/nationalise them and then go, cap in hand, to your wealthy neighbors and beg for money. Hillary did it in China, Latvia did it in Brussels, Berlin and even here in Prague. The issue is, how long will the wealthy of this world have patience for the beggars.

Hansen said...

The European Union has to be much more carefull when allocating support money to Estonia. To much money has been spend on used german luxury cars and hollidays in Egypt. Nearly nothing has been invested infrastructure. It is not fair that western european taxpayers has to pay for that party.

Anonymous said...

"I know what I can and cannot do, but I can tell you some things about the structural characteristics of your situation that you won't discover having a chat in your local bar, or, dare I say it, reading the latest report from one of the able analysts of Swedbank."
That is true. I find it very useful if independent economist from outside of Estonia could study our situation and compare it with other countries. We certainly shall appreciate this. Hope you will find time to continue monitoring developments.

Devaluation is emotionally very sensitive issue in Estonia, so discussing it is not an easy task. Most people do not want devaluation and would prefer some other way to deal with problems.

Edward Hugh said...

Hi, and thanks for the comment.

"Devaluation is emotionally very sensitive issue in Estonia, so discussing it is not an easy task. Most people do not want devaluation and would prefer some other way to deal with problems."

I fully understand, respect and appreciate this. I feel it must be horrible for people who have never really previously been interested in economics to be thrown into the middle of all this. It is little consolation, but people in Spain where I live are facing a similar (if different) problem right now.

All I am trying to do is point out that things are not as straightforward as they seem, and that there are alternatives.

"Hope you will find time to continue monitoring developments."

Naturally, you can rest assured on that.