[LINK] "What went wrong with Latvia?"

[rfmcdonald]

The Financial Times' Simon Kuper examines the background behind Latvia's peculiarly sharp economic collapse, and concludes that a desire to quickly catch up to Europe economically without paying attention to the actual economy's fundamentals.

Few countries in history have risen and fallen as fast as Latvia. From 1991 to 2004, this country of 2.3 million people went from Soviet republic to member of the European Union and Nato. From 2004 through 2007 Latvia was probably Europe’s fastest-growing economy, with annual expansion above 10 per cent. People who had lived in rundown Soviet communal apartments, sharing one bathroom between several families, were suddenly buying BMWs.

Now Latvia probably beats Iceland to the title of Europe’s worst-hit country. The Latvian central bank predicts that the economy will shrink by 18 per cent this year; Iceland expects its decline to be a mere 10.6 per cent. Altogether, economists predict Latvia’s gross domestic product will drop by about a quarter between 2008 and 2010 – not far off the 30 per cent that the US shrank during the Great Depression. If other countries have economic hangovers, Latvia is in intensive care, having years of champagne pumped from its stomach.

[A]s late as 2004, few Latvians lived like Europeans. Some still inhabited Soviet communal apartments. Now they wanted their rewards. Daunis Auers, a British-Latvian political scientist at the University of Latvia, identifies the difference with the Icelandic collapse: “In Iceland there was a lot of speculation on the markets. But in Latvia people were finally buying the western consumer products they had been promised since 1990.” The money was flooding in to help them do it. It came from Latvians working in Britain and Ireland, from the EU, from foreign investors, but, above all, from Scandinavian banks.

Lending to a country whose last successful experience of capitalism had ended before 1940 was a leap of faith. Nonetheless, Scandinavian banks threw money at Latvians. Some of the boom-era television ads for consumer loans are legendary. One featured a beautiful blond family at a drive-in window, where instead of ordering hamburgers, they get loans to buy their fantasies. The payoff line: “And of course: a trip to Egypt!” Other connoisseurs prefer the one that shows a young man and an old man driving BMWs. The old man exclaims: “I’ve saved all my life to buy a car like this!” The young man says: “And I just leased it!”

Peasants in the countryside mostly just sat out the boom in the homes they had been given after the USSR collapsed. However, Riga’s impatient new middle classes put out both hands to catch the money. They almost all borrowed in euros, paying interest rates of just a few per cent while Latvian inflation was at 15 per cent. In other words, they were being paid to borrow. Better yet, there was no capital-gains tax on property, which, incidentally, made buying apartments an excellent way to launder money.

Kuper comes up with a simple set of rules that would help a national economy undergo a spectacular bubble.

1) Run high inflation; 2) Borrow profusely; 3) Import much more than it exports; 4) Build an economy on speculation in assets; 5) Put no public funds aside for a rainy day; 6) Meanwhile, peg its currency to a stable currency.

This doesn't sound wildly different from what happened to Iceland, actually.