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!


Here is an extra chart showing Estonian unemployment rates from 1993 to date, as provided by Tööturuamet, the Estonian Labour Market Board.

and here’s a longer time series for the Eurostat labour survey data. The difference between the two is methodological, and the Eurostat data is more comparable with other EU countries. As we can see, on both measures unemployment has been rising very rapidly of late, and with a 10% contraction forecast for this year, the end result is almost certain to go higher than the 13.2% peak registered in 2000 according to the Eurostat data.

This entry was posted in A Fistful Of Euros, Economics and demography by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

71 thoughts on “Why You Need Devaluation – An Open Letter To The People Of Estonia

  1. @ Jumpstart

    “Darius K asked you “Let’s assume that all three Baltic states are already in the Eurozone. What can be done to ease the suffering?” You didn´t answer, why?”

    Oh, only time and that this is a side issue. This takes us over to Spain, or Greece, and I have written plenty on these topics, just Google “Afoe” and “Spain” or “Greece”. Basically, it is a theoretical issue in your case, and it is better to devalue before you come in, rather than suffer the years of “light” wage deflation and slow economic growth Germany had to put up with after entering with an overvalued currency, a currency which wasn’t anything like as overvalued as the Baltic ones are.

    “Another question – do you agree that best remedy for some eurozone economies is quitting the eurozone as fast as possible? ”

    No, obviously I don’t. I am arguing that what we need is EU bonds, and Quantitative Easing with the ECB printing money, we have a very serious situation in the bubble countries (Spain, Ireland and Greece basically).These three countries need a collective bailout from having the wrong monetary policy applied to them, this is going to be a very big issue, but I don’t see how that helps Estonia, unless of course the eurozone actually falls apart (which I obviously hope doesn’t happen but might).

    Basically we are stuck in a halfway point with the Euro, now we either need to move forward US style and become one single United States of Europe, or the eurozone will simply fold under the weight of its own debts.

    “I think, you should – if you want to be consistent with your recommendation to Estonia.
    (Of course, recession in Estonia is deeper than in Ireland, for example, but at the same time it is much easier to cut wages in Estonia.)”

    No. The structural damage for everyone of a Eurozone blowout would just be too great, but Estonia doesn’t have to take the long painful path which faces Ireland, you can still devalue. Beyond that I don’t follow your logic.

    “It seems to me that many analysts – Edward among them – have small irrational bias toward devaluation – they just can´t imagine how competitivness can be restored through deflation. But if euro is here to stay, jump-starting economy with wage-cutting is the trick all EU economies have to learn.”

    It’s just a silly question, but why are we always assumed to be the “irrational” ones? I don’t really make this kind of statement.

    Anyway, yes, we do have a bias to devaluation – basically becuase mny generation lived the aftermath of the 1930s, and that of course was the main lesson, that many societies suffered more than necessary – with prolonged mass unemployment – because of sticking to the gold standard (my father was in the US between 1930 and 1933), and Barry Eichengreen even wrote a book about this kind of “folly” – Golden fetters.

    So we have a certain sense of Deja Vu here, with a lot of earnest young people coming up and saying that apples don’t fall downwards from trees they fall upwards.

    I mean, it doesn’t give me any pleasure to be right, frankly I’d rather be wrong, you have (in terms of poverty, health problems) one of the most vulnerable societies in Europe. I’d rather we were doing more to try and make all this much easier for you. I even blame the requirement of Euro membership placed on you when you joined the EU for part of the reason those Baltic banks carried out so much reckless lending in your countries, they thought you were underwritten by the ECB.

    In a certain sense you are the somewhat “innocent” victims in a huge game.

    But then here you all come along and tell me – this is my chin, I’m putting it there, now come along and take a good clean swipe.

    @ Darius K

    Edward, two questions to sum up:

    1. “All three Baltic states import a lot of the materials they use for production, most notably energy resources. Devaluing the currency would increase the prices of these materials, hence the total effect of devaluation to exporters might not be very positive in the end. If on top of that you add on the increased debt burden, how do we know that Plan 3 (devaluating) will be better off than Plan 1-2?”

    Well dropping wages and living standards is going to make energy more expensive, and obviously you need as far as possible to become more energy self sufficient. You don’t have enoughsun, but wind perhaps???

    But the thing is, assuming you can’t reduce energy imports, what matters is not the price you pay for them (which surely will go up significantly once “the crisis” is over) but how you can export enough to pay for what you import. Basically I will try and say more on all of this on the Baltic Economy Watch Blog, since I see it is a sticking point.

    “2. Finally, let’s assume that all three Baltic states are already in the Eurozone. What can be done to ease the suffering?”

    Well, as I said above to Jumpstart, you need help by belonging to the eurozone (at an appropriate parity) in the form of financing made available at a cheap price via EU bonds, and transfers to help with things like health and a “pro women”, “pro childhood” policy to attack the long term fertility issues without which we will never get any kind of stability.

    Probably you need a programme of systematically encouraging immigration, and probably we need a Europe wide pensions system like they have in the US, otherwise I am at a loss to see how the states in the East are going to handle the growing elderly burden. But really, one thing at a time, we need people back at work, and not sitting around at home.

  2. AON- the risk management, brokerage in the field of insurance-reinsurance and human resources consultancy company- considers that Denmark has the best pension system in Europe. Portugal, which was the leader in 2005, occupies now the 13th position as it is shown in the “2006 Situation of the European Pensions”. Estonia, which was not included in the 2005 classification, occupies the second position, Ireland occupies the third
    position, and Leetonia occupies the fourth position whereas Holland occupies the fifth position. Great Britain, Sweden, Spain, Lithuania and the Czech Republic occupy the following five positions. Cyprus and Poland, two
    new-included countries in this classification made by AON occupy both the eleventh position. The thirteenth position is occupied by Portugal, Luxemburg, Finland, and Germany. Slovakia, anther country that had not been
    present in the 2005 edition of the pension situation, now occupies the seventeenth position. The eighteenth position is occupied by Italy, Hungary and Austria (Austria occupied the tenth position in the “Situation of the
    European Pensions 2005”. Malta occupies the 21st position and France the 22nd. Greece occupied the 22nd position in the 2005 classification but now it occupies the 23rd position together with the country that was the
    latest to enter the E.U. Slovenia and Belgium, which occupied the last place in the 2005 classification, now occupy the 25th position. Denmark, Estonia, Ireland, Leetonia, Holland and Great Britain are considered the
    countries that have an “adequate” quality of the pension environment. For these three countries, most of the indicators taken into account are “superior as compared to the European average”.

    source: http://steconomice.uoradea.ro/anale/volume/2007/v2-finances-accounting-and-banks/50.pdf

  3. Some more facts to illustrate Estonian miserable situation?

    Estonian government is practically debt-free compared to average Eurozone member:

    At the end of 2007, the lowest ratios of government debt to GDP were recorded in Estonia (3.5%), Luxembourg (7.0%), Latvia (9.5%) and Romania (12.9%). Eight Member States had government debt ratios higher than 60% of GDP in 2007: Italy (104.1%), Greece (94.8%), Belgium (83.9%), Hungary (65.8%), Germany (65.1%), France (63.9%), Portugal (63.6%) and Malta (62.2%).


  4. Hi Tales from the Crypt:

    “Ireland occupies the third

    Sorry, can we run that one again, aren’t they on the verge of going bankrupt.

    “Portugal, which was the leader in 2005, occupies now the 13th position as it is shown in the “2006 Situation of the European Pensions”.”

    Portugal??? Had the most sustainable pensions system, are they mad? Portugal has had virtually no growth since joining the eurosystem (this would be another point to jumpstart, this internal deflation isn’t working in the working in the eurozone either, the only example of success so far has been Germany).

    Look, all this risk assesment they are using seems to have been based on pre crisis methodologies, and they are now, well, widely considered to be flawed.

    Having Latvia (sorry Leetonia) in in 4th place – when they along with Hungary seem to be stuck on the short path to going bust right now – also gives you some idea of how to treat this.

    “Estonian government is practically debt-free compared to average Eurozone member:”

    Definitely. But this is the tragedy Tftc, since they were free of government debt, but the gung ho mob ran up large household and corporate debt, and this is about to suffer major defaults, and then the debt is transferred over to the state. This is the big problem, and why you need to react and get back to growth before the debt gets too large.

    As you say, Latvia had only 9.5% debt in 2007, but by 2010 this will be 55% on the most recent IMF estimates, and could well be higher. ie even if Latvia don’t default, they may well not be able to join the eurozone becuas the debt to GDP will be over 60% (on the present rules, I hope we change those, of course).

    This is what all those loans you are receiving mean, that eventually state debt to GDP rises.

    On top of that, what are you going to do after next spring with all those people who will be being forced to live on 59 euros a month. The government will have to do emergency spending.

    Then there are the Nordic bank loan defaults, who will pay for the bad loans in these banks? Even when you get a debt restructuring at least a part of this is going to be shifted over to the state. You won’t get off scott free.

    And pensions, pah! This is the whole problem, all the people under 40 may be fully funded or something (I haven’t gone into the Estonian programme in any detail) but what about the people who are now over 50. Their health care and pensions will need to be paid for by the state. Of course, as someone pointed out, for the actuaries this isn’t a problem, since you only get to live to 60, but we want to do something about that, and this means more health spending, and then more pensions as people live longer. Or is that the proposal we have on the table – freez Estonian male life expectancy at 60 then all the numbers fit. Life certainly will be “nasty brutish and short”.

    The core problem of the East European transition is that you came out of your Soviet history with virtually no savings. What there were were largely destroyed in the crises of the 1990s, this is why you have been running those huge CA deficits, why you needed the Nordic Banks, and why you all weren’t – like the Germans etc – busy investing in the US sub prime mess.

  5. Edward, have seen kids movie “Neverland”?. Just a rhetoric question, no offence at all.

    Due to property reform big part of the Estonians got their flats practically free. This is the main reason of high home-ownership. So you got some sort of wealth what is formally not savings.

    Fresh news from Estonian overoptimistic prime (use google translator, if you wish):

    Government wants EUR from 1. july 2010.

    Valitsus tahab minna eurole üle 1. juulist 2010 (23)
    12.03.2009 12:12

    Kommenteeri | Prindi

    Peaminister Andrus Ansip ütles valitsuse pressikonverentsil, et Eesti võib paluda veel sel aastal Euroopa komisjonil hinnata riigi vastavust Maastrichti kriteeriumitele, et minna üle eurole 1. juulist 2010.

    Ansip ütles, et arvutuste järgi täidab Eesti inflatsioonikriteeriumi oktoobris, juhul kui hinnad ei tõuse, aga tõenäosus on, et hinnad pigem langevad.

    Ansip ütles ka, et usub, et riigieelarve defitsiidi kriteerium õnnestub koostöös riigikoguga täita.

  6. Tftc

    “Due to property reform big part of the Estonians got their flats practically free.”

    That IS interesting. Can you dig out some data here. When was it, and what % of the housing stock.

    What this means is that either:

    a) a very huge mortgage burden is being carried by a small proportion of the Estonian population – ie the default rate among those will be collosal, or

    b) A lot of the Estonian’s were busy spending their pension savings by doing refi’s (equity extraction) in order to buy new cars etc.

    Again, it is possible you had a lot of second home buying (you know get one for free, buy one), and then, of course, it is the second home market which will (as in Spain) crash almost permamently.

    Either way, the implications of this little detail seem to be quite profound.

    “Edward, have seen kids movie “Neverland”?”

    I haven’t, but it sounds interesting. What’s it about, a country where bad things can never happen, like Estonia, for example?

    “Fresh news from Estonian overoptimistic prime minister: Government wants EUR from 1. july 2010.”

    No, no. This is good news. This means we are having an impact. Now they really need to pile the pressure on, from all four countries on the pegs to be let in. Clamour at the door! And then just before you come in, devalue like hell. This is the part they can’t talk about right now, and my only beef is not that they don’t talk about it, but that they try to persuade people you don’t need to devalue. They will never let you in the eurozone with the overvalued currencies you have now, don’t you see?

    You would just become another Portugal and they won’t agree to that.

  7. Edward, have you ever had a slightest interest in how EUR adoption actually takes place?

    Please look:


    3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devaluated its currency during the period.

  8. You get some idea about Estonian property reform from here:


    As a local I just want to repeat: those things you tought are impossible are already happening. There was a big cut in 2009 budget and will have additional, if necessary. I was not sure some months ago that all this will get general acceptance from broad public without riots. But now this have gained almost unbelievable momentum and so far without serious setbacks.

    So do not try to interrupt this momentum and better take a “wait and see” approach.

    I know that you mean all the best, but at the end let’s them decide. They have done it well enough in history.

    And correct tile of the movie was “Neverending story”. So what happened to a Southern Oracle?

    And I’m sorry for my attitude!

  9. @ Tftc

    “Edward, have you ever had a slightest interest in how EUR adoption actually takes place?”

    Of course, take a look at my post on “Let The East Into The Eurozne Now”: Munchau and I are arguing for a revision of the Masstricht Criteria. I would have thought that this was obvious.

    Basically those who are arguing for this are arguing for devaluation and immediate entry. The IMF argued with this with the EU Commission and the ECB in the Latvian case (read the Report on the Stand-by Agreement, onsite at the IMF). These are not just incidental details. They are the heart of the matter.

    If all of this, including the rest of the “floaters” entering (here the argument is that they enter ERM2 now, and then come in after – say – one year) isn’t done and a systematic bank bailout isn’t organised for all the defaults which are coming from the East in time, then quite frankly there won’t be a zone here waiting for you by the time you get your act together.

    Do you realise just how much pressure the whole edifice is under at this point, from the North, the South, the East, and the West?

    “And I’m sorry for my attitude!”

    Oh don’t worry, these are hard times, and everyone is under stress. I just saw your January trade numbers, exports of goods down 29% and imports of goods down 37% compared to previous year. Biggest drop so far as I can remember. So this way the CA deficit will close, but with your living standards plummeting towards the floor.

    I don’t think you will have a revolution. I think the young people will just leave to send money home to help keep their families. They are really being left with no alternative. That is the tragedy.

    Goo luck to you anyway, in these hardest of hard times. I may think what you are all trying to do is ill-advised, but I respect your courage, even while worrying about your stubbornness.

  10. Hello, Edward,

    Some more comments: unfortunately you are right when you suggest that “a very huge mortgage burden is being carried by a small proportion of the Estonian population – ie the default rate among those will be collosal”.

    I hope I’m not cited anywhere when I say this, but this is one of the reasons that devaluation is a bad option for the Baltics – the policy makers and their sponsors are the mid-upper scale guys with all of the debt in EURos, so they don’t want to be on the receiving end.

    Also, keep in mind that the Baltic countries have gone through struggle and poverty since the XIV century, so we’re kinda used to it and would rather choose deflation. Devaluation, on the other hand, would mean we are admitting that we have made mistakes. Not to good for self-esteem.

    Finally, I doubt that we will devalue just before euro adoption. There are other forces in play here, and taking Latvia’s example, they proved to IMF that IMF would be better off by giving them money and not asking to devalue. Latvia even accepted, people say, extremely harsh conditions for that loan, but took it. Now, of course, they have problems meeting those harsh criteria, but they’d rather push themselves to achieve them than accept devaluation.

  11. Most business people i know in Estonia feel that devaluation and immediate euro accession is by far the preferred course of action.

    One proposal i have heard is to unilaterally adopt the Euro at a devalued rate, without approval from the ECB – i do not think the reserves would support this course, nor do the politicians. Given the current political realities in Brussels, what should Estonia’s plan B be when the EU says no to immediate accession?

    Especially as the consensus of business people i know in Latvia are convinced that devaluation in the second half of 2009 is unavoidable once they start missing all of the benchmarks under the IMF agreement.

    Devaluation alone causes worries due to the downside risk (in any case, the politicians certainly do not support devaluation at this time, and feel it to be an entirely political decision). Right are arguing about re-districting and other pre-election moves.

    Incidentally, the mother’s salary is one area where the politicians have not cut the budget, and where government policy has made some progress. I understand that they are forecasting a positive birthrate for this year largely due to the increased births from that program (they are also forecasting a huge decline in the birthrate as the 1990’s babies move into the peak childbearing years).

  12. “Of course, take a look at my post on “Let The East Into The Eurozne Now”: Munchau and I are arguing for a revision of the Masstricht Criteria. I would have thought that this was obvious.”

    Estonia is making it’s action plan according to current rules and they have chance to fill MAASTRICHT criterias at the end of this year already. Do you think we should instead plan according to some suggestions made by Ft journalist? Obviously not.

    “So this way the CA deficit will close, but with your living standards plummeting towards the floor.”

    Think also about “reinvested earnings” in CA, what have been one of the often misunderstood reason for huge CAD.

    Do you remember how Slovenia made EUR adoption? Noticed some short-term tricks then?

    Estonia used more than 96% of the EU funding available up to 2006. New cycle started from 2007 and so far only 1-2% of the available funding have been used. Perhaps this slow start can explained as counter-cyclical measure? In the next 5 years Estonia will receive some 30% of GDP funding from EU structural funds for improving infrastructure etc. European average stimulus to GDP is much smaller (less than 3%?)

    I guess that this funding will be (as much it depends of Estonia) in “full throttle” mode when it’s certain that inflation criteria is not problem any more. Not sure, that we need much more if you consider also that local banks are already more willing to make loans today. Margins on EUR mortgage where 3-3,5% on the “we finally cool this sucer down” period (nov-jan), now it’s less than 2% and falling.

    “I think the young people will just leave to send money home to help keep their families. They are really being left with no alternative. That is the tragedy.” is a bit premature.

    Look at the map and port of Tallinn statistics to understand how open Estonian economy actually is (peaople count 1.3 million, number of passangers 7 million). Devaluation would mean fast inflation and (at least) two more years waiting for possible EUR adoption.

  13. And one more thing I forgot to mention: Estonia does have some reserves, some 8-9% of GDP. Those are already in use and will help to stabilize things a bit.

    And also I forgot to mention, that this “full throttle” phase starts in May. Cash will reach to economy with a significant lag to avoid resurection of the inflation.

    So take your time, dig it a bit more.

    Somewhere in the summer or so, when most of locals are half-dead in the liquidity crunch and selling stocks to cover their every-day needs think about canceling your deposit.

  14. To counter the argument of DD that “Most business people i know in Estonia feel that devaluation and immediate euro accession is by far the preferred course of action”, i just recently had a conversation on the topic with a CEO of an Estonian company who has a strong contract portfolio and significant cash buffer from the good years. All of his revenues are in Estonian kroons as are most of his costs. However, he has a significant amount of leasing contracts in Euros.
    He was very much against devaluation as the resulting increase in leasing costs would hurt him badly. Also, his employees would have difficulties financing their mortgages in case of devaluation. He strongly believes that it is better to adjust workers’ salaries according to their contribution and financial situation (which he is already doing), rather than have a devaluation.
    The situation is of course different for export-oriented industries, but there are definitely a lot of businessmen who do not support devaluation.

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  16. I do not think I can find practically anybody with real weight in Estonia supporting DD’s case. Certainly there are some (usually Finnish) owners of some sub-contractors, who would like to see government doing their life easier with devaluation. Eurozone member Finland itself can not devalue and this would be sort of back-door opportunity for them to rise their competitiveness by davaluation in their dirty back-yard, only 60 km away.

  17. To Tales from the crypt and and Raiko Uri:

    I think you miss my point. I said devaluation with immediate euro accession. Without the euro accession, devaluation is a much more risky proposition (probably less painful in the long term for the reasons enumerated by Hugh, Krugman, et al.), though this is debatable.

    I would like to see more debate on the relative merits of Estonia’s various unpalatable options – what approach will best put Estonia in a position to grow again.

    Lets see how Slovakia, Ireland, Spain, and other similarly afflicted fare with the euro straightjacket, though the current indicators are not good.

    I would agree that no current consensus exists in favor of a straight devaluation right now (certainly not without some reasonable plan to support the EEK at a more reasonable level), though some financial people (of weight in perhaps more in the financial community that political world) feel that devaluation will be inevitable in the highly probable event of a forced Latvian devaluation in the second half of the year.

    Do you know anyone of “weight”, aside from people playing politics who keep their life savings in EEK at the moment?

    I certainly don’t, in spite of the high deposit rates for EEK currently on offer.

  18. please take a look at statistics from Bank of Estonia about size of EEK deposits and don’t talk nonsense.

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