More devaluation talk

Blogger Edward Hugh has yet again returned to the subject of devaluing the lat, something he notes has also been urged by former IMF chief economist and Harvard professor Kenneth Rogoff. Prof. Rogoff spoke at a traditional Swedish political shindig on the island of Gotland, known as Almedalsveckan. This has been a traditional forum for political and economic debate since the late 1960s and gets considerable attention in the Swedish and Nordic press. The Harvard economist said that Latvia should devalue as soon as possible, but probably wouldn't.

At this point, my view is that devaluation, while perhaps inevitable, would trigger a worst of two worlds scenario. Key elements of the public sector have already been gut-shot with both barrels by massive budget and salary cuts. More cuts are coming and, as I wrote in an earlier post, Latvia is unintentionally bumbling its way toward being not only a failed state, but a failed minarchy (a place where rag-tag remnants of a police and court system, a scattering of skeleton-staffed schools, and a largely black market health care system are all that remain of former state functions). Good minarchy, of course, is possible through a long-term, planned transition, but that is another story.

There is much speculation about where the lat would go if it were cut loose. Some say that a devaluation could be as bad as 50 % or more. The conservative variant is that the lat is allowed to float in a plus/minus 15 % corridor. Both scenarios would boost inflation , reduce imports and cripple the ability of enterprises to retool. Swedish banks would write off huge losses, turn distressed assets over to management companies that have already been formed, and declare (0r effectively continue) an indefinite lending moratorium. Many Latvian salaries would, effectively, fall to Third World levels (at 50 % devaluation, plus likely 2010 budget cuts, we could see teachers making under $150 a month). While the prospect of labor at devalued rates might attract some foreign investors, it will also be a great incentive for Latvians to emigrate to take any minimum wage job in any other "Old European" country. I met an American who has a small business teaching English. A few years ago, most of his students were taking English to deal with foreign customers and correspondence, or to study abroad for a year. Now more than half are taking English as preparation for emigration. In other words, the cheap skilled labor will be gone. As soon as the recovery starts elsewhere, thousands or tens of thousands will leave, making not only a choice of economic advantage, but also a choice of better governance (as I have written earlier)