On July 1, Cyprus, a tiny country on a divided Mediterranean island, will rotate into the Presidency of the Council of the EU—one of those bitter European ironies because Cyprus itself will have to be bailed out, according to its Central Bank governor.Reality is now even staining the Teflon economy of Germany with a daily litany of suddenly awful data points.
And Spain is begging desperately for a massive bailout of its banks, after claiming for years that they wouldn’t need one. But here is an uplifting story of austerity and growth at the edge of Eurozone mayhem.
Jörg Asmussen, Member of the Executive Board of the ECB and a German politician in the opposition SPD, was speaking in Riga, about Latvia’s problems, its astonishing rise from the ashes, and its lessons for the Eurozone.
In 2008, Latvia’s debt-fuelled economy collapsed with a cumulative GDP decline of 24%, the worst in the world. Its currency peg to the euro came under sharp criticism. Pundits pressured it to devalue. Paul Krugman called it “the new Argentina.” But instead of going for the “quick fix,” Asmussen said, Latvia implemented tough “fiscal consolidation and structural reforms.” In 2009 alone, it cut its budget by 9%—far beyond any EU country. Harshest austerity, instead of spending and borrowing its way out of trouble. In the middle of a gigantic crisis!
Against everything Krugman holds so dear, the economy stabilised in 2010, and in 2011, GDP jumped 5.5%, the fastest in the EU. Cut off from the financial markets, Latvia had received emergency loans from the IMF and the EU, but its stunning fiscal and economic performance allowed it to return to the financial markets far faster than projected. Its competitiveness improved. And its currency peg to the euro remained intact.
Despite unmitigated austerity, the Prime Minister was reelected twice, while all those in the Eurozone who tried to reform anything at all were kicked out of office. Latvia had accomplished in the shortest time an “internal devaluation” rather than choosing an “external devaluation” via its currency.
“Speed is of the essence,” Asmussen said. The government attacked the deteriorating public finances, got the people to take ownership of the reforms, and “frontloaded” the toughest measures, rather than dragging things out and implementing half-measures. And it got them passed before “adjustment fatigue” wore people down.
“The bottom line is this: when adjustment is inevitable, it is better to take the medicine right away than to let the fever rise for months,” Asmussen said. Latvia demonstrated that an “expansionary contraction” isn’t an oxymoron. “Even if fiscal consolidation weighs on the growth prospects in the short term, it has sizeable positive effects in the medium to long term.”
Austerity alone wouldn’t have been enough. The government also implemented “growth-enhancing structural reforms” to foster a policy environment favourable to “growth and wealth creation.” A bit tricky in face of vested interests. But a “critical mass” overpowered them. “Education, health care, central administration: hardly any public sector category was spared by the reforms.” But people weren’t left to twist in the wind. Social safety measures were put in place, which helped gain support for the measures. So what made all this possible? A “broad consensus in society,” he said, “the key difference” between Latvia and Greece.
Latvia is scheduled to adopt the euro on January 1, 2014, despite the mayhem in the Eurozone. For the former member of the USSR, the euro has a “geostrategic dimension, namely completing their firm anchoring in a Union based on freedom, democracy and human rights.”
Meanwhile, Switzerland, a speck of land surrounded by turmoil, is bracing itself, according to the President of the Swiss National Bank and euro-sceptic, for the collapse of the euro. In the process, it’s creating a housing bubble with potentially horrendous consequences. Read…. Bracing for a Euro Crash: The Swiss Caught in a Vice.
And here is a dark, thought-provoking, and awesome video by the author of Currency Wars, James Rickards—particularly powerful in light of the euro crisis: Currency Wars – The Making of the next Global Crisis (video).