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Europe’s leaders are playing with fire if they follow the Latvian example | Mark Weisbrot December 16, 2011

In recent months some advocates of Europe’s austerity policies have been touting Latvia as a success story that shows how “internal devaluation” can work. This was the theme of a book published earlier this year by the Peterson Institute for International Economics, one of Washington’s most influential think tanks. The book was co-authored by the Institute’s Anders Aslund and Latvia’s prime minister Valdis Dombrovskis.

The case study is relevant to Europe because there are important similarities between Latvia’s economic strategy since 2008 and that which is now being promoted by the European authorities – the European Commission, the European Central Bank, and the International Monetary Fund (IMF), otherwise known as “the troika”.

At first glance it might seem ridiculous to call an economic strategy a success if a country loses 24% of its output – the worst in the world for the crash of 2008-2009 – and official unemployment shoots up from 5.3% in 2007 to more than 20% in early 2010.

Although unemployment is now back down to 14.4%, and the economy is growing –an estimated 4% for 2011 – this is a steep price to pay for an eventual, not very rapid recovery. It’s kind of like bragging about the success of the 1929-33 downturn of the Great Depression in the United States.

But the advocates argue that Latvia was successful because it kept the country’s fixed exchange rate pegged to the euro. The argument is that if the country had tried to pursue expansionary macroeconomic policies – counter-cyclical government spending, lower interest rates, and therefore also a devaluation – the result would have been even worse than the worst decline in the world. The main idea is that the devaluation would have had devastating balance sheet effects: many households and businesses that borrowed in euros but had their income in local currency would have gone bankrupt, with catastrophic effects on the banking system, etc.

Of course it is true that there would have been serious negative consequences from a devaluation in Latvia’s circumstances, so this argument cannot be “proven” false. However, we can look at the experience of other countries that had crisis-driven devaluations and suffered these losses. For 13 countries over the last 20 years, the average loss of GDP following devaluation was 4.5% of GDP. Three years later, the average country was 6.5% above its pre-devaluation peak.

Latvia, by comparison, did not devalue, and, three years later, is still down 21% from its pre-crisis GDP.

So the argument that “it could have been much worse” does not seem plausible. Some of these other countries suffered severe financial collapses after their devaluation, such as Argentina, which was also mostly excluded from international borrowing since its devaluation and default in December 2001 and January 2002. Yet Argentina has done very well since its devaluation and default, with the economy shrinking initially by 4.9%, then growing more than 90% over the ensuing nine years. But all of these 13 countries with crisis-driven devaluations did vastly better than Latvia has done.

The social costs in Latvia were even higher than the official unemployment numbers indicate. Unemployment and underemployment – including those involuntarily working part-time or having dropped out of the labor force – peaked at more than 30% last year. And an estimated 10% of the labor force left the country – a huge emigration by any comparison, and a significant loss to Latvia.

All this unemployment and misery is not a side effect of the internal devaluation strategy, but a fundamental part of it. The idea of an internal devaluation is that, with the currency fixed, you have to push down prices and especially wages in order to make the country more competitive internationally.

This is done through a severe recession and very high unemployment. This is part of the current strategy of the troika for making Greece, Italy, Spain, Portugal, and Ireland more competitive.

Ironically, the internal devaluation in Latvia didn’t work even on its own terms. The weak recovery over the last year and a half owes little or nothing to net exports – which would be the driver of recovery if the internal devaluation actually worked, and made the country’s exports and import-competing industries more competitive.

Rather, it appears that the economy recovered because the government stopped its budget tightening after a huge economic contraction, and because there was a burst of inflation that helped the country out of its deflationary mess.

The internal devaluation in the eurozone is not working either, as the common currency area now appears to be in recession, according to the OECD’s latest estimates. The other part of the troika’s strategy – a rescue by confidence fairies in the bond markets, is doing even worse.

The bond markets seem to realize that current austerity and even agreements for more co-ordinated fiscal austerity in the future –as the European authorities announced with great fanfare last week – will only increase the eurozone’s debt burden.

Sooner or later, the European authorities will have to stop building that bridge to the 19th century, and use modern economic policy to pull the European economy out of recession. Europe cannot afford to go through what Latvia went through, and neither can the world afford it: a more severe recession in Europe could set off a financial crisis of the kind that we saw in 2008. That is the fire that the European authorities are playing with right now.

• Mark Weisbrot is co-director of the Center for Economic and Policy Research, in Washington, DC. He is also president of Just Foreign Policy

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Russia Pledges $10 Billion in Eurozone Aid

Russia says it is ready to commit more than $10 billion to the International Monetary Fund to help support the struggling eurozone economy.

President Dmitry Medvedev made the pledge Thursday in Brussels during the biannual EU-Russia summit. “We will abide by all the commitments being the participant of the International Monetary Fund, and we are ready to invest the necessary financial means to back the European economy and the euro zone. We are ready to look at and consider other measures of support,” he said.

His economic adviser, Arkady Dvorkovich, earlier said $10 billion would be the minimum commitment Russia would make.  The offer follows last week’s summit of European leaders in which nearly all EU countries pledged up to $200 billion in funds and loans to the IMF rescue fund.

Mr. Medvedev says 41 percent of Russia’s currency reserves are invested in euros, and that Russia is interested in seeing the European Union preserved as a powerful economic and political force.

“Only Europe will be able to help Europe, but other countries should provide conditions for Europe to liberate itself from the crisis burdens as soon as possible and recover from this downturn as soon as possible,” he said.

Thursday’s summit gathered EU President Herman Van Rompuy, EU Commission head Jose Manuel Barroso and Mr. Medvedev, among other officials, and comes just days after Russia’s much criticized parliamentary elections.

At a news conference after the summit, Van Rompuy criticized the vote, saying the EU is concerned about irregularities, but he welcomed Russia’s pledge to monitor future polls.

On Friday, the World Trade Organization is set to approve Russia as a member, after 18 years of trying to join.

Some information for this report was provided by AP, AFP and Reuters.

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Fed may give loans to IMF to bail out euro zone central banks: paper December 6, 2011

December 5, 2011

by legitgov


Fed may give loans to IMF to bail out euro zone central banks: paper 04 Dec 2011 The Federal Reserve, along with the 17 euro zone national central banks, may help provide the International Monetary Fund with funds that could be used to aid debt-ridden states, a German newspaper said. Die Welt cited sources close to the negotiations as saying the euro zone central banks could pay at least 100 billion euros ($134.2 billion) into a special fund that could be used for programs for nations struggling to control their debts. “Also other central banks, for example the U.S. Federal Reserve, are apparently prepared to finance a part of the costs,” the paper said in an advance copy of an article to appear on Monday. [WHY should US taxpayers -- via the (audit-or-eliminate) Federal Reserve -- bail out European banksters? This is INSANE. Start reading.]

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The IMF must heed G20 decisions | Kevin Gallagher November 30, 2011

The G20 meeting in Cannes earlier this month was derailed by the pressing eurozone crisis. Actors were disappointed if they were looking for concrete action on global imbalances and the food crisis, let alone the new global monetary system that French President Nicolas Sarkozy boasted would be the goal of the summit when he first took the helm as host. But behind the scenes, the G20 actually delivered on a set of “coherent conclusions” on the management of speculative capital flows in emerging markets that should not be overlooked, especially by the International Monetary Fund (IMF).

Sarkozy assumed his role as head of the G20 during a period of excessive volatility in global capital markets that continues to this day. Because of loose monetary policy, low interest rates and a slow recovery in the North Atlantic, accompanied by high interest rates and rapid growth in emerging markets, the world’s investors flocked from north to south – to Brazil, Chile, South Korea, Taiwan and others. More recently, in response to eurozone jitters, capital has retreated from emerging markets to the “safety” of the United States – showing how dangerous speculative capital flows can be. New work released by the IMF this week suggests they are picking and choosing their direction from the G20.

In a significant reversal of past policy, in 2010 the IMF began recommending that nations deploy capital controls to mitigate the effects of speculative capital. Indeed, IMF work in 2010 showed that those countries that deployed capital account regulations were among the least hard-hit during the worst of the global financial crisis. As numerous countries across the globe began using controls in 2010-2011, further IMF work showed that those measures showed signs of working, too.

Sarkozy thus called for a code of conduct on capital controls and tasked the IMF to propose a set of guidelines for reform. The IMF delivered a set of guidelines in April of this year that met stiff resistance from the emerging market and developing countries that have been most successful in deploying capital controls. The IMF’s proposed guidelines recommend that countries deploy capital controls only as a last resort – that is, after such measures as building up reserves, letting currencies appreciate and cutting budget deficits.

Developing countries thought the guidelines missed the point. In the cases where the IMF found controls to be effective, such measures were part of a broader macroeconomic toolkit, and were deployed alongside other measures – not as a “last resort”. In October, these concerns were echoed by an independent task force of academics and former policy-makers that I co-chaired. We stressed that “consigning such measures to ‘last resort’ status would reduce the available options precisely when countries need as many tools as possible to prevent and mitigate crises.”

By the runup to the Cannes meeting, most of the G20’s apparatus was focused on the eurozone. However, a working group was formed to take the capital flows issue to the highest level. Headed by Germany and Brazil, the group forged the “G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences”. The document was “endorsed by the G20 finance ministers and central bank governors in October, then endorsed by the G20 leaders themselves in Cannes.

In stark contrast to the IMF guidelines, the G20’s conclusions say that “there is no ‘one-size fits all’ approach or rigid definition of conditions for the use of capital flow management measures”, and that such measures should not be solely seen as a last resort. Instead, the G20 now calls on nations to develop their own country-specific approach to managing capital flows and, as Sarkozy said in his final Cannes speech, “the use of capital controls, and this is very important, is now accepted as a measure of stabilisation.”

Throughout the crisis, the IMF has usually been keen to accept new direction from the G20, but there are signs that it may be resisting the new G20 consensus on capital flows. The IMF’s latest report addresses the fact that industrialised country policies trigger unstable capital flows to developing countries and that the rich nations need to design policies that are mindful of such negative “spillovers”. Yet, the IMF merely adds that such principles will be added to their existing guidelines – seemingly ignoring the fact that those guidelines have now been superseded by the G20’s decisions.

The IMF should not ignore the G20’s direction on capital flows. Rather than pushing ahead on a globally enforceable code of conduct that could eventually lead to capital account liberalisation across the globe, the IMF should instead work to reduce the stigma attached to capital controls, protect countries’ ability to deploy them, and help nations police investors who evade regulation. G20 finance ministers, central bankers and heads of state have endorsed the use of capital controls by emerging markets, and on their own terms. The IMF should not pick and choose which directions by world leaders it will follow.

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Eurozone Economy Nearly Static in Third Quarter November 15, 2011

The eurozone economy barely advanced in the July-to-September period, weighted down by the financial woes in debt-ridden Greece and Italy.

The European Union said Tuesday that the economy in the 17-nation bloc that uses the euro currency expanded just two-tenths of one percent in the third quarter, largely supported by bigger growth in the continent’s two biggest economies in Germany and France. But the Greek economy retracted by 5.2 percent in the quarter, while economists think Italy also may have slipped into a recession.

Stocks fell on major exchanges in London, Paris and Frankfurt as investors continued to worry about the ability of fledgling coalition governments in Athens and Rome to adopt unpopular austerity measures to control deficits and pay back long-term debts.

Greek government workers staged a protest march through Athens on Tuesday against planned wage cuts on top of earlier salary cuts. More demonstrations are planned for later in the week.

The Greek Parliament is preparing for a confidence vote Wednesday on the caretaker government of its new prime minister, Lucas Papademos, and analysts say he is expected to prevail. Greek financial leaders are set to meet Friday with members of the International Monetary Fund, European Central bank and the EU in an effort to secure release of Greece’s next next $11-billion loan installment to keep it from defaulting next month on its international obligations.

In Rome, prime minister-designate Mario Monti won crucial support from Italy’s two main political groups as he moved to name his Cabinet. He said Monday he wants the government to stay on until 2013, the scheduled date for new elections, even as some Italian lawmakers are calling for earlier elections.

The government’s debt woes put new pressure on Monti to move quickly to name government leaders, with the country’s interest rate on its debt again topping 7 percent on Tuesday. That is the threshold that forced Greece, Ireland and Portugal to seek international bailouts.

The EU said Germany’s economy expanded by one-half of one percent in the third quarter, buttressed by increased household spending and by businesses investing in machinery and new equipment. The French economy advanced by four-tenths of a percent.

Some information for this report was provided by AP, AFP and Reuters.

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