Wednesday, July 8, 2009 4 comments ++[ CLICK TO COMMENT ]++

The fall of the Baltics


Portraying the Baltic states in their current mess requires more than words and numbers. Only an old-fashioned chart, with a sea monster, a whirlpool, or perhaps a skull and crossbones, would begin to do justice to the plight of what were until recently the shining success stories of the ex-communist world. Eating a meal in a deserted restaurant in one of the fine old capital cities of Tallinn, Riga, or Vilnius gives a sense of the collapse. So does the silence of the half-finished construction sites, the rock-bottom rates in the glitzy hotels that shot up during the boom years, and the fall of a Latvian government under the weight of the current troubles. The Baltic states today are prime candidates to be the new basket cases of Europe, with their double-digit economic declines, beleaguered governments, and shriveling state spending.


It took the collapse of the Latvian government in February, amid fevered speculation about devaluation and political unrest, to bring the Baltic states’ problems to the world's attention. Signs of trouble had been visible much earlier, however. For those who knew the countries well, the sense of hubris in the years of the post-2004 boom was almost stifling. Growth in Latvia, for example, was an unsustainable, debt-fueled 11.9 percent in 2006 and 10.2 percent in 2007. Current account deficits—a good sign of how far beyond its means a country is living—soared too, reaching nearly 25 percent of gdp. That made all three countries completely dependent on outsiders’ willingness to keep lending them money. As upsets elsewhere in Europe from Iceland to Ireland have proved, the trouble with this model is that borrowing money is easy when you don’t need it, but difficult when you do. In past years, the inflows inflated the bubble. Now, national survival depends on the willingness of Swedish taxpayers to guarantee banks that so unwisely overextended themselves.

The Fall and Rise and Fall Again of the Baltic States in Foreign Policy magazine chronicles the complicated past of the three Baltic states—Lithuania, Latvia, and Estonia—and their present debacle. Written by Edward Lucas, the article provides a very good introduction to the history of the Baltics and some reasons for why they are in the mess they find themselves in.

One of the problems with capitalism, apart from excessive greed, is the addiction to debt. As investors, we all know how attractive debt is, given how it can boost returns. In a similar manner, debt is very attractive to businesses and consumers because it allows them to own something they otherwise would not. Some capitalists, especially on the right, like to blame government intervention for all the debt problems; but as far as I'm concerned, consumer/corporate debt is generally driven by the private sector and individual citizens. The situation in the Baltics was clearly caused by excessive leverage. Of course, when things blow up, the indebted, either the consumers or the corporations, just walk away let the governments clean up.

I never realized how intoxicating debt can be until the crisis hit. A few years ago, I remember thinking that the freer a market was, the better off it is. Nowadays, I have shifted more to the left and believe that private actors are often too greedy and could care less about the country, their neighbours, or anyone other than themselves. I remember looking at Latvia a few years ago and thinking how spectacular the growth was. Others like Ireland were also booming due to increasing leverage (primarily residential real estate debt in Ireland.) I didn't realize how bad the foundations were.

I keep saying how China can easily implode due to political problems or various bubbles in manufacturing and fixed asset investment in general. A Chinese bust won't be anything like the Baltic states. But a country like India can easily face a bust similar to the Baltic states. Similar to the three Baltic countries, India has been running current account deficits, large fiscal deficits, and likely also has serious real estate bubbles in some urban regions. I wonder if, in 5 years, someone will be writing a story about India, mirroring this article on the Baltic states.

(Thanks to Paul Kedrosky's Infectious Greed for bringing this article to my attention)


4 Response to The fall of the Baltics

Daniel M. Ryan
July 9, 2009 at 1:45 AM

Actually, back in the days when minimal government was the norm, it was much harder to get loans than it is today. One of the reasons for the quasi-socialization of the finance sector was the number of complaints about "stingy bankers who always say 'no'."

Not that I'm trying to influence your political opinions. One well-kept secret about the laissez-faire age is that businesspeople back then would consider almost all of us to be shockingly irresponsible fools. Borrowing options we take for granted now, like credit cards, would have had most of them spluttering.

Mark @ Stock Pursuit
July 9, 2009 at 5:20 AM

"Borrowing options we take for granted now, like credit cards, would have had most of them spluttering."

exactly. I think there were no credit cards before 1950s. A lot of decades of fantasy capital...

July 9, 2009 at 10:33 AM

Dan and Mark
Its the same ol' blame game.  The have nots blame the "greedy capitalists", the have's blame the government!!.

In reference to Latvia's demise the answer is very simple.  During the soviet regime its citizens were cut off from the rest of the world and did not realize what they were missing.
Its like letting a child in a candy shop whose store owners are willing to extend credit for a bag full of lollypops when one only had enough money for one.

July 9, 2009 at 10:45 AM

Hey, feel free to fire off political opinions. Being influenced can be good, and I always want people challenging me (so that I can improve or correct myself)...

Daniel Ryan: "Actually, back in the days when minimal government was the norm, it was much harder to get loans than it is today. "

I would argue that it had nothing to do with minimal government and more to do with an undeveloped financial system. If you go to most undeveloped or developing countries, what you describe of the past in America, is still true. Credit cards, student loans, buying cars on credit, etc, are rare and generally limited to upper-middle-class or higher. For example, countries like China and India still have very low consumer credit. A lot of transactions, even for big-ticket items like homes, are still primarily a cash transaction. Yet, I would argue that the problem is not financial innovation. Credit cards are great; so is the ability to forgo consumption in the future for the present. The problem is when it gets out of control.

If credit wasn't a problem in a more laisse-faire economy, how come we had massive bank runs in the late 1800's and early 1900's? I would argue the bank runs in the 1800's and early 1900's were far worse than anything now. Even the Roaring 20's, when government involvement was low, saw huge credit growth, particularly in a new innovation called auto loans. People were able to buy cars on credit for the first time and I would argue this was a good thing (it's just that it got out of control by the late 20's).

The way I look at it credit was always a problem. I don't really think it has anything to do with the government or regulations or banks per se. If there is excessive usage, it will always be a problem.

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