From a pseudo-economist 5

Here is a bit more on this dreaded subject - devaluation.

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But first of all, let me make my position on this very clear. There is a state of the world A, in which devaluation would be the right thing to do, and state of the world B, in which it is not. I am not a divine being, so I don't know which state of the world is the true one. However, I believe we can form an educated guess by thinking hard, and doing some research, and establishing the facts, etc. It would probably be only a slight exaggeration to say that most "experts" here in Latvia are working hard (or maybe not so hard) to produce arguments that it's really state of the world B that we have. Yet the problem is that I don't find most of this arguments convincing. Much of what I see is arrogance and ignorance. This arouses my suspicions and makes me write blogs like this one.

So here is what happened last week. There was an interview to Diena newspaper by Einars Repše, a prospective minister of finance in the new government. Then there was a big (one page) analysis by Dienas Bizness, a business daily. Finally, there was the Central Bank Governor Ilmars Rimševičs. Let me take those one by one.

First, Mr. Repše was asked whether devaluation was a good idea and he firmly rejected it, saying the following (my translation):

"...often talk about advantages for exporters. Yes. If the currency were to be devalued, exporters would feel some advantages in the short run, until prices would re-equilibrate and the situation would return to the earlier equilibrium."

For the record, I don't understand what Mr. Repše is talking about. One of the preconditions for attaining the "earlier equilibrium" is that wages in lats would have to increase to what they were at the previous (higher) exchange rate. With unemployment rate being more than 12% (and rising), I just don't see how this might happen. Devaluation will benefit the exporters and it will also help the economy when there is slack capacity, e.g. unemployment. Period.

Second, there is this "analysis" from Dienas Bizness. Honestly, I expected something better from a major business newspaper. The punch line is quite simple: we will all lose because (i) households that borrowed in euros will have to pay more; (ii) exporters will not gain because the exports markets are effectively shut, and (iii) we have that 7.5 billion euros loan which needs to be repaid in euros. Neither stands criticism. Well, for a start, DB has forgotten that the alternative is that the wages will be reduced or, worse, that people will lose their jobs. That will make it quite hard to pay back the loans, won't it? So there goes DB point one. Then, I really don't understand the notion of the export markets being closed "shut ". I can only surmise that this means that you can't sell at any price. Is this really happening? Did Russian customers stopped buying altogether? Or, what I suspect is closer to the truth, they cut down on spending AND switched to cheaper products? Offering a lower price can make a big difference! This is Econ 101 stuff. To say that the exports markets are closed shut anyway comes pretty close to denying the law of demand. Finally, about this 7.5 billion euros loan. I don't think you need so much money if you don't have an overvalued currency to defend.

Third, last week in an interview to the Latvian TV's 100 pants, the Central Bank Governor Rimševičs publicly called for those "pseudo-economists", who think that the exchange rate corridor should widened, to tell how this would help the economy. "Pseudo-economists"??! When the governor of the central bank decides it's a good time to become so personal, it really makes me wonder. Does that mean that the Governor has run out of more sound arguments for why the peg should be preserved? Are we already seeing the "last line of defense"? And who are these people that the Governor is referring to as "pseudo-economists"? Edward Hughes, Torbjorn Becker, Nouriel Roubini, Paul Krugman? Well, if I have to take sides in this, I'd be honored to be classified as a "pseudo-economist".

In Latvian here

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Komentāri (5) secība: augoša / dilstoša

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pseudo-economist 06.04.2009 23:37
Hi Vyacheslav,

Some economists and businessmen think that tax policies and government support is not really favorable for the business in this country. Some economists think that there are few economic sectors that could benefit because of devaluation.

1. (If we assume that economists are right) do you think that exchange rate corridor widening (+/-15%) could help to improve economy significantly and why?
2. In your article you said that currency is overvalued. Don't you think that currency should be devalued at least 50%-80% until economy will experience any effect? (If yes, don't you think such huge devaluation could stop an economy?)
3. Is devaluation only tool that could help to the economy in this situation? Are there any other factors that should follow/precede devaluation? If yes, is government ready to employ these factors?

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V Dombrovsky 19.03.2009 15:48

Thanks for pointing out this channel. I have to say it didn't occur to me. I am not sure I fully understood your question though. If the CAP subsidies are denominated in euros, Latvian farmers will gain because their payments in LVL will increase. They would also gain because this will give a boost to their exports.

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Dag Kirsebom - 18.03.2009 22:11
"we have that 7.5 billion euros loan which needs to be repaid in euros"

Hi Vyacheslav,

Maybe there is another side to this coin? I am no expert in EU regulations, but cant understand why it would be different for Latvia after a devaluation compared to Swedens floating currency losing value against the EUR.

This was in Swedish news earlier this week:
"Swedish farmers get 1 billion SEK more in EU subsidies. The reason is that EU subsidies are paid out in EUR and SEK has lost very much in value against EUR since last year."

Cheers, Dag

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V Dombrovsky 13.03.2009 13:07
Thanks, Edward. I am afraid we will need lots of luck in this country.

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Edward Hugh 13.03.2009 11:37

Just to say hi. And good luck.


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