As we saw in last Monday's "Creditanstalt Redux?: Failure to save East Europe will lead to worldwide meltdown", the place where international money flows are impacting the common volk of eastern Europe is currently in their mortgages. If your UBS mortgage is priced in Swiss francs and your wages are paid in a local currency, say the zloty, which has fallen 50% vs CHF, you have to come up with twice as much money to keep the house.
As hedge funds smell blood in the water they will short the piss out of eastern European currencies in an attempt to crush the smaller countries. Ah, good times, good times.
From the Financial Times Lex column:
Nowhere is the economic agony of “emerging” Europe worse than in Latvia, where output declined 10.5 per cent year on year in the fourth quarter. So, perhaps unsurprisingly, Latvia’s prime minister late on Friday became the first government head to resign since crisis struck the region. Latvia is also becoming a test case not just among its Baltic neighbours, Lithuania and Estonia, but for other emerging Europe states with fixed exchange rates.
Huge borrowing, financed mostly by Nordic banks, funded consumer and property booms in the Baltics, creating yawning current account deficits – Latvia’s was 14 per cent of gross domestic product in 2008. Difficulties in correcting those imbalances are compounded by the fact that currencies are pegged to the euro, which removes devaluation as an option. Instead, Latvia has been forced into a real economic adjustment, reducing wages and prices. After a €7.5bn bail-out led by the International Monetary Fund in December that retained the currency peg, Latvia adopted austerity measures including a 15 per cent cut in public sector wages.Because most recent lending was in foreign currency, devaluation would cause a rush of loan defaults. But the economic outlook is even worse than when the IMF programme was agreed, while devaluations elsewhere in eastern Europe have only increased Latvia’s competitiveness problems. So the real economic adjustment will be agonising indeed. Capital Economics forecasts that the economy could shrink 15 per cent this year, and 5 per cent in 2010. As unemployment rises and deflation sets in, increasing the real value of debts, defaults will probably rise to levels similar to those after a devaluation, albeit more slowly.
Will Latvia hold the course? Historical precedents are inauspicious. Peru and Venezuela attempted similar adjustments two decades ago and ended up abandoning fixed exchange rates. If Latvia were to dump its currency peg, Lithuania, Estonia and Bulgaria’s currency boards would look vulnerable too. And foreign parents of banks in those countries face the choice of walking away from rising defaults or costly recapitalisations of their local operations....MORE
Here's today's Financial Times' Editor's Choice: