We are having a snowy winter here that started very dramatically at the end of November with a great storm. Even the Estonians were taken by surprise when a metre of snow descended overnight and strong winds blew the drifts every which way. One expects panic in the UK at the descent of the first flake but not here! The winds were so strong that buses were blown off the road – I saw three lying or standing in adjacent fields when I travelled from Tallinn to Tartu two days later. Winds were still quite strong but the bus driver made us buckle our seat belts and our bus crawled the 180 km.
The journey took an hour longer than usual. The bus was full – few took a chance on travelling in a car! When I arrived back in Tartu my car, parked next to the woodshed, was inundated as was my outdoor cat’s food supply - the wind had carried a snow drift into my shed. I have never seen Mustu so pleased to see me. The storm was deadly in Latvia – people died – but it was very beautiful to see – the towers, gates and yellow lamps of the streets of Tallinn old town were set about by whirling snow and the fresh snow shone so brightly!
2008 was the year the party began to end in Eesti, just as in the rest of the capitalist world. The BBC is calling the economic situation ‘the Downturn.’ But for many countries, including Estonia, it’s a good old classic Recession defined as the reduction of a country’s GDP (Gross Domestic Product, the output of goods and services produced by labour in an economy) for at least two quarters. The amount of business being conducted has shrunk: there is a decline in real personal income, in employment, industrial production and wholesale-retail sales.
I have struggled for some time to keep up with what Alan Greenspan (Chair of the US Federal Reserve, 1987-2006) calls "a once-in-a-century credit tsunami.” As far as I can make out it all started about 10 years ago in the USA when large numbers of people decided that real estate was selling at a bargain rate. Wall Street was making it easier for buyers to get loans by globalising mortgages: investors from almost anywhere could pool money to lend. But global investors, flush with cash from booming Asia or rising oil prices demanded good returns. The answer was sub-prime mortgages.
A sub-prime mortgage is usually taken up by people on low incomes stretching to afford a house, or with a bad credit record. It comes (even if disguised by low initial rates) with a higher interest rate and thus, higher returns. Wall Street earmarked money for sub-prime mortgaging, divided it up and bundled into investments, often known as C.D.O.s (collateralised debt obligations). Once bundled, mortgages could be sold to different groups of investors. Are you with me so far?
Investors then gambled to increase their returns through leverage (know in UK English as gearing). Roughly speaking, if the bank’s initial capital was $7000 and it supplemented it’s investment with $3000 of money borrowed at fixed interest, it could be said to have a gearing of 30%.
What makes my hair stand on end is the knowledge (NY Times, 19.3.2008) that American investors made $100 million bets with only $1 million of their own money and $99 million with borrowed money, i.e. sky high leverage!!! The returns if successful were excellent - if the value of the investment rose to just $101 million, the investors would double their money. This process was mirrored in micro land by buyers who put down just a small deposit to obtain their homes. The US Federal Reserve helped, sharply reducing interest rates in order to prevent a double-whammy recession after the technology crash of 2000. The FR kept rates low for several years enabling people to obtain cheap, easy credit.
Where did it all go wrong? Well, assumption, goes the popular saying, is the mother of all f**k ups and the assumption made by the FR, the top executives of almost every Wall Street firm and the majority of American homeowners was that the usual rules didn’t apply and that property prices would never fall. Prices rose ever higher and people borrowed more and more for and against the value of their homes. Prices rose so high that they were destined to fall. The mortgage mess has had such ripple effects because The American Home seemed like such a safe bet that a huge portion of the global financial system ended up owning a chunk of a product that could not deliver.
Last summer, many American policy makers were hoping that the crisis wouldn’t spread to traditional banks because they had sold off the underlying mortgages to investors. But many banks had also sold complex insurance policies on mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by selling their house for a profit. The whole system collapsed like the flimsy house of cards it really was.
President-elect Barack Hussein Obama, although a Democrat would do well to heed the words of the 16th president, the Republican Abraham Lincoln, after the National Banking Act of 1863 was passed: "The money power preys upon the nation in times of peace and conspires against it in times of adversity. It is more despotic than monarchy, more insolent than autocracy, more selfish than bureaucracy. I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. Corporations have been enthroned, an era of corruption in high places will follow, and the money power of the country will endeavour to prolong its REIGN by working upon the prejudices of the people until the wealth is aggregated in a few hands and the Republic is destroyed."
The new president is the first African American to hold the post and this, of course, is very important historically. Its really impressive that America has it’s first Black president just under fifty years after Dr. Martin Luther King, in 1963, in one of humanity’s greatest orations, dreamed of a time when his four children would one day live in a nation where they would not be judged by the colour of their skin but by the content of their character. But what will the incoming 45th president of the USA make of the poison chalice he has inherited? The man is certainly going to need the “unyielding hope” of his marvellous victory speech … but Barack Obama, no matter how intelligent and caring, can’t walk on water and the pressures on him will be enormous. But, whatever comes next, it’s got to be better than the war-mongering, sloppiness, moral as well as financial bankruptcy and corporate greed that have marked the Bush years. God speed the new Liberal administration, may they steer the crippled ship of state safely home to harbour. ‘Yes you can!’
Now, back to our little Eesti. How will we weather the economic storms?
The Estonian economy (reported the Ministry of Finance in November) expanded 10.4% in 2006 and 6.3 % in 2007 but has shuddered to a halt this year in the face of double-digit inflation and tighter credit while the global crisis hits exports of goods and services. The economy grew just 0.2% in the first quarter of 2008 compared with the same period of 2007, then contracted 1.1 percent in the second. The slump deepened further in the third quarter, as output shrank by a 14-year record of 3.3 %.
We have had our share of sub-prime problems here in Estonia but we are lucky in as much as the Estonian banking system is mostly owned by Swedes. The Swedes had their banking crisis in 1992, recovered and appear to have learned their lessons. Whilst not being immune to toxic debt and the credit crunch, Swedish banks have a good war chest and relevant experience with which to face the current storms.
Inflation is more of a worry. See http://epp.eurostat.ec.europa..... Estonia must curb inflation in order to meet EU criteria and achieve the security of being part of the euro-zone, one of the world’s largest and most powerful trading blocks. In this case big is beautiful. Easier said, however, than done. Wages have risen due to labour shortages as Estonia's population ages and retires and young workers move to wealthier countries in other parts of the EU. In early 2008 unemployment was at a 15-year low. This has led to labour being able to demand higher wages. The impact of rising wages with no discernable rise in productivity, has, however, led to continuing inflation and, even more important in macro terms, in increasing export prices. When domestic demand - government and EU projects or service industries (e.g. banking) owned by foreigners- reduces or stops then exports is the only hope for sustained GDP growth. Estonia has still to really start this process.
If prices continue to rise Estonian exports will become less and less competitive, there will be more pressure on the kroon (pegged to the Euro) and devaluation will become more likely. Other factors that will affect inflation will be the willingness of Estonians to work for less at home and the return of ex-pat Estonians if their host countries find that their own citizens, faced with affects of world recession, are willing to work for the truncated wages acceptable to Estonians.
Foreign investments are a mixed blessing. These poured in during the ‘Baltic Tiger’ years the FDI business environment remains user friendly; the government does not tax funds re-invested in Estonia. Last year 73.9% of FDI emanated from neighbouring and sensible Scandinavia. The main area of activity, however, was finance (47%). How will the downturn affect the financial services sector? It is also a matter of concern that 40% of remaining economic activity is also based on service industries (real estate, wholesale and retail, transport and a mysterious 14% ‘other’). Only 13% of activity actually manufactures anything (machinery, wood products, textiles, foodstuffs, metal and chemical products, transport equipment and another mysterious - 26% - ‘other’).
Our main trading partners for export (as of 2006) are Finland and Sweden accounting for 52%, the other two Baltic States take 22%, Russia 14%, Germany 9% and Denmark 4%. See http://eed.infoatlas.ee/?incl=.... These export figures, however, are now rather elderly and so much has changed since 2006 that they can only be used as a snapshot.
The impact of Russian sanctions against the transit trade through Estonia – once a main export channel for the USSR) –since the "Bronze Soldier" dispute of 2007 remains unclear. The Ministry of Finance estimates that the decline in transit trade since the Tallinn riot cut Estonian GDP growth by up to 1.5% points in 2007 and that 2008 loss of trade could cost up to 2% of GDP.
Politically, it’s difficult to judge what is happening, as most politicians are busy doing a very good imitation of an ostrich. They have cut public spending and the usual people (the poor, the elderly and the ignorant) will suffer, regardless of whether they deserve to or not. We hear a lot about the desirability of a Finnish-style ‘Nokia factor’ (a bright idea that will bring fame and fortune) but where is it and why is so little money put into researching it?
I have shut up trying to probe my friends about politics as they get grumpy and seem resigned to the leadership that fate has dealt them. I am beginning to feel the same. I have a feeling that Estonia will weather the storms because of a factor that few economists or politicians have taken into consideration. The "purchasing power of non-monetary items does not change in spite of variation in national currency value" said one economist and Estonia still does a large amount of business by barter. People did this during the Soviet time and have not forgotten the merits of the system. IThe fact is that mostly Tallinn fat cats with their gas guzzling cars and illusions of grandeur who will have difficulty with a necessity for thrift. Most Estonians will trade a sack of spuds for a plumbing job. Most Estonians, pragmatic and earthy, will burn building detritus and discarded furniture in solid fuel stoves (I did it myself with a Soviet monster this autumn), they will hand down clothes, they will not be too proud to buy second hand and their (of necessity) Soviet ‘Golden Hands’ will be brilliant at make-do-and-mend.
So, onward and upward! It’s going to be a tough 2009 but ‘Yes we can!’ ‘Bird Droppings’ wishes one and all a happy and prosperous 2009. Credit crunch or no credit crunch.