Latvia's economy is contracting 19% this year, and it has failed in a bond auction this week. Deposit interest rates have skyrocketed to 25%. From the WSJ:
In the first quarter, GDP slumped by 18.6%. Without devaluation, extraordinarily painful cuts would be needed. Perhaps the real issue now is not whether to devalue, but when and how.
With more than 85% of private sector loans in foreign hands, this means default.
The Latvian stress also soured sentiment on emerging markets, with the Hungarian forint and Polish zloty both remaining under selling pressure. At 0835 GMT, the euro was at HUF286.38 against the forint, little changed from levels late in New York Wednesday. The euro was also at PLN4.4975 against the zloty, slightly below the PLN4.5320 area from late New York hours.
All of Eastern Europe is now in a similar situation as Latvia. And the Western European banks are leveraged to a hilt on Eastern Europe. Eastern European defaults would take down the Western European banks.
Angela Merkel and the ECB are too busy lecturing the US about imaginary inflation to take care of their own backyard. They do not recognize the gravity of the situation that if EE goes down in a currency crisis, credit spreads will widen again and it will be just like the failure of Kreditanstalt in 1931. This opens the door to sovereign credit defaults.
Remember, during the mass defaults of the 1931-36 "contagion", almost every major country in the world defaulted, including the United States, by repegging the gold standard from $20.67 per ounce to $35 per ounce and making gold inconvertible.
What's needed is massive quantitative easing by the ECB with proceeds pumped into the troubled countries. Unfortunately that will not happen due to the ideological nature of the ECB, and therefore disaster is likely. Next are Ireland, Spain, the UK...