Economy Redux

Oh all right then. I really didn't want to talk about the devaluation scare, because it's just too mind-bogglingly stupid, a cringe-inducing example of lemming behavioral patterns. But if you insist...

Here's what happened:

Back in early November, someone at an Estonian Russophone messageboard posted a game scenario where the Estonian government announced a snap devaluation of the kroon, and asked the regulars to suggest their actions.

Because the disclaimer was in fine print, some people didn't notice it, and thought it was an actual information leak. So they started converting their assets to Euro and calling all their friends to warn them. This apparently caused a wave of vague rumors: nobody knew where they were coming from, but everybody was talking about an imminent devaluation, and people were scared.

A few days ago, the original messageboard post got picked up by someone from the Night Watch, who posted it on their website. This sparked a mass panic among the Russian population: if Night Watch says it, it must be true. The information spread so pervasively that even those who didn't care about Night Watch were convinced by all their friends. Since the text said that the devaluation would happen on Monday morning, Sunday saw a run on currency exchange companies: people were buying up Euros, Swedish kronor, British pounds, even gold (but curiously, not dollars). Tallinn's big independent currency exchange company, Tavid, actually ran out of foreign cash.

This run was almost entirely confined to the Russophone population. The Estonians had gotten wind of the original rumors, but never panicked. They had good reason not to: devaluation of the Estonian kroon is extremely unlikely, for multiple very good reasons.

First of all, the law. The kroon is pegged to the Euro by legislation; removing the peg would require a new bill, and a bill can only be passed if it has gone through no less than two readings in parliament, with no less than two weeks between them. The Bank of Estonia can only vary the peg rate by 3% (0.47 EEK). In theory it is possible for the BoE board to hold a continuous series of sessions through the night, adjusting the rate by 3% every time, but I will dare you to find a politician who could pull that off and not get lynched by an angry mob the next morning. Otherwise, a devaluation with forewarning is entirely pointless. The idea of devaluation is to remove excess wealth from the economy, wealth which defeats motivation to try harder. If everyone just converts their savings to Euros and back again, you've lost a lot of voter confidence with no benefit at all. Say what you will about the Estonian government, but they know a bit about economy theory.

Second, the kroon is secure. Estonia operates on a currency board system, whereby the BoE only issues kroons in return for foreign currency. Every kroon in circulation is backed by a dollar, Euro, pound, yen or dinar sitting somewhere deep in the vaults under Estonia Puiestee. While the total worth of these reserves does naturally vary, overall the BoE is capable of redeeming all the money out there at the peg rate. The sort of concentrated market effort that would drive the value of the kroon down enough that the BoE reserves would be depleted is not possible due to the rules of international banking. So the kroon isn't going to crash on its own; it can only be devalued by the government.

Third, there is simply no reason to do it. The kroon has been in far worse trouble than today. It wasn't devalued then (when it was still pegged to the Deutschmark) and it won't be devalued now. There is simply nobody who would benefit from it. The banks need their Euro-denominated mortgages paid back, and don't want the general population to suddenly lose a big chunk of its purchasing power. The businesses don't want it, because the devaluation only benefits industrial exports, which are a minor factor in the Estonian economy. Estonia's main economic force is its skilled labour, and that has shown willingness to go abroad in search of higher pay. To retain their workforce, the employers would have to recalculate salaries in Euros, which they can do with relative ease because they sell their products for Euros anyway. So devaluation is pointless.

But why did the currency run happen, then? The scare is rooted in the general sense of pessimism that has arisen in the wake of the economic slowdown. We seem to be heading for the soft landing rather than the hard crash, but people have come to expect wild growth and are discouraged when they don't find it. Accession to the Eurozone was our next grand project, after EU and NATO membership, and now that looks unlikely for at least a decade. Consciously or subconsciously, people want their government to jumpstart the economy, initiate another period of massive growth. Without a deep understanding of economic processes, based simply on hearsay and Delfi editorials, they expect that the government would do something like this - trade off a momentary lapse against future growth. And besides, who in Estonia has savings anyway?

The reason that the scare was prevalent among the Russophones is that - and I know I'll be called all sorts of bad things again for this - the majority of them are working-class immigrants without the education or the curiosity to try and figure out what is happening, exactly. Their pervasive distrust of the government, a reflex applied through surviving the Perestroika, coupled with a nagging suspicion that Andrus Ansip personally hates each and every one of them, makes them susceptible to such rumours.

People are mostly lemmings. There isn't much we can do about that. In this case nobody got hurt very much, although people will indeed lose money on the exchange rate. Far from being critical, the situation is simply embarassing.