The Latvian economy went into recession at the beginning of 2008 and has since lost an estimated 25.5 percent of GDP, making it the worst two-year decline on record. Although "The Great Depression" in the United States had witnessed a loss of 29%, this loss was accrued during a four year period and not two years, as in the case of Latvia.

The International Monetary Fund loaned Latvia 7.5B Euros late last year, but banks loan you an umbrella when it's sunny and demand it back as it starts to rain. When the likelihood of currency devaluation becomes larger, lenders will typically withdraw capital from the region, which leaves businesses and consumers without access to credit. Although foreign banks continue to talk about a continuation of their lending operations, currency devaluation could change that instantly.

Since 90% of Latvian loans are denominated in foreign currency, devaluation would make debt repayment impossible. Swedbank, the largest lender in Latvia, recently noted that 54% of its mortgage loans are underwater. Those are problems for the lender as much as the borrower and devaluation would force banks to curtail loans as a replay of the 1930 Great Depression European banking crisis begins. In addition, as a result of the recession, the Latvian government is rapidly accumulating debt. From just 7.9 percent of GDP in 2007, Latvia's debt is projected at 74 percent of GDP for this year, stabilizing at 89 percent of GDP in 2014. This would put Latvia far outside the Maastricht debt/GDP limit of 60 percent of GDP for adopting the euro.

Unemployment increased from 5.3 percent in the fourth quarter of 2007, to more than 22 percent today. Credit to households and the private sector, which had been growing at rates as high as 90 and 70 percent, respectively, collapsed into negative territory. Overdue and non-performing loans, which were at less than 0.5 percent before the crisis, rose to 7 percent (and over 8 percent for household loans) by the end of 2009. It is true that Latvia had an unsustainable, bubble-driven growth, with excessive borrowing, prior to the collapse. Credit to households grew by more than 60 percent annually from 2002-2006. The current account deficit passed 22 percent of GDP in both 2006 and 2007. The real estate bubble, as in many countries, was a significant part of the story - including speculators "flipping" houses and, in Latvia, not even having to pay capital gains taxes on their profits. All of these conditions made a serious recession almost inevitable.

However, even given that the bubble growth and current account deficit implied that some adjustment was inevitable, the question is: how much economic decline is required in order to adjust to a sustainable growth path? The fact that Latvia's losses are so extreme by any historical comparison indicates that policy errors have been made. There were many bubble economies in the world before the world recession of 2008 - including the United States with its $8 trillion housing bubble. But none have suffered the magnitude of losses experienced by Latvia.

On an annual basis the Baltic state's gross domestic product plunged 17.7 percent in the October to December 2009 period, according to a flash estimate released by Statistics Latvia, testifying to the economy's weak position. Retail sales, for instance, plummeted 30 percent annually in the fourth quarter, the agency said. Data for the full year 2009 is unavailable, but most analysts have forecast that GDP sunk approximately 18 percent, the steepest drop in the 27-member EU and the worst performance on record since Latvia regained its independence in 1991. The modest jump in growth in the fourth quarter is unlikely to assuage Latvians, who are coping with the highest rate of joblessness in the EU at 22.8 percent, according to Eurostat and one of the coldest winters in memory.

The hardship is expected to continue this year, with analysts forecasting a further 4 percent decline in economic output. Growth is likely to resume in 2011.