Klaus Regling, chief executive of the European Financial Stability Facility, wants you to know that monetary union without fiscal integration is workable after all and he offers, as an example, Latvia:

Latvia which has a currency pegged to the euro, testifies to the success of this policy. Contrary to commentators who predicted disaster for Latvia early last year unless it gave up its hard peg – in line with advice from the commission – it did not devalue its exchange rate. A real effective devaluation was achieved through severe cuts in nominal income. Today its economy is growing again. Those outside “experts”, who always seem to know what is good for Europe, should take note.

So to be clear about this, the Latvian economy suffered a 4.2 percent contraction in 2008. By way of comparison, in the horrible year of 2009 the US economy contracted 2.44 percent. So that was a very bad recession, much worse than the American recession. At this point, so called “outside ‘experts’” predicted disaster for Latvia in early 2009 unless it devalued its exchange rate. Latvia declined to devalue and its GDP shrunk 18 percent! That’s the disaster right there. Overall GDP growth for 2010 is forecast to be slightly negative again. So, yes, Latvia has returned the growth. But the toll was terrifyingly high.

As ever, there were some “real” shocks involved in this. Some loss in Latvian living standards was inevitable and unavoidable. But the unemployment rate in Latvia is nearly 20 percent. That means a great many able-bodied adults are simply not working, not producing any goods and services for market consumption. That represents a vast loss of living standards that could have been largely avoided in a floating exchange rate regime.

To suggest that this is some kind of success story that illustrates the underlying workability of the system is horrifying.

I’ve mentioned the economic meltdown in the Baltic countries a couple of times, mostly to tweak right-wingers whose favorite economic models largely seem to have washed away in the Panic of 2008. But it’s worth pointing out, as Paul Krugman does, that what’s unfolding in Latvia is a genuine disaster in terms of human welfare. Mark Weisbrot and Rebecca Ray have a report on the matter which starts with the observation that this is the worst economic collapse ever:

The culprit is hard money. When a small country like Latvia takes a large negative shock, the normal response is for the value of its currency to tumble. Suddenly everyone is poorer. But by the same token, all their stuff is now cheaper for foreigners to buy and their workers are cheaper for foreigners to hire. So even though everyone is way poorer than they were pre-crisis, they can hit the floor relatively quickly and start moving back up. Latvia, however, has been maintaining a peg of its currency to the value of the euro preventing this kind of adjustment.

Here’s Cato’s Daniel Mitchell writing in April 2007:

The International Herald Tribune reports that the new government in Estonia plans to lower the rate on the flat tax from 22 percent to 18 percent. Estonia already ranks as one of the world’s most laissez-faire economies. Reducing the flat tax rate – which was originally imposed at a rate of 26 percent – will further enhance Estonian competitiveness and increase the power of tax competition in Europe.

Ah, Estonia:

Estonian GDP Shrinks By An Annual 15.6% In The First Three Months Of 2009

Well, the best thing that can be said about this is that it wasn’t as bad as the 18% contraction recorded in Latvia.

Back to Daniel Mitchell, writing with his colleague Chris Edwards who observe that “Latvia became the third Baltic country to adopt a flat tax . . . Latvia has experience rapid economic growth in recent years . . . like in Estonia, Latvia has been able to cut the overall size of its government.”

Not, of course, that flat taxes breed spectacular economic meltdowns. But many of the “miracle” economies pointed to by the right as proving the virtues of tax cuts—Ireland, the Baltics, to a lesser extent other neoliberal regimes in Central Europe—in fact clearly seem to have powered their past several years worth of growth largely by tapping the credit bubble in even bigger ways than the United States did.

Meanwhile, recall that the shoe of Eastern European defaults hasn’t necessarily finished dropping yet. The impact would be felt primarily in European banks, but it still spells trouble for everyone.