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In financial circles, the mere mention of Eastern Europe these days conjures up images of collapsing banking systems, currency in-stability, and capital flight. The travails of the Baltic states have come to symbolize all that has gone wrong with Eastern Europe's high-growth economic model. Some analysts even believe that the region is now the weakest link in the global economy and could be the source of yet another financial contagion.

At the center of the storm are small countries like Latvia, now paying the price for the heady growth of the past few years, which was fueled by unbridled household consumption and property investment. With capital flows drying up of late, Latvia is under pressure to break the peg with the euro and devalue the exchange rate"”a move that could...