Transcript Slide 1

The Global Economy
And
Foreign Economic Policy:
Where do the Candidates
Stand?
Today’s Discussion
•Historical Context: The Great
Depression and American
Leadership
•The Cause: Absence of a Leader
•The Solution: Global Financial
Institutions
•The United States as Leader
•Globalization: Unregulated
markets
•Today’s Crisis
•The candidates and their solutions
The Business Cycle
•Prosperity
•Transition
•Trough
•Recovery
The Big Contradiction
• Market Mechanisms vs.
• Society’s needs
• the market threatens the very essential
bonds that hold society together.
: Globalization in Early 20th
Century: The Prosperity Phase
• International Interdependence and the
division of labor
• Credit and International
interdependence
• Britain as the world’s creditor and
lender of last resort in the “through”
phase of the business cycle
A bit like the Clinton era…….
Growth of production
Growth of consumerism
The Business Cycle with Britain as
Global creditor
Britain is
The World’s
Creditor
Great Depression
Hidden Problems
• Britain no longer able to provide credit
• Wages lagged behind profits, so that mass
purchasing power could not absorb the
vast output that it was technically possible
to produce.
Crash and Spread
• The crash of 1929 and the spread of
economic crisis
• Britain could no longer be the lender of
last resort, the buyer of other’s exports, or
infuse credit into the system
• The spread of the depression from finance
to industry
• The internationalization of the crisis
Market solution: “purge rottenness
out of the system”
• After the 1929 crash, Treasury Secretary
Andrew Mellon advised the government to
cut spending to balance the budget, and
leave desperate banks, businesses, and
families to fend for themselves because
the market alone would "purge the
rottenness out of the system."
Government intervenes: SmootHawley Tariff
Don’t Trade
Protectionism
The Global Response:
Protectionism
• . “every country for itself”
• Tariffs and qualitative restrictions
• Trade became bilateral
• Currency devaluations to stimulate
exports
The end of international
interdependence
Protectionism makes things
worse….Unemployment 25%
Then and Now….
Global Depression
• The combined output of the world's seven
biggest economies declined nearly 20%
from 1929 to 1932.
• The unemployment rate soared in the U.S.
and Germany to a peak above 33%.
• World trade collapsed by two-thirds, not
least because of retaliation to the SmootHawley tariff.
Depression and War
The Unemployed are Mobilized
Germany’s debt exceeded its national income in 1923 and
could not pay its international debts. The government
printed money which led to hyperinflation
Germany invades Poland
Causes? Solutions?
Leadership
• a central source of the Great Depression in the
1930s was a lack of British leadership and the
unwillingness of the U.S. to provide leadership in
the world economy.
• Leadership is needed to stabilize the world
economy
• leadership means three things:
1. providing a market for distress goods
2. providing long-term lending
3. discounting in crisis
Leadership for Stability: Post-war
Global Financial Institutions
• Market Anarchy caused the Depression
• Market can be tamed by government
intervention
• Global Markets need global governance
and intervention
IMF
World Bank Paul Wolfowitz he head of World Bank (2005-07), visited a mosque during an
official visit to Turkey. Obeying local customs, he removed his shoes and revealed two
large holes in his socks!
WTO
American Leadership
• the United States assumed primary
responsibility for the management of the
world monetary system, beginning with the
Marshall Plan and partially under the
disguise of the IMF.
• The dollar became the basis of the
international monetary system.
• The US took in the world’s distressed
goods and began to build a trade deficit
Multilateralism, American style
Marshall Plan
Marshall plan in action
The U.S.: market for world’s distressed goods,
source of credit, lender of last resort
• US becomes market for world’s distressed
goods
• Source of credit
• Lender of last resort
• How?
European Cooperation
The US Trade deficit: 1950-1973
Too many dollars
Vietnam war: more inflation
War on Poverty
Value drops
Value drops
inflation
Free Trade
Casino Economy
The more free trade, the higher the
income
Decline in real wages
Rise of Temporary workers
Growth of a low wage work force
• Between 1975 and 1990, the percentage
of low wage employees in the total work
force grew by 142 per cent, from 17 per
cent to 40 per cent
Rise in unemployment
But No Capital shortages
• . Capital markets are grew more quickly
than demand for capital, and new
calculations show that Asia could very well
finance much of its growth through
savings.
Deregulation and corruption
1945-73 U.S. Leadership
International Financial Institutions
International Trade Organizations
1920s
Globalization
Absence of
Leadership and
Regulation….
Govt = “private
good, public
bad”
1980’s
1990’s
1970’s Recession
1930s
Depression
Follow the crisis….
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1. Housing values remain stable for 100 years to 1995
1995-2005 Housing prices double
+
2. Wage stagnation and income inequality
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3. Deregulation of financial markets
4. Easy money  easy mortgages as bets on  in housing prices + Run of
CDOs and derivatives + borrowing to buy them (betting on  in value) +
rating fraud + easy insurance (AIG)  highly leveraged banks
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Housing supply overwhelms demand  housing prices fall + mortgage defaults
 CDOs lose value + Bank stock prices fall  credit drys up  Begin the
bailout  (hopefully) more credit  (hopefully) save businesses and jobs
 (hopefully) economic growth
Fannie Mae Freddy Mac
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pened The Floodgates
MISDIAGNOSING THE CAUSES OF THE CRISIS COULD LEAD BOTH TO REGULATORY OVERKILL AND TO MORE RECKLESS RISK TAKING.
by Stuart Taylor
Saturday, Oct. 18, 2008
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President Bush, his Securities and Exchange Commission appointees, other free-enterprise dogmatists who have stood in the way of regulating risky and opaque financial
manipulations, and greedy Wall Streeters deserve the blame heaped on them for the financial meltdown that has so severely shaken America.
But the pretense of many Democrats that this crisis is altogether a Republican creation is simplistic and dangerous.
It is simplistic because Democrats have been a big part of the problem, in part by supporting governmental distortions of the marketplace through mortgage giants Fannie
Mae and Freddie Mac, whose reckless lending practices necessitated a $200 billion government rescue last month. It is dangerous because misdiagnosing the causes of
the crisis could lead both to regulatory overkill and to more reckless risk taking by Fannie, Freddie, or newly created government-sponsored enterprises.
Fannie and Freddie aside, it's worth pointing out that many, if not most, of those greedy Wall Street barons are Democrats. And that the securities and investment industry
has given more money to Democrats than to Republicans in this election cycle. And that opposing regulation of risky new financial practices by private investment banks
and others has been a bipartisan enterprise, engaged in by the Clinton and Bush administrations alike.
But the roles of Fannie and Freddie are my focus here. Powerful Democratic (and some Republican) advocates of affordable housing, including Senate Banking, Housing,
and Urban Affairs Committee Chairman Christopher Dodd, D-Conn.; Sen. Charles Schumer, D-N.Y.; and House Financial Services Chairman Barney Frank, D-Mass.,
have been the GSEs' most potent and ardent champions in recent years. Meanwhile, the agencies and their employees have orchestrated a gigantic lobbying effort
(costing more than $174 million between 1998 and 2008). They have also made campaign contributions of more than $14.6 million between the 2000 and 2008 election
cycles, with some of the largest going to Dodd and Barack Obama.
A leading illustration of this Democrat-GSE symbiosis came in summer 2005. The Senate Banking Committee adopted a bill to impose tighter regulation on Fannie and
Freddie, with all Republicans voting for it. But the Democrats voted against it in committee and killed it on the floor.
Also in 2005, Fannie and Freddie began buying vast amounts of subprime and "alt-A" mortgages with, in many cases, virtually no down payments, that had been taken
out by people with low credit scores and low incomes relative to their monthly payments. To finance more and more affordable housing, as leading Democrats, and some
Republicans, had urged, the GSEs dramatically lowered their traditional underwriting standards.
Between 2005 and 2007, Fannie and Freddie "sold out the taxpayers" by financing almost $1 trillion in such highly risky mortgages, according to "The Last Trillion Dollar
Commitment: The Destruction of Fannie Mae and Freddie Mac," a carefully researched essay posted on the conservative American Enterprise Institute's website by Peter
Wallison of AEI and Charles Calomiris of Columbia Business School.
They base their trillion-dollar figure, which is much higher than most published estimates, on detailed analysis of what they call "accounting practices that made it difficult
to detect the size of those exposures."
Fannie and Freddie appear to have played a major role in causing the current crisis, in part because their quasi-governmental status violated basic principles of a healthy
free enterprise system by allowing them to privatize profit while socializing risk. That is, their special privileges as GSEs -- created decades ago to promote
homeownership by buying mortgages from banks, which could then use the cash to make more loans -- enabled them to lend at high rates to reap enormous profits for
their private stockholders and executives and to borrow at low rates based on the government's implicit promise to rescue them from any failure, as it has now done.
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Unbeknownst to the investment banks, the experts at Fannie and Freddie knew very well that their bosses were taking reckless risks.
Many conservatives have gone so far as to blame Fannie, Freddie, and their Democratic sponsors for the entire meltdown. Some (not including Wallison and Calomiris)
also blame the Community Reinvestment Act of 1977, which forced banks to lend and invest more in minority and low-income areas.
This accusation has spurred furious rebuttals by Democrats and their media friends. Some have been well reasoned. Some -- especially a July 14 column by New York
Times columnist Paul Krugman, who was awarded the Nobel Prize in economics this week -- have been flat-out incorrect.
As Wallison and Calomiris demonstrate, Krugman was egregiously wrong in writing that "Fannie and Freddie had nothing to do with the explosion of high-risk lending." He
was wrong again in stating that "they didn't do any subprime lending, because they can't ... by law." He was further wrong in writing that the GSEs were "tightly regulated
with regard to the risks they can take."
Others in the don't-blame-Fannie-and-Freddie camp reasonably point out that private Wall Street investment banks and others financed even more of the $3 trillion in
substandard mortgages than Fannie and Freddie did, and that these investment banks and many of the mortgage lenders who made (and then sold) the loans were not
covered by the Community Reinvestment Act.
Wallison agrees that the 31-year-old law does not appear to have been a major cause of the current crisis. He also notes that although the Clinton administration pushed
British Leadership (again?)
• At a special European summit meeting on
Sunday, the major economies of continental
Europe in effect declared themselves ready to
follow Britain’s lead, injecting hundreds of
billions of dollars into banks while guaranteeing
their debts. And whaddya know, Mr. Paulson —
after arguably wasting several precious weeks
— has also reversed course, and now plans to
buy equity stakes rather than bad mortgage
securities (although he still seems to be moving
with painful slowness).
Global Leadership?
Britain? G8?
International
1990’s Globalization Organizations?
No Leader!!!! No
regulation!!!! “Private
Good, Public Bad”
Wage stagnation
Housing
Bubble
Easy Money
2008
Future?
McCain solutions
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Sen. John McCain is proposing a new set of tax cuts aimed at helping investors weather the financial crisis. It
includes temporary reductions on capital gains tax, on taxes paid by senior citizens when they withdraw money
from retirement accounts, and on taxes paid on unemployment benefits.
The total package would cost $52.8 billion, according to senior policy adviser Douglas Holtz-Eakin. All of the
proposals would apply for 2009 and 2010.
The McCain campaign has struggled to figure out the best response to the economic crisis, suggesting a number
of proposals over the last few weeks. None of them appears to have caught fire with the public, though, as polls
show voters trust rival Sen. Barack Obama more on the economy. The Democratic nominee has been gaining in
national and battleground state polls with Election Day just three weeks away.
The Obama campaign called the McCain initiative “a day late and 101 families short,” saying it will not spur job
growth for the middle class.
“His trickle-down, ideological recipes won’t strengthen our economy and grow our middle-class, but Barack
Obama’s pro-jobs, pro-family economic policies will,” Obama spokesman Bill Burton said in a statement. He
added that a capital gain tax cut won’t be very helpful in a year when people don’t have many capital gains.
The McCain plan would reduce the tax on long-term capital gains to 7.5% from 15% for 2009 and 2010. The
campaign said this would “strengthen incentives to save, invest and restore the liquidity of the markets.” That
would cost $10 billion.
He also wants to increase the amount of capital losses that can be used to offset ordinary income from $3,000 to
$15,000.
The most expensive part of the plan would lower the tax rate on money seniors withdraw from IRAs and 401(k)
retirement plans to the lowest rate — 10%. This would apply to the first $50,000 withdrawn from these accounts
each year. The campaign estimated it would help nearly 9 million Americans over age 60 and would cost $36
billion.
Obama solutions
• Obama proposed tax breaks for businesses that create
new jobs, a freeze on foreclosures by banks that
participate in the government's rescue program and a
public-works fund to rebuild the nation's infrastructure
while keeping people employed. He embraced McCain's
proposal to suspend the rule that would require retirees
to start liquidating their 401(k) holdings at the bottom of
the stock-market crash. And he went a step further,
proposing that Americans should be able to withdraw
some of those retirement savings without penalty during
the economic crisis.
Back in the USA: Keynes
Triumphs?
Times Square News Ticker