Transcript My Big Fat Greek Crisis

My Big Fat Greek Crisis
IASET
October 13, 2011
Helen Roberts
Greece versus Illinois
Both have beaches
Greece versus Illinois
 Both are known for architecture
Greece versus Illinois

 Both have persistent structural budget deficits. Illinois 2012
deficit would be $1317 per person (10/2010 projection).
What is the European Union, and
why is the Greek crisis seen as
bringing it down? Nobody says IL
will break apart the US.
 http://europa.eu/index_en.htm
 http://europa.eu/quick-links/eu-kids/index_en.htm
27 Member Countries
Member states of the EU (year of
entry)
Austria (1995), Belgium (1952), Bulgaria (2007),
Cyprus (2004), Czech Republic (2004),
Denmark (1973), Estonia (2004), Finland (1995),
France (1952), Germany (1952), Greece (1981),
Hungary (2004), Ireland (1973), Italy (1952),
Latvia (2004), Lithuania (2004), Luxembourg (1952),
Malta (2004), Netherlands (1952), Poland (2004),
Portugal (1986), Romania (2007), Slovakia (2004),
Slovenia (2004), Spain (1986), Sweden (1995), United
Kingdom (1973)
EU Countries NOT on EURO
As of the 1st of January 2011, 17 members of the European Union use the
Euro.
The 10 that do not are:
United Kingdom
Bulgaria
Czech Rep.
Denmark
Hungary
Latvia
Lithuania
Poland
Romania
Sweden
Candidates for EU Membership
Croatia
Former Yugoslav Republic of
Macedonia
Iceland
Montenegro
Turkey
European Countries Not in EU
Albania, Andorra, Armenia,
Azerbaijan, Belarus, Bosnia and
Herzegovina, Georgia, Liechtenstein,
Moldova, Monaco, Norway, Russia,
San Marino, Serbia, Switzerland,
Ukraine, Vatican City State
One Currency versus Floating
Exchange Rates: Optimum
Currency Areas (Robert Mundell
1999 Nobel)
 2 regions are considering a currency union: Market integrations
and efficiency benefits versus economic symmetry and stability
costs
 If markets are more integrated, net economic benefits from a
currency union (lower transactions costs and reduced
uncertainty) increase.
 If countries use the same currency, they lose monetary
autonomy—must have same monetary policy and interest rates
as others in that currency.
 If regions are very similar, so they potentially have the same
economic shocks (symmetric shocks, not asymmetric) then cost
of joining currency union goes down.
Dollarization
 A country adopts a foreign currency and plays no role in
managing the common currency.
 Example: Panama uses the U.S. dollar
 Even when the adopted currency is not the U.S. dollar, the
process is often called dollarization.
 Rare for multilateral currency unions like the Eurozone where
all member countries participate in the monetary affairs of the
union.
Symmetry-Integration
 Benefits of floating dominate: Sweden, UK
 Benefits of fixing exchange rate dominate: Denmark
 Benefits of full currency union dominate: United States
 Where does Eurozone fit?
EU compared with USA
 EU is not a federation like the United States.
 EU is not an organization for co-operation between
governments, like the United Nations.
 The EU member states (countries that make up the EU) are
independent sovereign nations.
 EU countries ‘pool their sovereignty’ in order to gain a strength
and world influence none of them could have on their own.
 Pooling sovereignty means, in practice, that the member states
delegate some of their decision-making powers to shared
institutions they have created, so that decisions on specific
matters of joint interest can be made democratically at
European level.
EU Decision Making
 EU law is divided into 'primary' and 'secondary' legislation.
The treaties (primary legislation) are the basis or ground
rules for all EU action.
 Secondary legislation – which includes regulations, directives
and decisions – are derived from the principles and
objectives set out in the treaties.
Co-Decisions
 The EU’s standard decision-making procedure is known as
'codecision'. This means that the directly elected European
Parliament has to approve EU legislation together with the
Council (the governments of the 27 EU countries). The
Commission drafts and implements EU legislation.
 The Treaty of Lisbon increased the number of policy areas
where 'codecision' is used. The European Parliament also
has more power to block a proposal if it disagrees with
the Council.
Main Institutions of EU
 The EU's decision-making process in general and the codecision procedure in particular involve three main
institutions:
 the European Parliament, which represents the EU’s citizens
and is directly elected by them;
 the Council of the European Union, which represents the
individual member states;
 the European Commission, which seeks to uphold the
interests of the Union as a whole.
European Central Bank
 The European Central Bank (ECB, based in Frankfurt,
Germany) manages the euro – the EU's single currency –
and safeguards price stability in the EU.
 The ECB is also responsible for framing and implementing
the EU’s economic and monetary policy.
ECB Purpose
 keep prices stable (keep inflation under control), especially in
countries that use the euro.
 keep the financial system stable – by making sure financial
markets and institutions are properly supervised.
 The Bank works with the central banks in all 27 EU countries.
Together they form the European System of Central Banks
(ESCB).
 It also leads the close cooperation between central banks in
the euro area – the 17 EU countries that have adopted the euro,
also known as the eurozone. The cooperation between this
smaller, tighter group of banks is referred to as the
‘Eurosystem’.
ECB Tasks
 setting key interest rates for the eurozone and controlling
the money supply
 managing the eurozone's foreign-currency reserves and
buying or selling currencies when necessary to keep exchange
rates in balance
 helping to ensure financial markets and institutions are
adequately supervised by national authorities, and
that payment systems function smoothly
 authorising central banks in eurozone countries to issue euro
banknotes
 monitoring price trends and assessing the risk they pose to
price stability.
US Federal Reserve Dual Mandate
 2 key objectives for monetary policy--maximum employment and
stable prices--in the Federal Reserve Act. These objectives are
sometimes referred to as the Federal Reserve's dual mandate,
the long-run goal for monetary policy.
 Congress established the Federal Reserve as an independent
agency.
 This is critical to guaranteeing that monetary policy decisions
are free from political influence and focused exclusively on
achieving the Federal Reserve's dual mandate.
 A problem experienced in many countries without an
independent central bank is that elected officials have put
pressure on monetary policymakers to follow policies that boost
the economy in the short run even if doing so would result in
high levels of inflation later on.
EU Economy
 With 12 new member countries joining since 2004,
the EU’s GDP — output of goods and services —
is now bigger than that of the US:
 GDP (€12.2684 trllion 2010)
 1.33 dollars per euro, so
 EU GDP in dollars was $16.3170 trillion
 GDP—the value of all of the goods and services
produced in the United States—in 2010
was $14.5265 trillion.
EU International Trade
 With just 7% of the world’s population, the EU's trade with the
rest of the world accounts for around 20% of global exports
and imports. The EU is the world’s biggest exporter and the
second-biggest importer.
 Around two thirds of EU countries’ total trade is done with
other EU countries.
 The United States is the EU’s most important trading partner,
followed by China. In 2005, the EU accounted for 18.1% of
world exports and 18.9% of imports.
Production and Trading Partners
 EU and U.S. together account for 40% of total
global trade.
 The intertwined economies employ 12-14 million
workers on both sides of the Atlantic.
 Europe is by far the most significant source of
foreign investment in the US economy.
US International Trade in Dollars
 http://www.census.gov/foreigntrade/statistics/highlights/top/top1012yr.html
 Top US Trading Partners (72-75% of trade accounted for by
top 15 countries)
 Total Trade in Goods, Euro countries in top 15: Germany (5), UK
(6), France (8), Netherlands (11)
 Exports: UK (5), Germany (6), Netherlands (9), France(11),
Belgium (14)
 Imports: Germany (5), UK (6), France (8), Ireland (10), Italy (15)
EU-US Trade
Trade in goods
 EU good exports to the US in 2010: €242.1 billion
 EU goods imports from the US in 2010: €169.5 billion
Trade in services
 EU services exports to the US 2010: €125.2 billion
 EU services imports from the US in 2010: €131.0 billion
Foreign Direct Investment
 EU investment flows to the US in 2009: €79.2 billion
 US investment flows to the EU in 2009: €97.3 billion
 Investment stocks inward in 2009: €1044 billion
 Investment stocks outward in 2009: €1134 billion
International Crises 101
Financial Crisis
Credit Crisis
Currency Crisis
Sovereign Default
Contagion
Financial Crisis
 Some financial institutions or assets suddenly lose a large
part of their value.
 In the 19th and early 20th centuries, many financial crises
were associated with banking panics, and
many recessions coincided with these panics.
 Other situations that are often called financial crises
include stock market crashes and the bursting of other
financial bubbles, currency crises, and sovereign defaults.
 Financial crises directly result in a loss of paper wealth; they
do not directly result in changes in the real economy unless a
recession or depression follows.
Credit Crisis
 Financial institutions issue or are sold high-risk loans that
start to default.
 As borrowers default on their loans, the financial
institutions that issued the loans stop receiving payments.
 This is followed by a period in which financial institutions
redefine the riskiness of borrowers, making it difficult for
debtors to find creditors.
Currency Crisis, also called
Balance of Payments Crisis
 Sudden devaluation of a currency caused by chronic
balance-of-payments deficits
 Occurs when the foreign exchange value of a
currency changes quickly, undermining its ability to serve as
a medium of exchange or a store of value.
 Currency crises usually affect fixed exchange rate regimes,
rather than floating rate regimes.
 Recessions attributed to currency crises include the 1994
economic crisis in Mexico, 1997 Asian Financial Crisis, 1998
Russian financial crisis, and the Argentine economic crisis
(1999-2002).
Sovereign Default
 Failure by the government of a sovereign state to pay back
its debt in full.
 If potential lenders or bond purchasers begin to suspect that a
government may fail to pay back its debt, they may demand a high
interest rate in compensation for the risk of default.
 A dramatic rise in the interest rate faced by a government due to
fear that it will fail to honor its debt is sometimes called a sovereign
debt crisis.
 Governments may be especially vulnerable to a sovereign debt
crisis when they rely on financing through short-term bonds, since
this creates a situation of maturity mismatch between their shortterm bond financing and the long-term asset value of their tax base.
 They may also be vulnerable to a sovereign debt crisis due
to currency mismatch if they are unable to issue bonds in their own
currency, as a decrease in the value of their own currency may then
make it prohibitively expensive to pay back their foreigndenominated bonds
Contagion
 A crisis in one part of global capital markets triggers adverse
changes in market sentiment in faraway places.
 Some economists consider this evidence of market
inefficiency or irrationality.
 Example: investors revised their risk premia sharply upwards
for Argentina in response to crises in Mexico (1994), Asia
(1997), when there were no major changes to Argentine
fundamentals during these crises.
Walk through May 2010 Analysis of
What Greek Crisis means for
Manhattan Real Estate
 Aggregate demand down and fiscal drag in Europe; slowing
trade flows
 Reallocation of capital from weaker to stronger in Eurozone
 Volatility in financial markets and wider credit spreads
 Investors move away from stocks to bonds
 Euro declines
 What has happened over the past year?
World Output Growth (UN World
Economic Situation 2011), %
2006 2007 2008 2009
2010 2011
2012
World
4.0
3.9
1.6
-2.0
3.6
3.1
3.5
Developed
2.8
2.5
0.1
-3.5
2.3
1.9
2.3
Eurozone
3.0
2.8
0.5
-4.1
1.6
1.3
1.7
Japan
2.0
2.4
-1.2
-5.2
2.7
1.1
1.4
UK
2.8
2.7
-0.1
-4.9
1.8
2.1
2.6
US
2.7
1.9
0.0
-2.6
2.6
2.2
2.8
World Trade
9.3
7.2
2.7 -11.4
10.5
6.6
6.5
http://www.un.org/en/development/desa/policy/wesp/wesp_current/2011wesp
_prerelease1.pdf
Fiscal Drag
International Capital Flows
 Capital flows resumed after the 2010 crisis.
 http://www.scribd.com/doc/53986940/IMF-World-EconomicOutlook-April-2011
TED Spread Widening
TED spread measures the difference between the interest rates on US Tbills (thus the 'T') and interbank loans (or LIBOR, represented by
Eurodollar futures or the "ED" ticker on the CME). When the spread
widens, it means investors are nervous about credit risk and the possibility
of defaults, sending LIBOR rates higher and T-bill rates lower.
Not surprisingly, given recent trends and the Eurozone crisis, the Ted
spread increased Oct. 11, 2011 to just below 37 basis points, much higher
than the safer 20 to 25 basis points range we saw in the spring.
The spread is still nowhere near the highs it reached in 2008, when it once
soared above 450 basis points, but the uptick means that investors are
increasingly fearful about the big events able to rock global markets, like
the future of the Eurozone bailout, volatility, and the fast-approaching US
'super committee' deadline.
Standard & Poor's 500 Index History
Chart
January 1, 1953 Through August 12,
2011
Euros per US Dollar Forex Chart
Links on How the Greek Crisis affects US
http://www.youtube.com/watch?v=aM4q0Uh4sQQ
“Ask Steve” talks with River City Bank President (Sacramento) explains basics in 3 minutes.
http://www.cmegroup.com/education/files/my-big-fat-greek-debt-crisis-1.pdf
CME Group looks at 2010 crisis and implications for traders
http://www.cmegroup.com/education/files/my-big-fat-greek-debt-crisis-2.pdf
CME Group looks at 2011 crisis and (compared with 2010 crisis) looks at implications for traders.
http://theapplepeeled.com/economics/my-big-fat-greek-crisis-w hat-european-troubles-may-mean-forthe-nyc-housing-market/
Example of reasoning for the Greek crisis affecting US housing market (NYC).
http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2011/cflnovember2011_292.
pdf
Chicago Fed summary of international financial regulators cooperating after the financial crisis
http://www.chicagofed.org/webpages/publications/chicago_fed_letter/2011/october_291b.cfm
http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2011/cflmay2011_286a.pdf
http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2009/cflaugust2009_265.pdf
Rick Mattoon Chicago Fed Letters on State and Local Government Financial Situations and whether
the federal government should bail out states
http://www.chicagofed.org/webpages/publications/chicago_fed_letter/2011/may_286a.cfm
Video with Rick Mattoon talking about background to Fed Letter