Transcript Int'l Monetary Crisis - University of Texas at Austin

Financial Crisis- I
Pre-Capitalist Finance
“Money lenders” loaned their own money
From ancient times
Money was loaned to:
Individuals for consumption
The state, governments, for roads, wars, exploration
Merchants for trade
Rise of Banking
Loans from deposited monies
Renaissance Italy in 14th Century
See: Shakespeare’s Merchant of Venice
Capitalist Finance
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Commercial credit: finances trade
¢ Just as before, money borrowed to buy cheap and
sell dear
Industrial credit: finances real investment
¢ Money borrowed to build plants, buy machinery
and raw materials and hire workers
Consumer credit: finances personal consumption
¢ From pawnbrokers through installment plans to credit cards
¢ Mortgages to buy homes
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State credit: Governments borrow and lend
¢ Borrows to finance expendiures > tax revenues
¢ Lends at home and abroad, e.g., foreign aid
Financial Institutions - 1
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Banks
¢ Private banks
Lend to consumers, business & governments
Objective: profit
¢ National banks
Central Banks: regulate money supply, oversee private
banking sector
Development Banks: fund investment, consumption, buy
political support
¢ Supranational Banks
International private banks
World Bank
Financial Institutions - 2
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Stock markets
¢ Buy & sell stocks
¢ Stocks are ownership shares, of various sorts
 e.g., some pay dividends, some don’t
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Commodity Markets
¢ Buy & sell commodies, e.g., metals, soy beans, pork bellies,
spot sales & futures contracts (that can be bought and sold
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Foreign exchange markets
¢ Buy & sell currencies
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Bond Markets
¢ Buy & sell bonds
Crises & Financial Crises
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Many kinds of crises:
¢ Commercial crises
¢ Industrial crises
¢ Financial crises
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All are Interrelated
¢ Remember discussion of growth & what has to
happen:
¢ M-C(MP,L) . . . P . . . C’-M’
¢ Or, to be more complete:
Interrelationships
L - M - C(MS)...P(2)...L * . L - M - C(MS)
M-L
M-L
. . . P(1)... C’ - M’ .
...P...
M - MP
M - MP
A rupture at one point circulates to others, e.g.,
if money (M) can’t be had for investment, then
M-L and M-MP can’t take place, then no P(1),
etc.
Circulation of Crisis
in Industrial Circuit - 1
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Crisis of Industrial credit means no M
No M (no bank credit, no stock sales, etc.),
then no M-L, M-MP, …P…, C’, M’
No L (refusal of labor market), or no MP
(trade disruption), then no …P…C’, M’
No …P…, then no C’, M’
No C’-M’, then no revenue, no profit, no
beginning again in new period
Circulation of Crisis
in Industrial Circuit - 2
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Crisis of Commerical Credit means
breakdown in C’-M’
Expand C’-M’….
C’ sold to wholesalers (who need credit)
C’ sold by wholesalers to retailers (who need
credit)
Breakdown in C’-M’ circulates
Circulation of Crisis
in Reproduction of Labor - 1
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No L-M (refusal to enter labor market), then no
wage), more …P(2) …, Life but no L. (assuming
ability to produce consumer goods)
¢ E.g., frontier, unsubordinated colonials
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No L-M (no jobs), then no wage, less C(MS), more
…P(2) …, less L. (assuming some MS purchased
with savings)
¢ E.g., downturn, rising unemployment
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In other words: a breakdown in the subordination of
life to labor, or in the reproduction of labor.
Circulation of Crisis
in Reproduction of Labor - 2
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Crisis of Consumer Credit
¢ E.g., default on consumer debt  repo’s
¢ E.g., defaults on mortgages  foreclosures
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Surge in Consumer defaults
¢  collapse in consumer demand for durables and housing
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Collapse in consumer demand
¢  drop in aggregate demand, drop in both C’-M’ and in M –
C(MS) which provokes fall in investment, employment etc.
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Collapse in market for consumer debt
¢ E.g., mortgages and mortgage-based securities
Finance & Keynesian Models - 1
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All the major components of aggregate demand: C, I,
G, X and M depend on finance
C = consumer demand, depends on consumer credit
I = investment demand, depends on capital markets
(loans, stocks, bonds, etc.)
G = government expenditures, depend upon
borrowing, e.g., in US Treasury Bills
X = exports, depend upon commercial credit
M = imports, depend upon commercial credit
Finance & Keynesian Models - 2
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Two-way relationship:
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Healthy credit  growth in C,I,G,X,M.
Healthy growth  confident credit markets, but….
Breakdown in credit  breakdown in C,I,G,X,M
Breakdown in C,I,G,X,M  breakdown in credit markets.
Monetary Policy
¢ Central bank affects finance through interest rates and
handling of government debt
Via reserve requirements, discount rate, open market
operations
¢ Regulation of finance part of monetary policy
Financial Crises & Regulation - 1
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Regulations were created because:
¢ the “free market” was subject to manipulation and abuse and
regularly produced crises that undermined part or all of the
economy.
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Examples:
¢ Tulip Mania (1634-1637)
¢ Bank Panics and Crises of: 1792, 17961797,1819,1825,1837,1847,1857,1866, 1873, 1884, 1893,
1896, 1907
¢ Wall Street Crash of 1929.
Financial Crises & Regulation - 2
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Primary purposes of regulation:
¢ To create and maintain confidence in various financial
institutions and their operations
¢ In order to create and maintain useful flows of money to
finance consumption, investment, trade and government
expenditures
¢ To protect those who depend upon credit from misconduct
and exploitation
Financial Crises & Regulation - 3
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Financial regulation includes:
¢ Specification of what actions are legal and which ones are
illegal and…
¢ Specification of what institutions can do what
Broadly this involves laws passed by congress
¢ Supervision to enforce laws, prosecute violations
of laws
¢ Institutions to supervise, to check to see if
regulations are being adhered to, investigate
violations and prosecute them.
Financial Crises & Regulation - 4
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Regulatory institutions in the US include:
¢ Federal Reserve System (Fed)
 Regulates member banks reserves, etc.
¢ Federal Deposit Insurance Corporation (FDIC)
 Insures deposits, regulates bank deposit behavior
¢ US Securities and Exchange Commission (SEC)
 Regulates securities markets (stock, bonds, etc.)
¢ National Credit Union Administration (NCUA)
 Licences, supervises and regulates credit federal credit unions
¢ Commodity Futures Trading Commission (CFTC)
 Oversee and regulate commodities markets, futures & options
Great Depression & Financial
Regulation
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Stock Market Crash of 1929
¢ October 29, 1929 “Black Tuesday”
¢ Financial collapse contributed to collapse of economy more
generally
¢ Despite Federal Reserve Act of 1913
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New financial regulations in 1930s:
¢ Farm Credit Administration,
¢ Federal Securities Act, Glass-Steagall Act (creates FDIC,
lets Fed set max interest rates on S&L, splits commercial
and investment banking),
¢ Export-Import Bank created,
¢ Exchange Stabilization Fund created, Federal Farm
Mortgage Corporation, SEC created, etc.
Keynesian Era & financial Crises
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Comprehensive financial regulation at home
meant virtually no domestic financial crises
Bretton Woods agreement on fixed exchange
rates with IMF as overseer and lender of last
resort
UNTIL: accelerating inflation and growing
gov. debt, trade deficits and speculative
attacks on the dollar lead to abandonment of
Bretton Woods, volitile flexible exchange
rates and negative interest rates.
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