Transcript International Political Economy--

International Political Economy--
International Debt and Financial Crises
Professor Yu Xunda
2013. 05
Suggested Readings
 Clive Dilnot. “The Triumph of Greed,” New Statesman, December4, 2008.
 Barry Eichengreen. Globalizing Capital: A History of the International Monetary
System. Princeton, NI: Princeton University Press,1996.
 Dani Rodrik. “Goodbye Washington Consensus, Hello Washington Confusion?”
Journal of Economic Literature, XLIV(December 2006), pp.973-987
 Jeffery Sachs. The End of Poverty: Economic Possibilities for Our Time. New
York: Penguin,2006.
 Robert Wade. “The First-World Debt Crisis of 2007-2010 in Global
Perspective,” Challenge, July-August 2008,pp.23-54.
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Content
8-1
The Debt Crisis of The 1980s
8-2
The Asian Financial Crisis
8-3 The Global Financial Crisis of 2007
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1. The Debt Crisis of The 1980s
The first LDC debt “crisis” began in 1982, when Mexico
announced that it would default on its bank debt, generating fear that
other countries with substantial debt, such as Brazil, would follow
Mexico’s lead.
Huge financial flowed from the North to the South, especially
those LDCs.
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1.1 The Reasons ----(1)
Why?
----totally, the globalization of financial flow
which powered by market deregulation and
technological change
----for the North:
 financial centers in the industrial North increasingly
sought new investments possibilities and higher
returns.
 While those scare resources, low-cost labor,
favorable economic development policies in LDCs
all favored new investment opportunities..
----for the South(LDCs):
 they were receiving less financial assistance from
ODA sources.
 inflation rates were running ahead of interest rates
on loans—creating negative real rates, which
traditionally favor borrowers.
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1.1 The Reasons ----(2)
However, the uncoordinated actions of the market generated a “debt trap”
for both debtor states and their creditors. In retrospect, too much was
loaned to too many.
 International banks continued to make additional loans to states with growing debt
both to provide more resources for economic development and to sustain interest
payments on earlier loans.
 With so much debt outstanding, the banks were in as much trouble as the debtor
nations. Debtor nations owed more than they could reasonably reply, yet they
continued to borrow more in order to meet their short-run obligations.
In essence, debtor states only refinanced their loans and stretched out the
time period for repayment of the loans.
Most states restrained imports and promoted exports to generate income.
But at last, only Korea and Turkey recovered, other went deeper into the red.
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1.2 Measures: ------- (1) US’s Baker Plan
US’s Baker Plan
 -------------to implement market-oriented structural changes to debtor economies
combined with $20 billion in new loans, provided by commercial banks over three years.
However, it did not work.
 As countries tried to expand their exports all at once, commodity and oil prices
collapsed, leaving many nations (especially African countries) worse off than before the
loans.
 By the late 1980s, many debtor states faces “donor fatigue,” whereby social and
political tensions related to policies adopted to relieve the debt grew and dissatisfaction
with international debt management festered.
The U.S.
Treasury secretary
James Baker
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1.2 Measures: ------- (2) debt swaps were employed in some cases.
 Then debt swaps were employed in some cases.
-------some amount of debt could be swapped with a bank in
exchange for land or valuable properties in debtor countries.
 However, the banks found themselves unable to grant debt relief in this
manner, since they were caught in a situation referred to as the
“prisoners’ dilemma”.
 Finally, given the high stakes and the intensely competitive nature of
international finance, no one state or bank was willing to forgive LDC
debts, and the vicious cycle of debt for these nations continued.
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1.2 Measures: ------- (3) The Brady Plan
As cooperation can be encourages by a hegemon, whose share of the
resulting gains is so great that it is willing to bear the costs of
organizing a cooperative effort--------the U.S.
 In 1989, President George H.W. Bush initiated the Brady Plan-----whereby old debt was
exchanged for bonds that could be exchanged for new bank loans.
 Under this scheme, Mexico benefited from some debt relief, the banks reduced the risk
of default, and the U.S. government avoided increasing international financial instability.
While to honor such huge debt and interest burdens would have required
harsh mercantilist policies restricting imports and expanding exports,
generating problems in the industrialized nations that rely on LDCs to
import some of their manufactured goods.
The discipline and sacrifice necessary for LDCs to service their debt
often generated much social and political unrest, including strikes and
riots.
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1.3 Debt Crisis and a New Role for the IMF
During the mid-1980s, the U.S.pushed the IMF to work closely with the World
Bank on solving LDC debt problems.
Washington Consensus emerged as the best strategy for developing
nations.
 According to the neoliberal ideas of the Reaganism, debt would be
overcome as economies opened up and integrated into the growing
global economy.
The role of IMF then shifted away form “helping member states deal
with balance-of-payments problems” into the “lender of last resort”
in the international economy
 an institution that could help nations pvercome their debt burden.
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1.4 The logic of the IMF’s policies
 The logic of the IMF’s policies was to reduce
the current account deficit by increasing exports
and reducing imports and simultaneously help
finance the capital account by stemming capital
fight and limiting new borrowing needs.
 In the long run, these policies were also intended
to encourage economic growth, creating a situation
in which the nation can repay its old debts and be
less dependent on credit in the future,
 In the short run, the debtor-nation government
was expected to enact policies that at first lowered
living standards and imposed hardships, especially
on the poor, in some cases leading to violence and
civil unrest.
In practice, the relationship between the IMF and
those debtor nations was often conflictual.
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1.5 A Balance-of-Payments Financial Crisis
 Definition:
states borrowed too much money to use for
development projects or pay for imports.
 This type of debt stems from many of the
transactions states conduct every day.
 Capital fight:
when investors transfer their bank accounts out of
the country to “safe harbor” nations. In turn, it
creates an extreme shortage of funds in the debtor
nation’s banks, which sends national interest
shooting up.
 Debt problems related to a balance-ofpayments crisis brought on by speculation
and capital fight can disrupt and distort trade
and international financial relationships.
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2. The Asian Financial Crisis
The crisis started on July 2, 1997, when Thailand’s currency , the baht,
suddenly collapsed in value.
 It started a chain reaction of economic, political, and social effects, together
referred to as the Asian financial crisis because it spread to Indonesia, Malaysia,
Taiwan, Hong Kong, South Korea, and elsewhere in the region.
It raises questions abut the trade-offs surrounding speculative attacks in a more
integrated global monetary and finance structure.
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2.1 Whole Process of the Asian Financial Crisis
Whole process
1. The government’s exchange-rate pledge -2. A business bubble ----
3. Bad loans -----4. Disinvestment -5. A hedge fund ----- Eventually, on July2, 1997, the Thai government was forced to abandon its pledge.
And at last, the new exchange rate was about 50 baht per dollar, with similar
collapses in other Asian countries.
 For many, the Asian crisis was an economic collapse similar to the Great Depression.
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3. The Global Financial Crisis of 2007
By September 2008, the U.S.real estate-mortgage problem had resulted in a full-blown
crisis that quickly became a global financial debate, essentially freezing the circulation
of credit within and between states.
financial turmoil: Some of the world’s largest financial institutions had either gone
bankrupt, been nationalized, or been rescued by the government.
a deep global economic recession with dizzying job losses, record home foreclosures, and
a substantial increase in poverty.
Public confidence in governments’ handling of economic affairs faltered.
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3.1 Why did this happen?
Some often-mentioned causes include:
A global economic imbalance rooted in a U.S.balance-of-payments problems.
A U.S.regulatory regime that led to excessive debt and imprudent lending
practices of banks, mortgage companies, and other financial institutions.
A myopic ideology that promoted globalization and the “magic of the market”
without accounting for market failure and the impact of deregulation on financial
institutions.
The irrational, unethical, and even illegal behavior of some individuals and
companies.
Weak global governance
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3.2 the Run-up to the U.S. Financial Crisis
The shift of ideology:
 From 1930s to the 1960s, Keynesianism.
 In late 1960s, in pursuit of economic growth, the orthodox economic liberal
ideas (OEL) gradually replaced the Keynesianism.
 In 1973, the U.S.adopted a more economic liberal outlook and replaced the
fixed-exchange-rate system with a flexible-exchange-rate system, which lead to
increased speculation on currencies and more money circulating in the
international economy.
 In 1980s, Reaganism and Thatcherism
 In the late 1990s, stock prices skyrocketed and the development of new
technologies and communication systems enhanced market activity.
 By the end of 1990s, many nations were competing to attract huge amounts of
unregulated “hot money”. In 1999, the U.S repealed the Glass-Steagall Act.
Even the dot-com investment bubble burst in 2000 and 2001 did not
change the liberal ideas.
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3.3 Structural problems’ role in 2007
 The U.S.was running a huge trade deficit with China,
Japan, and other exporters who had been financing this
deficit by buying enormous amounts of U.S.stocks, Treasury
bills, etc. The U.S gradually built up an unsustainable level of
personal and public debt.
Structural
problems’ role
in the onset of
the financial
crisis in 2007
 The Federal Reserve lowered interest rates following the
dot-com bubble burst, making it easier to buy a house on
credit. Subprime mortgage loans are believed to allowed to
have caused many buyers to make irrational decisions often
based on incomplete (hidden) information.
 Deregulation allowed making the “bid deal” to overshadow
careful risk assessment.
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3.4 the Bubble Bursts
 By early 2007, a slew of large mortgage companies with significant portfolios of
subprime loans—worth $13billion or 20%of U.S.home lending—failed for
bankruptcy.
 Home mortgage markets in other countries, including the UK and Japan, began
reflecting the same trend occurring in the U.S.
 By August 2007, a worldwide credit crunch grew amongst banks and hedge funds
that held a vast amount of mortgage-backed securities. Troubles at many financial
companies around the world unfolded and mounted through the end of the year.
 The real estate bubble -began to tear in July 2008 after panicky investors started unloading their
stocks in the state-created Fannie Mae and Freddie Mac loan agencies,
which together owned or guaranteed $6 billion of the $12 trillion mortgage
market in the U.S.
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3.5 Congress ----”rescue plan”
 But investors were rapidly losing confidence
and began disinvesting the U.S.real estate
and stock markets.
Impacts:
 Ripple effect:speculators left real estate and
focused on hot commodities like oil, gold, rice, and
wheat, etc, causing the ripple effect of high energy
costs on consumers and business.
 Herd effect: when big banks began to fall. The herd
effect took over and investors scrambled to
disinvest in U.S.mortgages and other securities.
 Contagion effect: a border global financial crisis
spread all over the world.
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3.6 We Are All Keynesians Now
 As the fear of not only a recession but a second
Great Depression mounted, more and more
people began to sound like Keynesian HILs than
Milton Friedman OELs.
 Although many OELs preferred to let the market
run its course, culling a number of big banks and
letting the strongest ones survive.
But most HIL and mercantilist-oriented officials
supported a quick injection of new national bank
monies in the hope that this would unfreeze the
U.S.and global monetary and financial systems.
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3.7 Contagion Takes Over
By October, the crisis was spreading through Europe.
By December 2008 the global economy was clearly in a recession as reverberation
from the financial crisis continued to rock both Wall Street and Main Street.
 Most countries agreed to further cut interest rates to stimulate the world
economy.
 Many states, especially those emerging economies, more and more
involved in negotiations to solve the crisis.
 Many officials focused on encouraging emerging economies like China and
Saudi Arabia to invest in real estate and home mortgages in the U.S.and
other industrialized nations.
In effect, globalization would work in reverse, helping rescue the developed
nations while making them more dependent on the developing nations.
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3.8 Riding Out the Storm
 Since late 2008 almost every member of the G20, including the U.S.,
implemented a large government-spending program.
 In April the U.S and other G20 countries pledged $1.1 trillion to deal with
the financial crisis, including $750 billion in additional funding for the IMF.
---------By the end of summer 2009 it seemed that the worst of the crisis was
over. However, many structural problems remained and new ones
loomed ahead.
Many poorer countries in the world are likely to struggle with the effects of the
financial crisis longer than the wealthier countries
 Bring large numbers of people living in poverty to over one billion;
 Many countries are adopting more protectionist policies that threaten the growth of
global trade and incomes of Southern exporters.
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Discussion Questions
 Compare and contrast the three different types of debt problems that were
discussed in this chapter in terms of (a) the source of the debt, (b) the
major actors in each situation and their interests, and (c) how the situation
was resolved, if it was.
 Why so much fuss over speculation? Why do you suppose Keynes would
be concerned about it today?
 Explain the connection between debt that results from borrowing money
and the debt associated with a deficit in the balance of payments. Use
examples from the readings.
 Which of the main causes of the financial crisis offered in this chapter do
you think best explain it? Justify your answer.
 Explain the role of the IMF in helping to solve these balance-of-payments
crises. Do you feel the IMF could do more? Why? Why not?
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Thank You !