Transcript Understanding the Global Economic Crisis

Understanding
the Global Economic Crisis
Presentation by Heiner Flassbeck
Director, Division on Globalization and Development Strategies
Geneva, 3 April 2009
Outline
• First session
The global economic crisis : what went wrong
• Second session
Systemic failures and multilateral remedies
Reference text:
“The Global Economic Crisis:
Systemic Failures and
Multilateral Remedies”
Report by the UNCTAD Secretariat Task Force on
Systemic Issues and Economic Cooperation
First Session
The global economic crisis :
what went wrong
Understanding the Globalized Economy
When there is a mouse trap in the house,
the whole farmyard is at risk
Understanding the Globalized Economy
Commodity Market
Stock Market
Currency Market
Unwinding of speculative flows
Subprime Credit Collapse
The subprime credit collapse highlighted the exposure to risk
in many areas and triggered the sudden unwinding of
speculative positions in different markets
Starting point…
The fact that the global financial crisis originated in a
relatively obscure corner of the United States housing credit
system means that it cannot be analysed adequately by just
looking at this segment of the market while ignoring the
huge asset-price bubbles that arose elsewhere seemingly
independently
Causes of the Crisis
What really went wrong:
The blind faith in the efficiency of financial
markets
What made it worse:
Global imbalances
Absence of a regulatory scheme
Causes of the Crisis
• There are no simplistic explanations:
– “too much liquidity”,
– saving glut in China
– individual misbehavior
• The drivers of the crisis are more complex and the analysis
needs to entail three specific areas in which the global
economy experienced systemic failures:
Financial market
Commodities market
Currency market
FINANCIAL MARKETS
Financial Markets
Fundamental misconceptions:
• Assumption that “markets know best”
• Regulators should not play an active role
• More financial innovation would always be
beneficial from society’s point of view
Implications:
• Poorly designed regulation can backfire and
lead to regulatory arbitrage
→This is what happened with banking regulation
Arbitrage as a Result of the Regulatory
Framework
Figure 2.1
LEVERAGE OF TOP-10 UNITED STATES FINANCIAL FIRMS BY SECTOR
30
Leverage
25
20
15
10
Banks
Financial services
Life insurance
5
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Source: UNCTAD secretariat calculations, based on balance sheet data from Thomson Datastream.
Note: Leverage ratio measured as share of shareholders equity over total assets. Data refer to 4 quarter moving average.
The decrease in the leverage ratio of commercial banks was
accompanied by an increase in the leverage ratios of nonbank financial institutions
Financial Innovation and the Shadow Banking System
Figure 2.2
THE SHADOW BANKING SYSTEM, 2007, Q2
18
instrument for shifting
leverage
16
14
$ trillion
12
• Financial Innovation as an
Government
sponsored
enterprises
7.7
10
8
6
Finance
companies
1.9
Brokers and
dealers
2.9
Commercial banks
10.1
4
2
Asset backed
securities
issuers
4.1
0
Market based
Savings
institutions
1.9
Credit unions 0.8
• The shadow banking
system in the United States
held assets of more than $16
trillion
Bank based
Source: Shin (2009).
While regulation focused on banks, it was the collapse of
the shadow banking system which kick-started the
current crisis.
Financial Regulation
• Wrong belief that securitization had contributed to
both diversifying and allocating risk to sophisticated
economic agents who could bear such risk
• Regulators assumed that, unlike deposit taking banks,
the collapse of large non-bank institutions would not
have systemic implications
BUT IT HAD
COMMODITY MARKETS
Commodity Markets and the Financial Crisis
The build-up and eruption of crisis in the financial system
was paralleled by an unusually sharp increase and
subsequent strong reversal of the prices of internationally
traded primary commodities
Commodity Price Index (S&P GSCI)
1000.00
900.00
700.00
600.00
500.00
400.00
300.00
03.12.2008
03.11.2008
03.10.2008
03.09.2008
03.08.2008
03.07.2008
03.06.2008
03.05.2008
03.04.2008
03.02.2008
03.03.2008
03.01.2008
03.12.2007
03.11.2007
03.10.2007
03.09.2007
03.08.2007
03.07.2007
03.06.2007
03.05.2007
03.04.2007
03.02.2007
03.03.2007
200.00
03.01.2007
Index Number
800.00
The Growing Presence of Financial Investors
in Commodity Markets
Figure 3.2
FUTURES AND OPTIONS CONTRACTS
OUTSTANDING ON COMMODITY EXCHANGES,
DECEMBER 1993–DECEMBER 2008
(Number of contracts, millions)
Figure 3.3
NOTIONAL AMOUNT OF OUTSTANDING OVERTHE-COUNTER COMMODITY DERIVATIVES,
DECEMBER 1998 – JUNE 2008
(Trillions of dollars)
50
14
45
12
40
10
35
30
8
25
6
20
15
Other commodities
Other precious metals
Gold
4
10
2
5
0
Dec.
1993
0
Dec.
1995
Dec.
1997
Dec.
1999
Dec.
2001
Dec.
2003
Dec.
2005
Dec.
2007
Source: BIS, Quarterly Review , March 2009, table 23B.
Dec.
1998
Dec.
2000
Dec.
2002
Dec.
2004
Dec.
2006
June
2008
Source: BIS, Quarterly Review , December 2008, table 19.
Trading volumes on commodity exchanges strongly increased
during the recent period of substantial commodity price
increases
What Evidence for a Correlation between Speculative
Position and Price Development ?
Wheat
Maize
250
1400
500
800
200
1200
400
700
150
1000
300
100
800
200
50
600
100
0
400
0
-50
200
-100
0
-200
600
500
400
-100
01/01/2002
06/01/2004
03/01/2006
01/01/2008
01/01/2002
Soybeans
300
200
100
0
06/01/2004
03/01/2006
01/01/2008
Soybean oil
250
1800
100
80
200
1600
80
70
60
60
40
50
20
40
600
0
30
400
-20
20
200
-40
10
0
-60
01/01/2002
1400
150
1200
100
1000
800
50
0
-50
-100
01/01/2002
06/01/2004
03/01/2006
01/01/2008
Net long non-commercial positions, '000
contracts, left scale
Net long non-commercial positions excl. CIT,
'000 contracts, left scale
Net long CIT positions, '000 contracts, left
scale
Price, cents/bushel, right scale
0
06/01/2004
03/01/2006
01/01/2008
Net long non-commercial positions, '000
contracts, left scale
Net long non-commercial positions excl. CIT,
'000 contracts, left scale
Net long CIT positions, '000 contracts, left
scale
Price, cents/lb, right scale
Correlation between
Speculative Position and Price Development (?)
• The scepticism among economist is based on the
efficient market hypothesis
• However,
– Short-term price elasticity of many commodities is
low
Position changes that are large relative to the size of
the total market have a temporary, or even persistent,
price impact
– Changes in market positions may result from the
behaviour of a certain group of market participants
who respond to factors other than information about
market fundamentals
Correlations between the Exchange Rate of Selected
Countries and Equity and Commodity Price Index
BRAZILIAN REAL TO JAPANESE YEN
June 2008–December 2008
• Strong correlation
between the
unwinding of
speculation in
different markets
that should be
uncorrelated
• All participants
react to the same
kind of information
NEW ZEALAND DOLLAR TO JAPANESE YEN
Future and Options Market Positions
Futures and options market positions, by trader group,
selected agricultural commodities, January 2006 –
December 2008
Average long position of
index traders is very large,
sometimes more than ten
times the size of an average
long position held by either
commercial or noncommercial traders
(Per cent and number of
contracts)
Long positions
Average position size
NonCommodity
Maize
Commercial
Commercial
Index
1134
1499
16260
Soybeans
590
1052
6024
Soybean oil
790
1719
4418
Wheat CBOT
553
964
8326
Wheat KCBOT
680
632
1816
Cotton
363
1010
4095
Live cattle
580
409
4743
Feeder cattle
258
162
469
Lean hogs
419
712
3983
• Positions of this order are likely to have
sufficiently high financial power to drive prices
• Speculative bubbles may form and price changes
can no longer be interpreted as reflecting
fundamental supply and demand signals
Commodity futures exchanges do not function in
accordance with the efficient market view
CURRENCY MARKETS
Currency Speculation and Financial Bubbles
The uncertainty associated with the subprime crisis generated an
unwinding of speculative currency positions
- causing large depreciation of former high-hielding currencies
130
120
100
90
80
70
02
.0
1.
08
02
.0
2.
08
02
.0
3.
08
02
.0
4.
08
02
.0
5.
08
02
.0
6.
08
02
.0
7.
08
02
.0
8.
08
02
.0
9.
08
02
.1
0.
08
02
.1
1.
08
02
.1
2.
08
Index Number
110
Hungarian Forint
Brazilean Real
Mexican Peso
Czech Koruna
The Carry Trade Phenomenon
Currency carry trade is a strategy in which an investor sells a
certain currency with a relatively low interest rate and uses the funds
to purchase a different currency yielding a higher interest rate
Yen Carry trade on the Icelandic Krona and the Brazilian Real
Real
12
10
12
8
6
8
4
2
4
10
6
Per cent
Per cent
Krona
0
-2
2
0
-2
-4
-4
-6
-6
-8
-8
-10
-10
12345678910
11 212345678910
11 212345678910
11 2123456789
2005
2006
2007
Uncovered interest return
Nominal exchange-rate change
Interest rate differential
2008
12345678910
11 212345678910
11 212345678910
11 2123456789
2005
2006
2007
Uncovered interest return
Nominal exchange-rate change
Interest rate differential
2008
The Carry Trade Phenomenon
• In this framework, nominal exchange rate movements
are mainly driven by speculative flows, moving away
from their “fundamentals”
• Currency specualtion and currency crisis has brought
a number of countries to the verge of default and
dramatically fuelled the crisis
• Risk exposure! Trade distortion effect!
Exchange Rate Fluctuations and the Trade Distorsion Effect
E m e rging m a rk e t ( no n- E uro pe )
E m e rging m a rk e t e c o no m ie s in E uro pe
a nd o t he r t ra ns it io n e c o no m ie s
E uro a re a
0.00040
0.00040
0.00040
P EER
co ntributio n
NEER
co ntributio n
VA R (REER
gro wth)
0.00035
0.00030
P EER
co ntributio n
NEER
co ntributio n
VA R (REER
gro wth)
0.00035
0.00030
0.00030
0.00025
0.00025
0.00025
0.00020
0.00020
0.00020
0.00015
0.00015
0.00015
0.00010
0.00010
0.00010
0.00005
0.00005
0.00005
0.00000
1993
0.00000
1996
1999
2002
2005
2008
1993
P EER
co ntributio n
NEER
co ntributio n
VA R (REER
gro wth)
0.00035
0.00000
1996
1999
2002
2005
2008
1993
1996
1999
2002
2005
The real exchange rate is a measure of countries’
competitiveness
Evidence shows that nominal exchange rate changes appear to
explain most of the real exchange rate changes
The present monetary chaos exerts a huge and distorting
influence on the effectiveness of international trade
2008
Second session
Systemic failures and multilateral
remedies
The Global and Systemic Crisis
• The crisis dynamics reflect:
failures in national and international financial
deregulation,
persistent global imbalances,
absence of an international monetary system
deep inconsistencies among global trading,
financial and monetary policies
The most important task is to
break the spiral of falling asset prices and falling demand
and to revive the financial sector’s ability to provide
credit for productive investment
The key objective of regulatory reform has to be
devise a system that allows shutting down the casino and
weeding out financial instruments with no social
return
The “money –for-nothing” mentality
In 1983, the financial sector generated 5 per cent of the
United States’ GDP and “statistically” accounted for 7.5
per cent of total corporate profits
In 2007, the United States financial sector generated 8 per
cent of GDP and “statistically” accounted for 40 per cent
of total corporate profits
Strong indications that this “industry” does not
contribute much to overall productivity
Financial Regulation: Policy Implications
• Banks and the capital markets need to be regulated
jointly and financial institutions should be supervised on
a fully consolidated basis
• Creating a clearinghouse that would net out the various
positions could increase transparency
• Micro-prudential regulation has to be complemented by
macro-prudential regulation
• Need of an international dimension to financial
regulation and institution to take into account systemic
risk
Commodity Markets : Policy Implications
Better regulation of these markets and direct intervention
in case of destabilizing speculation is needed
• Need to ensure that swap dealer positions do not lead to
‘excessive speculation’: key loopholes in regulation
• regulators need access to more comprehensive trading data
in order to be able to intervene
• In addition to regulatory measures, international measures
are needed: the world needs a new global institutional
arrangement consisting of a minimum physical grain
reserve to stabilize markets
Currency Markets: Policy Implications
Multilateral or even global exchange rate arragment are
urgently needed for the stability of the financial system
and a balanced international trade
Only one exchange rate/price adjustment rule:
nominal exchange rate changes should follow the
difference in the price levels of the trading partners
Conclusion
The state is back but national action is not sufficient:
• Preventing the competition of nations
(a new code of conduct is needed)
• Intervention in financial markets is
indispensable
• No “crisis solution” by markets
Thank you for your attention
[email protected]