Transcript Global Financial Crisis: The Aftermath

Global Financial Crisis:
The Aftermath
Kenneth Matziorinis, Ph.D., CMC
Canbek Economics & McGill University
www.canbekeconomics.com
AHEPA, Ottawa, January 27, 2010
What Happened?
Low interest rates, high leverage and overconfidence led to the creation of bubbles which
then burst
 US Housing market went bust and real estate prices started falling
 Prices of complex financial securities that were created by Wall
Street to underwrite the housing market collapsed
 Institutions that issued these assets along with the investors that
bought them suffered huge losses in many cases exceeding the
capital of these firms
 Losses along with collapse in confidence in these products trigerred
a financial meltdown starting from Wall Street and rapidly spreading
to London, Continental Europe, Asia and the Rest of the World
 With the global financial system on the verge of total meltdown,
governments stepped in to avert mass panic and an economic
collapse that would result in a global depression worse than that of
the 1930s
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What Did Governments Do?
Intervened in order to prevent a systemic collapse and an economic depression
 Governments responded swiftly and decisively to save the
system from collapse based on the hard lessons that were
learned in the 1930s by applying Keynesian economics
 Central banks stepped in and provided liquidity to the
banking system allowing it to keep functioning
 Slashed interest rates
 Expanded the money supply
 Governments provided bailouts for major financial
institutions to avert their collapse or took them over outright
 Governments also cut taxes and raised spending to
prevent the economy from falling into a deep recession or
even depression
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Did They Succeed?
It appears they have for now, but it is still too early to tell
 The magnitude of the financial shock, loss of confidence,
near panic was too large to prevent a hit on the real
economy
 The world economy went into a deep recession, the first
since the end of WWII
 But a global depression was averted!
 Now much of the confidence has been restored and
economic activity is rising around the world
 There is real hope that by the end of 2010 the recovery will
be on solid ground and self sustaining and that by 2011 we
can enter a period of stability and re-newed growth in the
global economy
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We are Not Sure Yet
The recovery remains too dependent on government support
 Although economies are rebounding around the world, the
recovery is not even
 The emerging economies of China, India, Brazil are faring better
and leading the rebound
 The economies of the USA, Europe and Russia are lagging
behind
 Canada is a special case -fortunately for us- but still tied too
much on the US economy, thus still vulnerable
 So far the recovery is still technical, driven by a restocking of
inventories, a bounce back from the lows of 2009
 Recovery is still overly dependednt on government spending,
bailout money and low interest rates
 It is still too early to declare victory, the patient is out of the OR
room but still in the ICU! Let us not forget this.
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World Economic Growth, 2001-2009 and Projections for 2010 & 2011
10
Percent (%) Growth
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
2001
2002
2003
2004
2005
Advanced Economies
Source: IMF WEO Update, January 26, 2010
2006
2007
Emerging Economies
2008
2009
2010
World Average
2011
This Intervention Comes at a High Price
We have not received the bill yet
 We have been pulled out of the clutches of Scylla, but we
may have fallen in the arms of Charibdis
 Why?
 Because the battle has been won at an enormous cost in
terms of a) unprecedented expansion in the supply of
money and b) unprecedented peacetime expansion in
government deficits.
 It is like we have gone on a giant shopping spree and
charged all our purchases on our credit card. The bank that
has issued the card will soon send us the bill, that is when
we will begin feeling the cost of our purchases and the pain
of paying it back!
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Change in US Real GDP, 1948-2009
This has been the worst downturn since end of World War II
15
Percent (%) Change
10
5
0
-5
1949
1954
1959
1964
1969
1974
1979
1984
Growth Rate
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1989
1994
1999
2004
2009
2014
Effective Federal Funds Rate, June 1954 - Jan 2010
Interest Rates have gone from 2% to 20% and then down to 0.12%,
They have nowhere to go but up now
20
15
10
5
0
1955
1960
1965
1970
1975
1980
1985
1990
Fed Funds Rate
Source: Federal Reserve Board of Governors
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1995
2000
2005
2010
2015
Adjusted Monetary Base, USA, 1925-2010
To save the financial system from collapse Federal Reserve had to expand the monetary
base by an unprecedented amount
2500
2000
1500
1000
500
0
1925
1935
1945
1955
1965
1975
Adj Monetary Base
Source: Federal Reserve Bank of St-Louis Canbek Economics
1985
1995
2005
Total Reserves Adjusted for Reserve Requirements, US, 1959-2010
They had to inject over 1 trillion in liquidity into the US banking system
1200
1000
800
600
400
200
0
1959
1969
1979
1989
Total Bank Reseves
Source: Board of Governors of the Federal Reserve System
1999
2009
MZM Money Stock (Broad Money Supply), US, 1959-2010
The money supply has risen less dramatically because banks are not as confident and have
not been lending
10
Thousands
Thousands
10
8
8
6
6
4
4
2
2
0
1959
0
1969
1979
1989
Money Supply
Federal Reserve Bank of St-Louis Canbek Economics
1999
2009
US Consumer Prices (CPI), 1959-2009
Consumer prices have remained remarkably tame so far in the face of such monetary
expansion, but for how much longer?
250
200
150
100
50
0
1959
1969
1979
1989
CPI
Source: US Dept of Labor, BLS
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1999
2009
US Federal Budget Deficit as Percent of GDP, 1900-2010
It has led to the biggest budget deficit in peacetime US history
Percent (%) of GDP
30
25
20
15
10
5
0
-5
1900
1910
1920
1930
1940
1950
1960
Budget Deficit
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1970
1980
1990
2000
2010
Federal and Total (state & federal) US Government Debt as Percent
of GDP, 1900 - 2010
Gross US public debt is now approaching 100% of GDP
140
120
100
80
60
40
20
0
1900
1910
1920
1930
1940
1950
State
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1960
Federal
1970
1980
1990
2000
2010
Total US Debt Outstanding: Household, Business & Government,
1974-2009
Total private and public debt in the US is now 370% of GDP
400
Percent (%) of GDP
Trillions of US Dollars
60
50
300
40
200
30
20
100
10
0
1974
0
1979
1984
1989
Total Debt to GDP
Source: Federal Reserve Board, Flow of Funds Accounts Z1 d3
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1994
1999
Total Debt
2004
2009
General Government Net Debt: 2003-2008 Actual, 2009-2014
Projections
The US is not unique, it is happening in Europe as well and to a less extent here in Canada
100
80
60
40
20
0
93-2002
2003
2004
2005
2006
Euro
Source: IMF, WEO, October 2009
2007
2008
USA
2009
UK
2010
CAN
2012
2014
Government Budget Deficits, Percent of GDP, 2009
Budget deficits have exploded all over with the worst affected being in the advanced industria
world
UK
G
Spain
I
USA
P
France
J
Russia
T
Belgium
I
Canada
0
2
4
6
8
Source: The Economist, EIU, January 16, 2010
10
12
14
16
Gross Debt-to-GDP Ratios, 2010 IMF Projections
Debt-GDP ratios have been rumped up dramatically in many countries
Japan
Italy
Germany
UK
Spain
Emerging G-20
0
50
100
150
200
Source: IMF, World Economic Outlook, April 2009 & October 2009
250
Where are we Headed from Here?
We are navigating through Scylla and Charibdis
 Governments will stay the course by keeping interest rates
low and policy stimulus high to nurse economy into selfsustaing growth
 Once this is achieved later in 2010 and 2011, they will start
withdrawing stimulus packages
 Short-term interest rates will start to rise
 Government spending will start to fall and taxes will start to
rise to bring deficits under control and stabilize high debtGDP ratios
 Given the unprecedented size of stimulus intervention, it
will take a long time to bring deficits under control and
 A meaningful self-sustaining expansion may be delayed
until 2012 or 2013.
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What are the Risks Facing Us?
Uncertainty is very high and the risks are huge
 Exit strategies of central banks might stumble or fail and
this may trigger a loss of confidence in their ability to
control the value of money, and may trigger a bout of
inflation and exchange rate instability
 We may experience a sovereign debt crisis, with credit
rating downgrades, drop in bond prices, rise in long-term
interest rates and mortgage rates that will dampen housing
values
 The public may balk at restrictive fiscal and monetary
policies and precipitate civil unrest and political crises
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The Great Conundrum of our Time
To avoid inflation interest rates will have to rise; to avoid economic stagnation and rise in debt
levels interest rates will have to stay low;
but you can’t have it both ways!
 With all this monetary easing, expansion in liquidity and
money supply, central banks will have to raise interest
rates to prevent inflation
 Higher interest rates will slow down economic growth and
raise the cost of funding public and private debts
 It may become extremely difficult for governments to bring
down deficits and public debt especially in the face of
public opposition and political instability and civil unrest
 In that case, the only exit strategy might be to allow
inflation to rise
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A Time for Reckoning
A difficult period lies ahead
 No one can predict exactly the future
 What one can say for sure is that we are headed for a difficult
and protracted period of undertainty, economic, social and
political adjustments
 At least here in Canada, we will experience much less pain
than others because we have gone through much of this
adjustment already in the 1990s
 Yet we will still feel the storm
 THANK YOU !
 www.canbekeconomics.com