Global Financial Crisis:

The Aftermath

Kenneth Matziorinis, Ph.D., CMC

Canbek Economics & McGill University

www.canbekeconomics.com

AHEPA, Ottawa, January 27, 2010

What Happened?

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

Low interest rates, high leverage and overconfidence led to the creation of bubbles which then burst

Canbek Economics

What Did Governments Do?

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

Intervened in order to prevent a systemic collapse and an economic depression

Canbek Economics

Did They Succeed?

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

It appears they have for now, but it is still too early to tell

Canbek Economics

We are Not Sure Yet

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.

The recovery remains too dependent on government support

Canbek Economics

World Economic Growth, 2001-2009 and Projections for 2010 & 2011

Source: IMF WEO Update, January 26, 2010

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0

1

2

3

4

5

6

7

8

9

10

-1

-2

-3

-4

Percent (%) Growth

Advanced Economies Emerging Economies World Average

This Intervention Comes at a High Price

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!

We have not received the bill yet

Canbek Economics

Change in US Real GDP, 1948-2009

This has been the worst downturn since end of World War II

Canbek Economics

1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014

0

5

10

15

-5

Percent (%) Change

Growth Rate

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

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

0

5

10

15

20

Source: Federal Reserve Board of Governors

Canbek Economics

Fed Funds Rate

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

Source: Federal Reserve Bank of St-Louis Canbek Economics

1925 1935 1945 1955 1965 1975 1985 1995 2005

0

500

1000

1500

2000

2500

Adj Monetary Base

Total Reserves Adjusted for Reserve Requirements, US, 1959-2010

They had to inject over 1 trillion in liquidity into the US banking system

Source: Board of Governors of the Federal Reserve System

1959 1969 1979 1989 1999 20090

200

400

600

800

1000

1200

Total Bank Reseves

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

Federal Reserve Bank of St-Louis Canbek Economics

1959 1969 1979 1989 1999 20090

2

4

6

8

10Thousands

0

2

4

6

8

10Thousands

Money Supply

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?

1959 1969 1979 1989 1999 20090

50

100

150

200

250

Source: US Dept of Labor, BLS Canbek Economics

CPI

US Federal Budget Deficit as Percent of GDP, 1900-2010It has led to the biggest budget deficit in peacetime US history

Canbek Economics

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

0

5

10

15

20

25

30

-5

Percent (%) of GDP

Budget Deficit

Federal and Total (state & federal) US Government Debt as Percent of GDP, 1900 - 2010

Gross US public debt is now approaching 100% of GDP

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 20100

20

40

60

80

100

120

140

Canbek EconomicsState Federal

Total US Debt Outstanding: Household, Business & Government, 1974-2009

Total private and public debt in the US is now 370% of GDP

Source: Federal Reserve Board, Flow of Funds Accounts Z1 d3 Canbek Economics

1974 1979 1984 1989 1994 1999 2004 20090

100

200

300

400Percent (%) of GDP

0

10

20

30

40

50

60Trillions of US Dollars

Total Debt to GDP Total Debt

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

Source: IMF, WEO, October 2009

93-2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2014

0

20

40

60

80

100

Euro USA UK CAN

Government Budget Deficits, Percent of GDP, 2009

Budget deficits have exploded all over with the worst affected being in the advanced industrial world

Source: The Economist, EIU, January 16, 2010

0 2 4 6 8 10 12 14 16

UK Greece

Spain Ireland

USA Portugal

France Japan

Russia Turkey

Belgium Italy

Canada

Gross Debt-to-GDP Ratios, 2010 IMF Projections

Debt-GDP ratios have been rumped up dramatically in many countries

Source: IMF, World Economic Outlook, April 2009 & October 2009

0 50 100 150 200 250

Japan

Italy

Germany

UK

Spain

Emerging G-20

Where are we Headed from Here?

Governments will stay the course by keeping interest rates low and policy stimulus high to nurse economy into self-sustaing 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 debt-GDP 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.

We are navigating through Scylla and Charibdis

Canbek Economics

What are the Risks Facing Us?

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

Uncertainty is very high and the risks are huge

Canbek Economics

The Great Conundrum of our Time

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

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!

Canbek Economics

A Time for Reckoning

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

A difficult period lies ahead