Herman Schwartz UNC-CH 20121116
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Transcript of Herman Schwartz UNC-CH 20121116
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From (US) financial crisis to eurocrisis: Why are American houses connected to Europe's internal imbalances?
Herman Schwartz University of Virginia 16 November 2012
UNC Chapel Hill / TAM
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Everything you need to know…
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Euroland: an Optimal Currency Area?
• Euro only works if Europe is an OCA
• OCA needs:
– Essentially open financial markets (Yes)
– Essentially open goods markets (Mostly, but…)
– High internal labor mobility (No)
– High fiscal transfers (No)
– And – same ideas about proper policy
• Result: regional instabilities that are magnified by national political structures
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Productivity vs average wage and average income of top 1%, in US, 1979+
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Rising US household debt compared to incomes
1:1 ratio
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The 1991-2007 US growth cycle
Asia Recycles US Dollars as new Treasury / MBS Debt
Disinflation Housing Finance System
More Consumption
US trade deficits Global Growth
Faster US Economic Growth
↑ Tax revenue Fed ↓ interest rates
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Low interest rates No welfare state
China’s growth cycle, 2000s
Central bank Sterilizes $$ Issuing RMB
State Banks & party elites
More investment for exports
Central Bank buys $$
Trade Surplus
↓ domestic consumption
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The 1995-2000s German growth trap
Slower job creation
Wage restraint
Low Domestic Demand
Less Domestic Consumption
Less domestic investment
Slower relative economic growth
↓ Tax revenue Tight money
policy
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The 1995-2000s German growth trap
Slower job creation
Wage restraint
Low Domestic Demand
Less Domestic Consumption
Less domestic investment
Slower relative economic growth
↓ Tax revenue
Tight money policy
Export surplus
German banks buy PIGS debt
German banks buy US
Mortgage bonds
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All these cycles are linked
CHINA GERMANY USA
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Euro16 balance with select countries (€bil)
-80
-60
-40
-20
0
20
40
60
80
100
-250
-200
-150
-100
-50
0
50
100
150
200
Norway
Turkey
Japan
Poland
Switzerland
Russia
ChinaxHK
United States
United Kingdom
EU 16
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Germany produces but does not consume – final consumption expenditure growth as
% of German growth (Germany = 100)
80%
100%
120%
140%
160%
180%
200%
220%
240%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Ireland Greece Spain Italy Portugal
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Germany’s trade surpluses (€ bil)
0
20
40
60
80
100
120
140
Germany to EU27
Germanyto ROW
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EU member interest rates 1995 - 2011
EURO introduced
Lehman crash
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Taylor rule interest rates
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Export growth, xEU27, index, 1999 = 100
50
100
150
200
250
300
Germany
Spain
France
Netherlands
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Import Growth xEU27, index, 1999=100
50
100
150
200
250
300
350
Germany
Spain
France
Netherlands
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EU internal trade balances, € mils More imports = rising “foreign” debt
-200,000
-150,000
-100,000
-50,000
0
50,000
100,000
150,000
200,000
250,000
300,000
1999 2000 2001 2002 2003 2004 2005 2006 2007
Netherlands
Germany
France
Greece
United Kingdom
Italy
Spain
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External trade balance, € mils
-300,000
-250,000
-200,000
-150,000
-100,000
-50,000
0
50,000
100,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Germany
France
Italy
Greece
United Kingdom
Netherlands
Spain
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US trade deficit (goods only, disaggregated, $bil.)
-800
-700
-600
-500
-400
-300
-200
-100
0
100
200
EU x Germany
Lat. America
Canada
Rest of world
Germany
Japan
Middle East
China
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FIG 6: Central Bank Currency Swap Network, 2007-2010
Central bank currency swap network 2007-2010
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$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
20
07
-12
-05
20
08
-01
-02
20
08
-01
-30
20
08
-02
-27
20
08
-03
-26
20
08
-04
-23
20
08
-05
-21
20
08
-06
-18
20
08
-07
-16
20
08
-08
-13
20
08
-09
-10
20
08
-10
-08
20
08
-11
-05
20
08
-12
-03
20
08
-12
-31
20
09
-01
-28
20
09
-02
-25
20
09
-03
-25
20
09
-04
-22
20
09
-05
-20
20
09
-06
-17
20
09
-07
-15
20
09
-08
-12
20
09
-09
-09
20
09
-10
-07
20
09
-11
-04
20
09
-12
-02
20
09
-12
-30
20
10
-01
-27
Fig 5: Central Bank Currency Swaps With U.S. Federal Reserve
Currency Swaps(Weekly Average) -Multiplier = 1,000,000
Value of FED currency swaps ($mil)
Lehman bankruptcy
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EU member interest rates 1995 - 2011
EURO introduced
Lehman crash
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Crisis Fiscal deficits (not the reverse)
-16
-11
-6
-1
4
2004 2005 2006 2007 2008 2009 2010
Sweden
Denmark
Germany
Italy
Netherlands
Euro area (16 countries)
Spain
United Kingdom
Greece
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What if Greece (Spain) defaults?
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Who owes and to whose banks
0
200
400
600
800
1000
1200
1400
1600
Spain Greece Portgual
0
50
100
150
200
250
300
350
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The eurozone is a straw house
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QUESTIONS?
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Intra-EU debt, absolute, $bil. @ 3/11
0
200
400
600
800
1000
1200
1400
1600
ITALY SPAIN IRELAND PORTUGAL GREECE
ROW
ANY PIIGS
FRENCH BANKS
BRITISH BANKS
GERMAN BANKS
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Why the ECB won’t ease rates: Ideas
[We are] calling upon [the] social partners to show a high level of responsibility. . . [I]t is clear that if one is not satisfied with the present level of unemployment, wage moderation should remain of the essence. . . [I]f you are in a position where there are doubts about your present level of cost competitiveness, then of course wage moderation remains absolutely of the essence.
• Jean-Claude Trichet, 12 April 2007
We have only one needle in our compass. That needle is price stability, our definition of price stability.
• Jean-Claude Trichet, 7 August 2008
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…and Mario Draghi
“The risk of inflation is rising. There is now a greater need to proceed with monetary policy normalization so as to prevent expectations of higher inflation from becoming entrenched.”
Mario Draghi, Bank of Italy’s annual meeting, May 2011
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Employment gains, 1991-2005
0%
10%
20%
30%
40%
50%
60%
Share of OECD Population, 2005, %
Share of New Jobs, %
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SIVs (phase 1 – money for nothing)
Bank $1000
$20,000 of CDO and / or MBS @ 7%
SIV $1,000 + $19,000 = $20,000
ABCP (your money market money) $19,000 dollars @ 4%
$1400 in interest
Payments from Subprime borrowers: $1400
$760 in interest
$640 in Interest RoE = 64%
investment interest
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SIVs (phase 2 – loan contraction)
Bank $1000
$20,000 of CDO and / or MBS @ 7%
SIV $1,000 + $19,000 = $20,000
ABCP (your money market money) $19,000 dollars @ 4%
Only $700 in interest !!
Payments from borrowers fall: $1400 => $700
$760 in interest
Bank must put in $60
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SIVs ( phase 3 – bank collapses)
Bank $1000
$20,000 of CDOs now worth only $15,000
SIV $1,000 + $19,000 = $20,000
ABCP (your money market money) $19,000 dollars @ 4%
$700 in
interest
Payments from borrowers fall: $1400 => $700 & foreclosures start => ↑ losses
$760 in
interest
Bank must
put in $$$
to cover re-
payment of
ABCP to
MMF
MMF wants whole
loan repaid
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Why SIVs’ collapse => AIG collapse
Bank $1000
$20,000 of CDOs now worth only $15,000
SIV MMF - ABCP
Borrowers: $20,000 mortgages
AIG $20,000 of CDS
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Ormand Quay (Sachsen Landesbank’s gambling unit)
Balance Sheet, July 2007
Assets (guaranteed by Sachsen Landesbank)
Liabilities (all short term debt with maturity < 1 month)
Residential Mortgage Backed Securities $6.3 b
ABCP $11.3 b
Commercial Mortgage Backed Securities $2.7 b
Consumer Loans $0.5 b
Other $1.8 b
Total $11.3 b Total $11.3 b
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Adjustment
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Adjustment
Trade Deficit Country
Excess Exports
What?
Trade Surplus Country
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Adjustment via labor flow
Trade Deficit Country
Excess Exports
Outmigration
Trade Surplus Country
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Adjustment via time
Trade Deficit Country
Excess exports (capital goods)
Future Exports
Trade Surplus Country
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Adjustment via exchange rate
Trade Deficit Country
Excess Exports
Devaluation more exports Trade
Surplus Country
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Adjustment via wage declines (1)
Trade Deficit Country (1)
Excess Exports
Trade Surplus Country
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Adjustment via wage declines (1)
Trade Deficit Country (1)
Excess Exports
Trade Surplus Country
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Adjustment via wage declines (1)
Trade Deficit Country (1)
Excess Exports
Trade Surplus Country
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Adjustment via wage increases (2)
Trade Deficit Country
Excess exports Rising incomes in (2)
Trade Surplus Country (2)
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Adjustment via wage increases (2)
Trade Deficit Country
Excess exports Rising incomes in (2)
(2) Imports more, exports less
Trade Surplus Country (2)