THE EURO AND THE PROCESS OF DELEVERAGING IN THE EUROZONE

Presented by A.G. Malliaris

SOCIETY FOR POLICY MODELING

Allied Social Science Associations Annual MeetingsSan Diego, California, January 3-6, 2013

Outline of Discussion

• The Financial Crisis of 2007-09• Real and Financial Factors• Special Emphasis on Deleveraging• Compare Japan During the 90s with the US

and EU Now• Key Lessons for the EU

The Global Financial Crisis of 2007-09

• Began as a Subprime Debt Crisis in the US• Global Credit Boom Ends• Housing and Equity Bubbles Burst• Balance Sheets of Households and Financial

Institutions Are Out of Balance• Real Sectors Contract; Unemployment Increases• EU Sovereign Debt Crisis Follows• Where Are We Now?

Lessons From Japan in the 90s

• Dual Bubbles Burst: Real Estate and Equity Markets

• Excessive Leverage in Corporate and Banking Sectors

• Prolonged Leverage Adjustment • Persistent Slow Economic Activity• Rapidly Rising Government Debt• Major Correction in Asset Prices/Lost Decade

6

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.083

85

87

89

91

93

95

97

99

101

103

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(%, Seasonally adjusted, inverted)

Unemployment Rate(right scale)

Sources: US Department of Labor, FRB

(2007=100, Seasonally adjusted)

Last seen in 2005

Unemployment rate:Last seen in 1983

Industrial Production:Last seen in 1997

Industrial Production(left scale)

Exhibit 4. US Economy Is still a Long Way from Previous Peak

11

Exhibit 5. Euro-Zone Economy Is still a Long Way from Previous Peak

12

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.085

90

95

100

105

110

115

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Sources: Eurostat

(%, Seasonally adjusted, inverted)(Seasonally adjusted, 2005=100)

Industrial Production(left scale)

Unemployment Rate(right scale)

Last seen in 1997

Last seenin 2005

Exhibit 11. Japan’s De-leveraging with Zero Interest Rates Lasted for 10 Years

23

-6

-4

-2

0

2

4

6

8

10

-15

-10

-5

0

5

10

15

20

25

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Borrowings from Financial Institutions (left scale)

Funds raised in Securities Markets (left scale)

CD 3M rate (right scale)

(% Nominal GDP, 4Q Moving Average) (%)

Sources: Bank of Japan, Cabinet Of f ice, Japan

Debt-financedbubble

(4 years)

Balance sheetrecession(16 years)

Funds Raised by Non-Financial Corporate Sector

Exhibit 10. Drastic Liquidity Injection Failed to Produce Drastic Increase in Money Supply (IV): Japan

24

-3-2-101234

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(y/y, %) CPI Core

50

100

150

200

250

300

350

Monetary Base

Money Supply (M2)

Bank Lending

1990/1Q

(1990/1Q = 100, Seasonally Adjusted)

Textbook Economics

(Monetary PolicyEf fective)

Balance SheetRecession(Monetary Policy NOT Ef fective)

QuantitativeEasing

Down 41%

Note: Bank lending are seasonally adjusted by Nomura Research Institute.Source: Bank of Japan

Earthquake

down87%

25

40

55

70

85

100

115

130

0

20

40

60

80

100

120

140

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

(Sep.1990=100, Seasonally Adjusted)

Real GDP(Right Scale)

Land Price Index in Six Major Cities(Commercial, Left Scale)

(Sep. 1990=100)

Sources: Cabinet Of f ice, Japan Real Estate Institute

Nominal GDP (Right Scale)

Likely GDP Path w/o Government Action

Last seen in 1973

Cumulative 90-05 GDP

Supported by Government

Action: ~ ¥2000 trillion

Cumulative Loss of

Wealth on Shares and Real Estate

~ ¥1500 trillion

Exhibit 12. Japan’s GDP Grew in spite of Massive Loss of Wealth and Private Sector De-leveraging

25

Key Lessons• The Eurozone Faces Significant Challenges to

Restore Banking Stability• A Repair of the Financial Sector is a Precondition

for Economic Growth• Sovereign Debt Crisis for Several Members

Remains a Major Concern• EU as the US and Unlike Japan During the 90s Has

a Good Corporate Sector• The Weakness of the Euro Contributes to EU

competitiveness