Anthony Budiawan

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The Global Financial and Sovereign Debt Crisis: causes, effects, and preventions

The Global Financial and Sovereign Debt Crisis: causes,

effects, and preventions

Anthony Budiawan

Rektor Institut Bisnis dan Informatika Indonesia

Jakarta, Auditorium Kampus IBII, December 21, 2011


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Discussion points

Global financial crisis 2008

o Subprime mortgage loan: how it works, how it creates bubble, and how it

creates financial instability

o Global trade imbalances: how it works, how it creates bubble, and how it

creates global financial turbulences

o What factors determine the global trade imbalances?

Exchange rate policy of the surplus countries: currency manipulation?

Eurozone sovereign debt crisis 2009o It will happen anyway, just wait for a right time (and it is now the time)

o How to save euro

Conclusion

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GLOBAL FINANCIAL CRISIS 2008

Subprime mortgage crisis

how it works, how it creates bubble, and how it creates global

financial instability

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Commercial Banks

Mortgage

Loan

Mortgage

Loan

Subprime Mortgage Crisis

House-

holds

Real

Estate

Deve-

lopers

Shadow Banking System

Investment

Banks

US

Home

Market

Insurance

Companies

Funding

Funding

(Synthetic)

CDOCDO

Worldwide Investors

Funding CDO

CDO

CDO

CDO

Structured Investment Vehicles

(SIVs)

Credit Default Swap (CDS)

(R)MBS

(C-R)MBS

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Commercial Banks

Mortgage

Loan

Mortgage

Loan

Subprime Mortgage Crisis

House-

holds

Real

Estate

Deve-

lopers

Shadow Banking System

Investment

Banks

US

Home

Market

Insurance

Companies

Funding

Funding

(Synthetic)

CDOCDO

Worldwide Investors

Funding CDO

CDO

CDO

CDO

Structured Investment Vehicles

(SIVs)

Credit Default Swap (CDS)

(R)MBS

(C-R)MBS

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Subprime Mortgage Loan:

Facts and Figures

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Mortgages loan increase incredibly since 1995:

in nominal as well as in % of GDP

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Impact on home and gold price index

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Crude oil and euro price index moved in the

same direction as home and gold price index

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Relationship between commodity prices and

U.S. inflation

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Discussion points









o How to save euro

Conclusion

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Global trade imbalances

how it works, how it creates bubble, and how it creates global

financial turbulences

Ben S. Bernanke: In my view it is impossible to understand this crisis without

reference to the global imbalances in trade and capital flows that began in the

latter half of the 1990s

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US GDP growth accelerated after the collapse of

Bretton Woods System

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1929

1936

1943

1950

1957

1964

1971

1978

1985

1992

1999

2006

Billion

USD

US GDP: 1929 - 2006

US GDP

Bretton Woods System Collapse:

US Dollar Off Gold

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Global trade and financial imbalances: they are

balance

Real Sectors

United States Rest of the worldGoods & Services

Dollar

Financial Sectors

Rest of the worldUnited States Dollar

Securities

Current AccountDeficit

Financial Account

Surplus

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Real Sectors

Global trade imbalances: how it contributes to

financial and subprime mortgage crisis

United States

Financial Sectors

Rest of the world

Rest of the worldUnited States

Goods & Services

Dollar

Dollar

Securities

Current AccountDeficit

Financial Account

Surplus

Stocks Bubble:

i.e. dot com crisis

(2000)

Assets Bubble:

i.e. mortgage crisis

(2008)

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The U.S. current account deficits continued

steadily since 1980s: why is it possible?

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Current account deficit is accelerated from 1990

Current Account Deficit

1971 2006: $ 5.98 trillions

1990 2006: $ 5.12 trillions

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The impact of Chinas economic development

on the U.S. current account deficit


1971 2006: $ 5.98 trillions

1990 2006: $ 5.12 trillions

Chinas first economic reform

Chinas fourth and last phase

economic reform & globalization

China Adopt Fixed Exchange

Rate: 1 USD = 8.27 Yuan

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Financial account surplus makes balance on

current account deficit

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Financial account surplus is a mirror of current

account deficit

Financial Account Surplus

1971 2006: $ 5.65 trillions

1990 2006: $ 5.04 trillions


1971 2006: $ 5.98 trillions

1990 2006: $ 5.12 trillions

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U.S. current account deficit in percent of GDP:

also increase steadily

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The deficit is flowing back to the US

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Discussion points









o How to save euro Conclusion

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What factors cause the global trade imbalances?

Currency manipulation imposed by surplus countries?

Ben S. Bernanke: the causes of the U.S. foreign deficit, and therefore its cures,

were primarily external to the U.S.

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Currency manipulation: illusion?

Ben S. Bernanke believes that the global financial crisis was induced by

the global imbalances in trade and capital flows, which primarily caused

by exchange rate policies imposed by foreign country, i.e. China

However, the data show differentlyo China adopted a fixed exchange rate from 1994 to July 2005 at 8.27 yuan per

dollar

o From July 2005 to July 2009 Chinese yuan appreciated around 21.1% (down from

8.27 to 6.83 yuan per dollar)

o

The latest ex

change rate is about 6.33 yuan per dollar, another 8%+ appreciationo Yet, U.S. trade deficit with China is widening during the appreciation period of

yuan

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U.S. trade deficit is widening during the

appreciation period of yuan

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Another view of the cause of the global trade

imbalances: fiat money

After WWII, dollar is fully convertible to gold with a fixed value

All other currencies were fixed to dollar

Surplus countries can convert the dollars into the U.S. gold

Conversion will provide an automatic adjustment in the domestic money supply

(in the U.S. as well as in its trading partner country) As a result, the price level of the deficit country (U.S.) will go down, while the

price level of the surplus country will go up, which will restore the trade balance

Therefore, the current account deficit cannot widen forever, as exclaimed by Alan

Greenspan in 2005

However, after 1971, following the collapse of the Bretton Woods, the U.S.

current account deficit can widen for an extended period

Instead of surrendering gold in exchange for the deficit dollar, the U.S. is

surrendering the financial instruments (shares, bonds, CDO, etc.), which

provokes an assets bubble, but is not reflected in the price level

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Discussion points










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EUROZONE SOVEREIGN DEBT CRISIS 2009

It will happen anyway, just wait for a right time (and now, it is

the time)

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Crisis always increase fiscal deficit

-400

-200

0

200

400

600

800

1000

1200

1400

1600

-4

-2

0

2

4

6

8

10

12

1995 1997 1999 2001 2003 2005 2007 2009

USD(

Billions)

Percent

US fiscal deficit 1995 - 2010

US Deficit/GDP Ratio US Federal Deficit

Dot comCrisis

LHS

RHS

Subprime

Mortgage Crisis

Subprime

Mortgage Crisis

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The response to the increasingly deficits

There are only two possibilities to deal with this issueo Bailout the governments in trouble or otherwise eurozone will disappear (or

shrink)

In any case, the response from the EU leader must be very fast toprevent the financial chaos in other regions that could lead to a

double dip recession

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Eurozone is a failed concept (since the

beginning)

Eurozone

Strong Economy:(Germany, Netherlands, etc.)

Weak Economy:

(Greece, Portugal, Spain, etc.)

Different

productivity

level

Different

economic

conditions

Countries with different level of economies need

different macroeconomic policies, monetary as well

as fiscal,

Countries may need to devaluate or inflate their

currency during a recession, which is impossible in

the common currency system

In Germany, Germans euro tends to be

undervalued: Germany gets benefit from the

common currency practice;

In Greece, Portugal or Spain, for example, their

euro tends to be overvalued: these countries bear

the cost of the common currency practice

Should Spain with 21% unemployment rate adopt

the same exchange rate policy as Germany?

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Inflation in the non-euro member states is more

varied than in the eurozone

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Discussion points










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CONCLUSION

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Conclusion

Global financial crisis is triggered by subprime mortgage crisis

resulting from global imbalances in trade

Global imbalances is a result from an international fiat money

monetary system adopted since 1971, which will cause turbulences

in world financial sectors that lead to crisis

Sovereign debt deficits increase during the crisis: this is a natural

event and unavoidable

Eurozone sovereign debt crisis is mainly due to an inherent problem

of the common currency concept itself (mission impossible?)

To save euro, eurozone need to be restructured, only consists of

advanced countries of Western Europe

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THANK YOU

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Anthony Budiawan

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