THE CURRENT ECONOMIC CRISIS AND FINANCIAL … CURRENT ECONOMIC CRISIS AND FINANCIAL UPROAR IN THE EU He who blames his failure to a crisis neglects his own talent …

THE CURRENT ECONOMIC

CRISIS AND FINANCIAL

UPROAR IN THE EU

He who blames his failure to a crisis neglects his own

talent and is more interested in problems than in

solutions

A. Einstein

Dr. Maria Lorca-Susino

Dept of Economics and Dept of International Studies

OUTLINE

• The euro: A quick overview

• The euro as a common currency

• The euro and an international and global currency

• The new monetary order

• The EU and the Eurozone:

– The 1st economic crisis

• The current economic crisis and financial turmoil

– Greece and the “bail-out plan”

• Final thoughts

INTRODUCTION

The euro: an overview

The most dramatic change in the international

monetary system since President Nixon tool the dollar

off gold in 1971.

Robert Mundell

The euro: a common currency area

• The adoption of the euro

– The only other successful monetary union:

• The US and the greenback after the Civil War of 1961-65

• Path to the euro:

– Many trials from 1865 to 1971

– An alternative in Europe: • The Union of Soviet Socialist Republics (USSR): from 1922-1991

– The Werner Report the Delors report and its 3 steps to adopt the euro:

• Nominally on January 1999

• Physically on January 2002

The Maastricht Treaty • The set of requirements that must be met to join the euro:

Target Requirement

Inflation Rate No more than 1.5 percentage points higher than the 3 best-performing Member States of the EU.

Public finances The ratio of the annual government deficit to gross domestic product must not exceed 3% at the end of the preceding fiscal year.

Interest rates The nominal long-term interest rate must not be more than 2 percentage points higher than the 3 best-performing Member States.

Exchange rate stability

Applicant countries should have joined the exchange rate mechanism under the European Monetary System for 2 consecutive years and should not have devaluated its currency during the period.

Denmark, Sweden, and the U.K.

• Denmark's national currency, the KROEN linked to the euro through – The government has met the economic convergence criteria for participating

in the third phase of the (EMU), but a September 2000 referendum rejected joining the EMU

• New Referendum: ? • Sweden: rejected the euro in a popular vote maintains its own currency, the

Swedish Krona – The Swedish Riksbank founded in 1668 is the oldest central bank in the world – Convergence problems – Working on inflation

• The U.K. The currency is the pound sterling. – The Bank of England is the Central Bank – The UK chose not to join the euro at the currency's launch. – British Prime Minister, Gordon Brown MP, has ruled out membership for the

foreseeable future. – Former Prime Minister Tony Blair promised to hold a public referendum based

on a number (five) points. – In 2005, more than half (55%) of the UK were against adopting the currency,

while 30% were in favour.

Eurozone Member States: EMU and €

Economic and Monetary Union

(EMU)

1. Monetary Policy: -European Central Bank

- Price stability - 2% inflation rate

2. Economic Policy: •Fiscal Policy: Stability and Growth Pact

• Gov. Deficit to GDP: 3% • Gov. Debt to GDP: 60%

Enlargements: 2004 & 2007

Country EMU entry date Expected Cyprus January 1, 2008 C.Republic 2013 Estonia January 1, 2011 Hungary 2012 Latvia 2013 Lithuania 2013 Malta January 1, 2008 Poland 2012 Slovenia January 1, 2007 Slovakia January 1, 2009 Bulgaria 2012 Romania 2014

Due to economic turmoil these countries will not be making this

deadlines since they are far from complying with the Maastricht

requirements

Non-EU countries and the euro

Country Pegged to Adopted Euro Agreement signed Seeking

Monaco French franc January 1, 1999 December 31, 1998

San Marino Italian lira January 1, 1999 December 31, 1998

Vatican City Italian lira January 1, 1999 December 31, 1998

Andorra French franc

Spanish peseta

January 1, 1999 December 31, 1998 Agreement but not

membership to EU

Montenegro German mark January 1, 2002 Never Membership to EU

Kosovo German mark January 1, 2002 Never Membership to EU

Existing (struggling) Monetary Union

The East Caribbean dollar: in Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent, and the Grenadines.

The Central and West CFA franc used by currency used in 12 formerly French ruled African countries plus Guinea-Bissau (Portuguese) and Equatorial Guinea (Spanish)

The East African Shilling used in the East African Community (EAC) between the Republics of Kenya, Uganda, the United Republic of Tanzania, Republic of Burundi, and Republic of Rwanda

The Facto Monetary Union

The euro is legal tender in Andorra, Kosovo, and Montenegro.

The Hong Kong Dollar is used in Macau

The Russian rubble is used in Russia and the Georgian Autonomous republics of Abkhazia and South.

The Swiss franc in Liechtenstein

The U.S. dollar is used in Palau, Micronesia, the Marshall Islands, Panama, Ecuador, El Salvador, Timor-Lester, the British Virgin Islands, and the Turks and Caicos Islands.

Planned Monetary Union

Name Currency Date

West African Monetary Zone – as part of the Economic

Community of West African States (ECOWAS)

Eco December 2009

Gulf Cooperation Council (GCC) Khaleeji 2010

Caribbean Single Market and Economy (CSME) as part of the

CARICOM

Unknown Due between 2010-

2015

Southern African Development Community Unknown 2016

Alternativa Bolivarianas para los Pueblos de América (ALBA) - Bolivarian Alternative for the Americas Bolivia, Nicaragua, Honduras, Cuba, Venezuela, Dominica, and San Vicente-Granadinas (which have the East Caribbean Dollar) and Ecuador is not sure bc it has the US dollar

SUCRE

(Sistema Unificado de Compensación

Regional)

4th quarter of 2009

(Oct/Nov/Dec)

The euro as an International and

Global currency

A global economy requires a global currency

Paul Volker

The Euro as an International currency

Function Private Sector Official Sector

Unit of account Invoice Exchange rate peg

Store of value Financial Assets Reserves

Medium of Exchange Vehicle/substitution Intervention

Store of value: Financial Assets

• The purchasing power of the euro is measured by the demand of products denominated in euros in the bond, money, and FX market

• Important: the bond market

– Two conflicting patterns

– Since the introduction of the euro growth

– Maastricht criteria forces government to comply with monetary and fiscal requirements

Graph 2. Total Issuing Activity (mill of euros)

750.000 €

1.050.000 €

1.350.000 €

1.650.000 €

1.950.000 €

2.250.000 €

2.550.000 €

2.850.000 €

3.150.000 €

3.450.000 €

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Graph 3. Evolution of Bond Issuing -Central and Local Government (mill of

euros)

500.000 €

600.000 €

700.000 €

800.000 €

900.000 €

1.000.000 €

1.100.000 €

1.200.000 €

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Governments have increased bond issuance to finance national

‘bail-out’ plans and increase government purchases

Sharp increase of Government issuing activity

• Jump from year 2007 to 2009

– Consistent with breaking the requirements

• Consequence: Negative effect on quality & rating of sovereign debt

– PIIGS or Garlic belt countries

– S&P, Moody’s, Fitch

– Spain: August 2008 suspended an aution of 15-year bond woth €3,825 mill for LACK OF DEMAND

– Greece: February 25, 2010 successfully raised €5billion with a 10-year bond issuance offering higher yields

• Yield differential with Bund increased even more

Ratings update (as of March 7, 2010)

Moody’s S&P Fitch

Austria Aaa AAA AAA

Belgium Aa1 AA+ AA+

Cyprus Aa3 A+ AA-

Finland Aaa AAA AAA

France Aaa AAA AAA

Germany Aaa AAA AAA

Greece A2 BBB+ (*-) BBB-

Ireland Aa1 AA AA-

Italy Aa2 A+ AA-

Luxembourg Aaa AAA AAA

Malta A1 A A+

Netherlands Aaa AAA AAA

Portugal Aa2 A+ AA

Slovakia A1 A+ A+

Slovenia Aa2 AA AA

Spain Aaa AA+ AAA

Greece:

March 7, 2011 Moody’s donwgrades

to B1

Ireland:

April 5, 2011 Moody’s donwgrades

to Baa1

Portugal:

April 15, 2011 Moody’s donwgrades

to Baa1

Spain:

March 10, 2011 Moody’s

donwgrades tp Aa1

Corporate and Financial

Graph 5. Evolution of Bond Issuing - Corportate and Financials (mill of

euros)

300.000 €

500.000 €

700.000 €

900.000 €

1.100.000 €

1.300.000 €

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

• The rise in corporate and financial bond issuance proves:

– 1). Euro has facilitated corporations and financial institutions access to market capital

– 2). Before the euro, government enjoyed a “crowding out effect”

– 3). Sharp increase from 2007 to 2008 and 2009 due to financing needs

Official Sector: Reserve currency

1995 1999 2000 2002 2007 2008 2010

Total FX holdings $1,3trill $1,7trill $1,9trill $2,4trill $6,4trill $6,6trill $9.2 tri

US$% 43,92% 54,98%$ 55,77% 50% 40,64% 40,62% 33.96%

€% 6.35% 13,86% 14.35% 17.74% 16.83% 16.79% 14.55%

Industrial countries

US% 44,43% 59,6% 56.1%

€% 9,6% 19,9% 21.5%

Emerging and developing countries

US% 42,91% 29,49% 22.8%

€% 0,36% 14,95% 11.07%

The € has not gained much terrain but the US$ has lost ground

The euro as a global currency to dethrone the US dollar hegemony

• 1. The size of the underlying economy and global trade

Graph 6. Gross Domestic Product

(Based on PPP valuation of country GDP in billions of U.S. dollar)

0

5.000

10.000

15.000

20.000

19

87

19

88

19

89

19

90

19

91

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10

United States Euro area European Union

Rank Exporters Value €bn Rank Importers Value €bn

1 Germany 1461,9 1 US 2169,5

2 China 1428,3 2 Germany 1203,8

3 US 1287,4 3 China 1132,5

4 Japan 783 4 Japan 763,6

5 Netherlands 633 5 France 705,6

6 France 605,4 6 UK 633

7 Italy 538 7 Netherlands 573,2

8 Belgium 475,6 8 Italy 554,9

9 Russian Fed 471,6 9 Belgium 469,5

10 UK 458,6 10 Rep of Korea 435,3

11 Canada 456,5 11 Canada 418,3

12 Rep of Korea 422 12 Spain 401,4

In terms of trade 5 of the Eurozone member states are in the top 10 nets exporters

December 2009 China overtook Germany as the world’s top exporter – in

2009 it reached US1.2tr

March 2011 China hit record high exports in April 2011

The breadth and depth • Breadth of the economy measures the behavior of capital market • Depth of the economy measures by the ration of the financial assets to GDP

Graph 8. Size of the Captial Market, 2007

0

5.000

10.000

15.000

20.000

25.000

30.000

35.000

Debt Securities (Public) Debt Securities (Private) TOTAL Debt

EU Eurozone US

Graph 9. Bond, Equities & Bank Assets (in % of GDP)

(2007)

0

100

200

300

400

500

600

EU Eurozone US

The new monetary order

The stability of the international monetary system can’t hinge on the currency of one single country, even thought that is the

largest economy in the world

Zhou Ziaochuan

The graph of the discord

• Current economic crisis and value of the US$ and US$ index:

– Vulnerability of the current existing international monetary system

– Certain countries are calling for:

• Need to reform the international monetary system and introduce a new global reserve currency

• March 23, 2009 President of the People’s Bank of China, Zhou Ziaochuan:

– Urgent need for “an international reserve currency with a stable value, ruled-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability.”

– Financial and economic war declaration to the US

• President Dmitry Medvedev at the G8 Summit in Aquila (Italy) July 2009 presented a new world currency bearing the words

– “unity in diversity”

• Alternative to the US dollar the SDR by the IMF

Arguments for the SDR and the IMF

• 1). To reduce certain countries’ tendency to accumulate international reserves to respond against account capital crisis

• 2). Stop the “Triffin Dilemma” a reserve currency issuer (the US) chooses a monetary policy and issues currency in response to the national needs and preferences and not to the need of the international monetary payment system and the world economy.

• 3). Change to from a dollar-centric to a more inclusive monetary system

Some problems with the SDRs… • 1). Limited amount of SDR’s and supported by develop

countries

– Only 200bn of SDR available

– In order to cover foreign exchange reserve need there should be a min US$1.1trill in SDR available.

• 2). Allocation based on member quota share

– G7 states have the largest share and least need for SDR

• The US has the largest share (17.816%)

• 3). SDR is a basket of 4 currencies the dollar the highest weight

– Fluctuation on these values will affect value of the SDR

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

1999 2000 2004 2008 2009 2010

Unallocated reserves 2/

Claims in euros

Claims in Swiss francs

Claims in Japanese yen

Claims in pounds sterling

Claims in U.S. dollars

Currency Composition of Official Foreign Exchange Reserves (COFER)

(In mill of US$)

Chinese Government and China’s currency war

Country Rank In US dollar (est. 2008)

China

Russia

India

Brazil

1

3

5

7

$1,955,000,000,000

$427,000,000,000

$254,000,000,000

$193,800,000,000

Figure 4.7. Time Series Data on International Reserves & Foreign

Currency Liquidity (in mill of US$)

$100.000

$150.000

$200.000

$250.000

$300.000

$350.000

$400.000

$450.000

$500.000

nov-08 dic-08 ene-09 feb-09 mar-09 abr-09 may-09 jun-09 jul-09 ago-09 sep-09

Brazil Russia India P.R. China: Hong Kong

The Yuan and the Hong-Kong dollar a picture is worth a thousand words

China: One Country Two systems

• Currency war because:

– China is in a “dollar trap”

– China increase in competitiveness currency dumping

– China running the largest account surplus

• Trade surplus Excess liquidity international creditor to US and other nations (LatAm)

• Undervalued currencies distort the economy trade edge distort prices wrong investment decisions

The EU and the Eurozone:

The first economic crisis

Those who cannot remember the past are

condemned to repeat it

George Santayana

The current situation

• PIIGS countries are not complying with the requirements from boom to bust:

– Ireland in 2009

– Greece in 2010

– Ireland in 2011

– Portugal in 2011

– Spain next??

• WHY?

– They used fiscal policy as a escape valve

• Off-set the rigor of common monetary policy

Graph 1. Government Debt Level

Decomposition of the 2010 gross government debt

0

50

100

150

200

250

AUS

LUX

NZL

CHEDNK

FINSW

ECZE

ESP

IRLPO

LNLD

DEU

AUTCAN

HUNG

BRPR

TFR

AUSA

BEL

ITA

ISL

JPN

All co

untri

es

% o

f 2007 G

DP

2007 Debt Cumm Defic Additional Factors Affecting Debt

`

Graph 3. Government Debt in Eastern EU Countries

0

10

20

30

40

50

60

70

80

Pol C Rep Hung Bul Rom Esto Lat Lith

2005 2006 2007 2008

Graph 2. Euro area Government Debt as % of GDP

60

65

70

75

80

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Graph 5. Euro area 16 Government Deficit

-8

-7

-6

-5

-4

-3

-2

-1

0

19

95

19

96

19

97

19

98

19

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20

00

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01

20

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08

Graph 6. Deficits and Surplus in Eastern EU Countries

-10,00

-8,00

-6,00

-4,00

-2,00

0,00

2,00

4,00

Pol C Rep Hung Bul Rom Esto Lat Lith

2005 2006 2007 2008

Graph 7. Sovereing Bond Spread with German Yield (% points)

0

0,5

1

1,5

2

2,5

3

Greece Irland Portugal Italy Spain Belgium Netherlands France Finland Denmark

Jyly 07 March 09 may-09 sep-09

This has led to the deterioration of the sovereign and corporate bonds

ratings

But default risk is also affecting • European companies:

– end of 2010 €500,000 bill of rated corporate debt comes to an end corporate default is a spectrum haunting the EU

• In 2009 global corporate default = 260 issuers

– 188 in the US

– 20 in Europe

– 36 in Emerging markets

– 16 in other developed regions

– Reasons: worsening of economic fundamentals, unfavorable economic and financial prospects and recessionary conditions

• The iTraxx Europe Index measures the evolution of the most liquid 125 CDS European investment grade credit corporations distributed in:

– Financial, TMT, Industrial, Energy, Consumer, auto industry

• On February 8, 2010 CDS reached an all time high at 111.8bp

– It costs $118,800 to insure $10 million in corporate bonds of an European corporation

Graph 8. The Markit iTraxx Europe Index

75

80

85

90

95

100

105

110

115

22/0

9/200

9

29/0

9/200

9

06/1

0/200

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27/1

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2/201

0

Current account deficit … the forgotten economic data

• Curiously, those countries with economic difficulties all share large current account deficits

• Only the SERVICE component is positive

Graph 9. EU Current Account (in bn euro)

-80

-60

-40

-20

0

20

40

Q3/08 Q4/08 Q1/09 Q2/09 Q3/09

Current Account Goods Services Income Current Transfers

Current account per country

Graph 10. Current Account Balance (mill of US$)

-200.000

-150.000

-100.000

-50.000

0

50.000

100.000

150.000

200.000

250.000

300.000

Germany France Norw ay Sw eden Spain Portugal Greece

2004 2005 2006 2007 2008 2009

In 1999 In 2009

Portugal 8%

Spain 3%

Greece 4%

Portugal 10.7%

Spain 10.5%

Greece 11%

Economic Sentiment Indicator remains low

• Economic sentiment suffered a dip and it seems to be recuperating still:

– All four components are negative

The Current economic crisis and financial turmoil

Eeny, meeny, miny, moe it is time for …

Bail-out yes, bail-out no

Greece

• Main problems:

– No compliance with Maastricht requirements

– Hide real problems Use of derivatives swaps

– €2 bill in debt redemptions in April and May (debt refinance)

• €4.8bn saving package

• Wage increase is a problem:

– If year 2000 is the base year:

» In 2009: Germany 102 while Greece 122

• Long list of wage and pensions cuts for the public sector

– Massive protests and strikes

• Moral dilemma: bail-out or no bail-out

– The Maastricht “no bail-out rule”

• Art 125: The Union shall no be liable for or assume the commitments of central governments, regional, local or other public authorities

The Bail-Out Dilemma If there is NO BAIL-OUT

Pros

Help will increase moral hazard

Spain 2nd in line?

Sets example to force conduct structural reforms

Cons

Speculation against other weak countries

Banking sector in danger:

Most of Greece’s Gov debt is held by EU banks (@€200)

It harms the image of the EU & political

instability

One problem: Greece is threatening we call the IMF for

help

Bail-out plan and Greece calls the IMF

Pros Cons

No bail-out clause is

broken

Other EU member

states do not increase

their exposure

The IMF is not too good

overseeing adjustment

processes

Stop EU integration

process a country

is left behind

Pros Cons Bail-out plan: a mix of bilateral guarantees and loans via EU structural funds,

concerted actions to buy bonds, etc

Strong surveillance mechanisms and further conditionality to the loans

Bail-out plan without the IMF

Pros Cons

Show political strength &

and ‘know-how’ to cope

Enhance EU political

coordination

integration

Harsh measures public

unrest

If the rescue plan fails

the EU is doomed

Pros Cons

Bail-out plan with IMF

Pros Cons Bring technical expertise and

more independence from EU

build ‘know-how’

Conditionality will increase

and will be respected

If fiscal adj is not enough, and

debt restructuring is needed, the

IMF $ might complicate matters

The IMF track record for

overseeing adjustment is

uneven: eg. Argentina

The IMF will take the blame for

unpopular measures

The IMF presence EU &

Eurozone weakness

THE OUTCOME:

A SOUP OF LETTER

Churchill once said:

you can always count on the Americas to do the right

things---after they have tried everything else.

THE BAILOUTS

• Two vehicles to save the Eurozone:

– 1) The European Financial Stability Facility (EFSF) €440 bn in loans from plus the IMF, the European Commission and other $622 bn

– 2) The European Stability Mechanism (ESM) will take effect in 2013 $996bn

• Bailouts so far:

– Greece 110bn

– Ireland 67.5bn

– Portugal 80bn

Final Thoughts

That which does not ‘kill’ us makes us stronger

Friedrich Nietzsche

• The EU and the Eurozone are in serious danger

– Lack of supervision (see no evil, hear no evil, speak no evil)

– This shows negligence EU politicians should be held accountable

• Common fiscal policy not viable

– Budget will be imposed fiscal sovereignty

– Politicians are not longer needed…

• If PIIGS are asked to leave:

– Currency devaluation with lack of comp immediate bankruptcy

• What about Germany leaving the EU?

– Best economy in the area and record high export rate despite euro

– FX vendors still maintain the DEM as a currency

• Solution is not:

– The European Monetary Fund

– Institution to supervise financial activity

Thank you