Anthony Budiawan

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
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 2009

o It will happen anyway, just wait for a right time (and it is now the time) o How to save euro
Conclusion
Page | 2
GLOBAL FINANCIAL CRISIS 2008 Subprime mortgage crisis how it works, how it creates bubble, and how it creates global financial instability
Page | 3
Subprime Mortgage Crisis
Investment Banks
Insurance Companies
Shadow Banking System Commercial Banks

Mortgage Mortgage Loan Loan Funding
US Home Market
(R)MBS (C-R)MBS Structured Investment Vehicles (SIVs) Funding Credit Default Swap (CDS)
CDO (Synthetic) CDO CDO CDO CDO CDO
Households
Real Estate Developers
Funding
Worldwide Investors
Page | 4
Investment Banks
Insurance Companies
Shadow Banking System Commercial Banks

Mortgage Mortgage Loan Loan Funding
US Home Market
(R)MBS (C-R)MBS Structured Investment Vehicles (SIVs) Funding Credit Default Swap (CDS)
CDO (Synthetic) CDO CDO CDO CDO CDO
Households
Real Estate Developers
Funding
Worldwide Investors
Page | 5
GLOBAL FINANCIAL CRISIS 2008
Subprime Mortgage Loan: Facts and Figures
Page | 6
Mortgages loan increase incredibly since 1995: in nominal as well as in % of GDP
Page | 7
Impact on home and gold price index
Page | 8
Crude oil and euro price index moved in the same direction as home and gold price index
Page | 9
Relationship between commodity prices and U.S. inflation
Page | 10
Discussion points

Conclusion
Page | 11
GLOBAL FINANCIAL CRISIS 2008 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
Page | 12
US GDP growth accelerated after the collapse of Bretton Woods System

US GDP: 1929 - 2006
14,000 12,000 10,000 Billion USD 8,000 6,000 4,000 2,000 0 1929 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006 Page | 13
Bretton Woods System Collapse: US Dollar Off Gold
US GDP
Global trade and financial imbalances: they are balance

Real Sectors United States
Current Account Deficit Goods & Services Dollar
Rest of the world
Financial Sectors United States

Financial Account Surplus Dollar Securities
Rest of the world
Page | 14
Global trade imbalances: how it contributes to financial and subprime mortgage crisis
Real Sectors United States
Current Account Deficit Goods & Services Dollar
Rest of the world
Assets Bubble: i.e. mortgage crisis (2008) Stocks Bubble: i.e. dot com crisis (2000)
Financial Sectors
Dollar Securities
United States
Financial Account Surplus
Rest of the world
Page | 15
The U.S. current account deficits continued steadily since 1980s: why is it possible?
Page | 16
Current account deficit is accelerated from 1990
Current Account Deficit 1971 2006: $ 5.98 trillions 1990 2006: $ 5.12 trillions
Page | 17
The impact of China s economic development on the U.S. current account deficit
China s fourth and last phase economic reform & globalization China s first economic reform China Adopt Fixed Exchange Rate: 1 USD = 8.27 Yuan Current Account Deficit 1971 2006: $ 5.98 trillions 1990 2006: $ 5.12 trillions
Page | 18
Financial account surplus makes balance on current account deficit
Page | 19
Financial account surplus is a mirror of current account deficit
1990 2006: $ 5.04 trillions Financial Account Surplus 1971 2006: $ 5.65 trillions
Current Account Deficit 1971 2006: $ 5.98 trillions 1990 2006: $ 5.12 trillions
Page | 20
U.S. current account deficit in percent of GDP: also increase steadily
Page | 21
The deficit is flowing back to the US
Page | 22
Discussion points

Conclusion
Page | 23
GLOBAL FINANCIAL CRISIS 2008
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.
Page | 24
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 differently
o 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 exchange rate is about 6.33 yuan per dollar, another 8%+ appreciation o Yet, U.S. trade deficit with China is widening during the appreciation period of yuan
Page | 25
U.S. trade deficit is widening during the appreciation period of yuan
Page | 26
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
Page | 27
Discussion points

Conclusion
Page | 28
EUROZONE SOVEREIGN DEBT CRISIS 2009
It will happen anyway, just wait for a right time (and now, it is the time)
Page | 29
Crisis always increase fiscal deficit

US fiscal deficit 1995 - 2010
12 10 8 800 600 400 USD (Billions)
1600 1400 1200
Percent
Dot com 6 Crisis

4 2
1000
LHS
0 -2 -4 1995 1997 1999 2001 2003 2005 2007 2009 US Deficit/GDP Ratio
200 0
RHS
-200 -400
US Federal Deficit
Page | 30
The response to the increasingly deficits

There are only two possibilities to deal with this issue
o 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 to prevent the financial chaos in other regions that could lead to a double dip recession
Page | 31
Eurozone is a failed concept (since the beginning)

Eurozone
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, German s 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?
Strong Economy: (Germany, Netherlands, etc.)

Different productivity level Different economic conditions
Weak Economy: (Greece, Portugal, Spain, etc.)
Page | 32
Inflation in the non-euro member states is more varied than in the eurozone
Page | 33
Discussion points

Conclusion
Page | 34
CONCLUSION
Page | 35
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
Page | 36
THANK YOU
Page | 37

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

 Eurozone sovereign debt crisis 2009

Subprime Mortgage Crisis

Shadow Banking System Commercial Banks

Real Estate Developers

Subprime Mortgage Crisis

Shadow Banking System Commercial Banks

Real Estate Developers

GLOBAL FINANCIAL CRISIS 2008

Subprime Mortgage Loan: Facts and Figures

Mortgages loan increase incredibly since 1995: in nominal as well as in % of GDP

Impact on home and gold price index

Relationship between commodity prices and U.S. inflation

 Eurozone sovereign debt crisis 2009

US GDP growth accelerated after the collapse of Bretton Woods System

Bretton Woods System Collapse: US Dollar Off Gold

Global trade and financial imbalances: they are balance

Rest of the world

Financial Sectors United States

Rest of the world

Rest of the world

Rest of the world

Current account deficit is accelerated from 1990

Financial account surplus makes balance on current account deficit

Financial account surplus is a mirror of current account deficit

U.S. current account deficit in percent of GDP: also increase steadily

The deficit is flowing back to the US

 Eurozone sovereign debt crisis 2009

GLOBAL FINANCIAL CRISIS 2008

Currency manipulation: illusion?

U.S. trade deficit is widening during the appreciation period of yuan

 Eurozone sovereign debt crisis 2009

EUROZONE SOVEREIGN DEBT CRISIS 2009

Crisis always increase fiscal deficit

Subprime Mortgage Crisis

1600 1400 1200

Subprime Mortgage Crisis

Dot com 6 Crisis

The response to the increasingly deficits

Eurozone is a failed concept (since the beginning)

Strong Economy: (Germany, Netherlands, etc.)

Weak Economy: (Greece, Portugal, Spain, etc.)

 Eurozone sovereign debt crisis 2009

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