A Brief History of Financial Crises

Transcription

1 International Finance A Brief History of Financial Crises Campbell R. Harvey Duke University, NBER and Investment Strategy Advisor, Man Group, plc Revised January 13, 2017 Some of the materials are drawn from Bob Swarup Till Debt Do Us Part

2 Crises Long history of financial crises Plenty of crises before Glass Steagall and after Crises occurred before deposit insurance and after Crises happened both before multiple levels of regulation and after For the U.S.: from (65 years) there were 49 recessions or depressions. From (97 years) there were 17 recessions or depressions. 2

3 Crises Crises costly and some of the costs hard to measure Prolonged unemployment, increasing role of government, knock on effects such as impact on public health Hysteresis: The longer someone is unemployed the more difficult to get a job because you lose your skills 3

4 Crises All recessions are not necessarily bad Part of creative destruction Imposes a discipline on firms to be efficient to survive However, deep recessions are bad 4

5 Crises Growth Volatility Trade Off Economic policy much like choosing an optimal portfolio you trade off growth (expected return) for growth volatility E[growth] Vol[growth] 5

6 Crises Key Questions? How important is moral hazard? What is the role of repeal of Glass Steagall?* Why are banks allowed to have so much leverage? Did the regulatory system help, hurt or have no effect? Are we facing another crisis due to Europe/Japan? *Gramm Leach Bliley Act (GLBA), also known as the Financial Services Modernization Act of 1999, allowed banks to also be investment banks. The 1999 act repealed the 1933 Glass Steagall Act. 6

7 Role of the U.S. Why focus on the U.S. (for international finance) While U.S. a smaller part of the world GDP than it has been in the past, it is by far the most important economy in the world USD is de facto world currency (with little competition) U.S. has been the dominant power since the end of WWI 7

8 Europe Then and Now Consider history of Europe after WWI Interestingly, many of the issues Europe faces today are similar to recent history Can we learn from the past? 8

9 Europe Then and Now Consider history of Europe over the past century 9

10 Aftermath of WWI Economic growth through WWI 10

11 Aftermath of WWI Challenges for Europe after war: 16 million dead; 20 million wounded (and many in need of state assistance) Infrastructure decimated Industries wiped out Huge debt (mainly financed by the U.S.) 11

12 Aftermath of WWI U.S. debt also increased However, most of the debt was financed locally (i.e., within the U.S.) This is important because it a factor that impacts country risk today. For example, the overwhelming amount of Japanese debt today is owned by Japanese households 12

13 Aftermath of WWI Credit crunch in Europe Hard for governments to borrow because of excessive debt levels Hard for corporations to borrow to make capital investments Example of the debt overhang problem in economics 13

14 Aftermath of WWI Credit crunch in Europe UK debt to GDP goes from 33% in 1913 to 144% in 1919! 14

15 Aftermath of WWI 15

16 Aftermath of WWI Woodrow Wilson s famous 14 points emphasized reconciliation Wilson wins Nobel Peace Prize in 1919 Yet outcome was different U.S. demands repayment of $12 billion from Allies Other countries also demand repayment (for example Britain owed $12 billion from other European countries) 16

17 Aftermath of WWI Europe saw reparations as a way out France, in particular, pushed for severe punishment for Germany given their history of many wars Looked to U.S. for some debt forgiveness Britain could not pay U.S. until France paid Britain France could not pay Britain (or the U.S.) until it extracted reparations from Germany 17

18 German view of reparations Aftermath of WWI What was being asked for would bankrupt Germany In recent memory was the Bolshevik revolution in All bonds defaulted 18

19 Aftermath of WWI Keynes quits the British delegation In The Economic Consequences of the Peace, he predicts: Economic chaos as a result of the plan Another world war 19

20 Aftermath of WWI Negotiations drag on into 1921 U.S. withdraws to an isolationist policy France takes control of negotiations and implements a punitive plan for Germany 20

21 Aftermath of WWI Inter Allied Reparations Committee 1921 Initially decides on 269 billion gold marks (530% of German GDP) (in the Treaty of Versailles) Soon revised down to 132 billion gold marks (230% of German GDP) In terms of the U.S. today, that is like a new $43 trillion dollar debt imposed on the federal government [currently $20 trillion] Also Germany lost all overseas colonies 2.3*18.675=$43 trillion 21

22 Aftermath of WWI 22

23 Aftermath of WWI French bad blood: In aftermath of Franco Prussian war, France paid: 20 25% of its GDP in reparations Germany annexed Alsace Lorraine 23

24 Aftermath of WWI Gold marks: Germany had suspended (gold) convertibility of currency during the war This is why Allies insisted on gold marks (to prevent Germany from inflating away their debts) 24

25 Aftermath of WWI Though Germany imposed austerity policies: Tax revenue fell Strikes Rise in both socialists as well as populist ultra nationalists Assassinations Inflation! 25

26 Aftermath of WWI 26

27 Aftermath of WWI Remember reparation debt was either in gold or foreign currency. Hence, printing of Reichsmarks had no impact on the amount of reparation debt 27

28 Aftermath of WWI Treaty also allowed for PIK if Germany missed payments 1923 Germany was declared in default French and Belgians invaded the Ruhr valley to seize industries (80% of German production of coal and steel) German workers did not cooperate and production ground to a halt 28

29 Aftermath of WWI 1923 Hitler s failed Munich Putsch November 1923 Rentenmark introduced which was linked to gold and other real assets Other countries returned to a quasi gold standard 29

30 Aftermath of WWI 1924 Britain renegotiates its debt with U.S. Effectively, the U.S. gets 80 cents on a dollar Done via maturity extension and interest rate reduction 30

31 Aftermath of WWI Dawes Plan, April 1924 German debt slashed France withdraws troops from Ruhr U.S. makes $100 million loan to Germany and effectively becomes lender of last resort Corporate debt becomes senior to reparation debt *Charles G. Dawes 1 st Director of Bureau of Budget; VP

32 Aftermath of WWI Dawes Plan Huge U.S. capital inflows to Germany as credit rating improves (given the priority) Huge economic growth in just a few years puts Germany as second largest economy in world Dawes shares 1925 Nobel Peace Prize 32

33 Aftermath of WWI Other debt renegotiations France s debt 46 cents on dollar Italy 22 cents Britain regrets early deal! 33

34 Aftermath of WWI Everyone relying on the U.S. Countries like Germany racking up large USD debt rather than local debt 1928 U.S. investors become concerned about German credit worthiness Credit rating cut and loans dried up Germany goes into recession 34

35 Aftermath of WWI Young plan Stretched reparations out to 1988* Provided some holiday situations for interest payments But Germans disappointed by the size of the reparations and more importantly, the seniority of the private loans was taken away (which hurt credit creation) However, German sovereignty fully restored with the withdrawal of French troops *Owen Young, US Industrialist, Chairman, RCA *Last payment October 3,

36 Aftermath of WWI Young plan Germany needed to run a trade surplus to pay off loans Yet they could not devalue their currency As a result, they relied on austerity (deflation via wage reduction, etc.) Social inequality Rise of extremist parties in

37 Aftermath of WWI 1929 National referendum To end the enslavement of the German people only got 14% participation but 95% of voters supported the end of reparations Gave new profile to National Socialist Party Wall Street Crash net portfolio lending from U.S. goes negative in

38 Aftermath of WWI Great Depression German Real GDP starts falling near 10% per year Money supply falls Government slashes spending Deflation takes hold Unemployment increases to 30% by

39 Aftermath of WWI Rise of Nazis National Socialists become second largest party in the Reichstag in September 1930 Communists the third largest 39

40 Aftermath of WWI Banking crises In 1931, major Austrian bank, Creditanstalt, declares bankruptcy leading Austria to abandon the gold standard Contributes to a run on German banks Mass nationalization of banks Germany stuck with the gold standard 40

41 Aftermath of WWI End of reparations? Hoover declares one year moratorium on sovereign debts (inter allied war loans) in Lausanne Conference recommended end of reparations. Some German debt transferred to the BIS. December 1932, U.S. Congress rejects treaty because it covers not just reparations but inter allied loans. 41

42 Aftermath of WWI 42

43 Aftermath of WWI Hitler rises to power January 1933 the President invites Hitler (leader of the largest party in the Reichstag) to form the next government March 1933, Hitler gets 43% of popular vote Germany defaults on all reparation debt 43

44 Aftermath of WWI Reparations over Strong growth in the later 1930s However, mainly a result of government spending on military hardware 44

45 Aftermath of WWI Most human beings have an almost infinite capacity for taking things for granted. That men do not learn very much from the lessons of history is the most important of all the lessons of history. Aldous Huxley "Case of Voluntary Ignorance Esquire (October 1956) 45

46 Europe today 46

47 Europe today A number of bad countries (periphery) required to make payments to Germany 47

48 Europe today A number of bad countries (periphery) required to make payments to Germany A fixed exchange rate that inhibits devaluation as a way to lead export growth 48

49 Europe today A number of bad countries (periphery) required to make payments to Germany A fixed exchange rate that inhibits devaluation as a way to lead export growth Austerity plans (increase in taxes, reductions in wages) 49

50 Europe today A number of bad countries (periphery) required to make payments to Germany A fixed exchange rate that inhibits devaluation as a way to lead export growth Austerity plans (increase in taxes, reductions in wages) Incremental restructuring (usually by extending maturity and reducing interest rates) 50

51 Europe today Rise of ultra nationalist parties: France: Marine Le Pen, Front National 51

52 Europe today Rise of ultra nationalist parties: Netherlands: Geert Wilders, Freedom Party 52

53 Europe today Rise of ultra nationalist parties: Greece: Golden Dawn 53

54 Europe today Campbell Harvey: R. Harvey: Finance International 663:1 Finance,

55 Europe today Options 1. Borrow more 2. Default 3. Export more to creditor countries 4. Export to new markets 5. Slash wages to be more competitive 6. Abandon the Euro 55

56 Europe today Current account/gdp 56

57 Europe today Worst performing countries in terms of GDP growth Germany and France 57

58 Europe today Worst performing countries in terms of GDP growth Italy (also Greece which came in later) Best performing country Germany 58

59 Europe today bank balance sheets/ 59

60 Europe today 60

61 Europe today than zero living with negative rates

62 Discussion Questions Is Gold Exchange Standard like the Euro? Evidence by Bernanke and James (1991) 62

63 Discussion Questions Italy has lower per capita GDP today than in Is Italy worse off today? Nonperforming loans have now reached 360 billion of which 80% is corporate which is about 20% of Italian GDP (December 2016). Italians, rather than depositing their money in the bank at very little or no interest, buy bank bonds to get at least some return. The total amount of bank debt held by Italian households is billion. It s not clear whether the Italian insurance deposit scheme has the money to cover even a fraction of the bigger potential losses. 63

64 Discussion Questions What is the social impact of divergence? Campbell Harvey: R. Harvey: Finance International 663:1 Finance,

65 Discussion Questions What is the social impact of divergence? eu&idim=country:es:el:de:it&ifdim=country_group&hl=en_us&dl=en_us&ind=false 65

66 Discussion Questions What is the social impact of divergence? eu&idim=country:es:el:de:it&ifdim=country_group&hl=en_us&dl=en_us&ind=false 66

67 Discussion Questions Why do we care about deflation? 67

68 Discussion Questions Spain has done well in as has Ireland (two countries that implemented severe austerity). Does this mean austerity is the way to go? The change stems from a Europe wide shift in the way investment is treated in GDP statistics. When a company executes a tax inversion, registering in Ireland to benefit from its low 12.5% corporate tax rate, it and its intellectual property are now added to the country s capital stock, and the returns are included in GDP. Ireland s capital stock grew by one third in 2015, as American firms rushed to pull off tax inversions in anticipation of a likely crackdown. why gdp growth 26 year mad not full shilling 68

69 Discussion Questions How much blame should be shouldered by Germany? How much would it cost to bail out southern Europe? 69

70 Discussion Questions How many years does the Eurozone have to go? 70

71 71