Financial Crises. Benjamin Graham. Videos in this lecture are from Kahn Academy

Transcription

1 Financial Crises Videos in this lecture are from Kahn Academy

2 Today s Plan An updated syllabus is posted Today s topics: Kahn Academy Videos on foreign currency reserves and speculative attacks The Asian Financial Crisis The Global Financial Crisis and the Euro Crisis

3 Reading Quiz What is the name of the Thai currency? A. Baht B. Ringit C. Yen D. Thai Peso E. Thai Dollar

4 Reading Quiz What was the root of the Thai crisis? A. The agricultural sector B. The mining sector C. The manufacturing sector D. Shipping E. The financial sector

5 Reading Quiz 3 What podcast was assigned? A. Something from Planet Money B. Something from This American Life C. Something from Freakonomics D. Something from Marginal Revolution University (Tyler Cowen) E. Something from Malcom Gladwell

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8 Why are large foreign currency reserves useful for keeping the value of your own currency high? a. Because the central bank always has enough foreign currency to buy imported goods b. Because the central bank can buy back its own currency to keep the supply of its currency low c. Because the central bank can sell its foreign reserves to keep the supply of the foreign currency high d. b & c

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10 In a speculative attack, do speculators want to other investors to duplicate their tactics? a. Yes, because the strategy only works if the central bank runs out of foreign reserves b. Yes, because the more people who are betting against a currency, the more likely a devaluation becomes c. No, because more participants means a smaller payoff per person d. No, because if too many people are doing it, the central bank will catch on and stop it e. a & b f. b & c

11 The Asian Financial Crisis in a nutshell In the early 1990s, many Asian countries opened for foreign capital Foreign loans came in, lots of investment took place Asset bubbles, especially in real estate In Thailand, property prices rose 400% in a few years Then the economies slowed, and the bubbles collapsed Banks had many pending defaults on their balance sheets This set the stage for: Speculative attacks on currencies

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13 So why did Thailand go down? Had lots of foreign currency reserves The peg should have been safe But the economy was small, so even lots of reserves as a % of GDP were still not that much Banks were way over-leveraged Had made a lot of bad loans Running a current account deficit Inflow of capital made people feel rich -- consumption was up Currency was pegged to the dollar, and the dollar was appreciating compared to the Yen and other Asian currencies

14 What did the crisis do to the economy?

15 The Crisis Quickly Spread Malaysia, Indonesia, Korea, the Philippines Contagion: Crisis in Thailand causes investors to pull out of other similar countries Research is expensive Investors take shortcuts They look at what other people are doing, and they lump similar countries together

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19 Also Contagion in the Eurozone crisis What did investors do when they sold all their Greek bonds? A. Bought Spanish and Portuguese bonds instead B. Sold all their Spanish and Portuguese bonds too C. Took a wait and see approach to the rest of Europe Side note: During the Global Financial Crisis, investors pulled out of everywhere risky Looked for safe places, like U.S. Treasury bills Allows the U.S. to borrow super cheap The fact that we lost our AAA rating almost didn t matter

20 Legacy of the Asian Financial Crisis After a lot of suffering, the region has rebounded well Silver Lining: The austerity and caution that followed the Asian Financial Crisis made Asia less vulnerable to the Global Financial Crisis of i.e. no currency crises or bank collapses But their economies still got hit -- they are dependent on exports to the U.S. and EU

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22 Why did the Euro make the Greeks feel rich? No previous access to credit = no debt New access to credit = ability to spend more than you earn (initially) Expectations of future wealth Entry into the European market came alongside the Euro Debt-financed investment was, to some degree, justified And of course, not only Greece

23 Loss of Confidence Greece lied about their balance sheets to get into the EU Later announced their current account deficit was double what they d been reporting And then wouldn t later come clean Trying to throw technocrats in jail Its expensive for investors to do their own research -- easier just to avoid Greece

24 Why can t Greece just correct their government deficit by printing money? A. Because they also have a current account deficit B. Because they are on the Euro and Germany won t agree C. Because they are out of foreign reserves D. Because the balance of payments is tilted against them

25 Why hasn t austerity worked? Step 1: You raise tax rates and cut spending Step 2: But this causes more recession Step 3: Tax revenues fall because no one is producing or earning Step 4: So you have to raise taxes and cut spending even more Pro-cyclical fiscal policy Step 5: You get mass protests and strikes making things even worse...

26 The path forward? Who knows? IMF says more debt forgiveness is needed Creditors have ruled that out until end of 2018 Can Merkel get re-elected if she approves more forgiveness of Greek debt?