Teoria International Economics

MAIN CAUSE:

Credit Crunch

A.

DEEPER CAUSES:

Chinese current account surplus

1. Expansionary monetary policy in USA (2000 2006)

2. De­regulation of financial markets (From 1999)

3. Increasing sophistication of financial intermediation (From 1980s)

4.

A: Summarizing, what happened in 2007?

Banks conceded mortgages to people with scarce financial credibility; to get rid of a part of the

risks, banks used to sell their credits to “special purpose vehicles”. These particular societies

paid banks after the emissions of bonds in the market. Sometimes these bonds were not easy

to sell and remained blocked in the market OR sometimes there were some bonds with a very

high risk that were issued in order to get liquidity immediately (but the possibility of the issuer

to “fall headlong” were so high that the bond had no chance to be repaid by the issuer itself to

the buyer Junk Bonds). If the emission went bad, the SPV did not have the liquidity to pay

banks. Moreover, the owner of the mortgages started to become insolvent, so the lack of

liquidity became THE MAIN problem of banks.

NB: a toxic asset is an asset that can ruin an entire portfolio, because it makes you lose

reputation. It has 0 market value (0 demand) so no one wants to buy it.

Especially for high­risk bonds, the custom was to make profit and then to get rid of them

distributing the bonds in the market itself, until someone did not want to take the risk of buying.

A “NO” is enough to stop this flow and destroy the reputation of the issuer of the bond itself.

1: Imports from China to USA were

more than exports:

IMPORTER (USA) YEN

PRODUCER (USA)

$

COMMERCIAL BANK IMPORTER COMMERCIAL BANK PRODUCER

( ) ( )

BUYS AT A LOW PRICE $ (DOLLARS CANNOT STAY IN COMMERCIAL BANKS)

CENTRAL BANK PRODUCER

( )

The dollar has left

USA, while the YEN

has not left China so the balance is not respected. The Chinese Central Bank will sell dollars to

America in exchange of government bonds the demand of bonds increases, the price of

PARADISE? NO!

bonds increases and the rate of interests in US will decrease!

The American traders are unsatisfied. Where does he get the money if the interest rate is

falling? They need a lot of bonds to get profits.

2: What is expansionary monetary policy? The expansionary monetary policy consist in an introduction of a

lot of liquidity by the Central Bank in order to revive the economy.

NB: the federal funds rate is the discount rate!

If the discount rate decreases, the cost of liquidity for banks

decreases, the cost of credit for client decreases, investments

increases and the economy revives.

2000: DOT.COM crisis; many investors decided to move capital to

internet­based companies (that economy was growing too fast).

When some of these companies failed, everybody wanted to sell

shares. The Central Bank decided to decrease the FFR in order to

avoid panic selling.

After 2008, the discount rate was flat to 0; 2001: Twin Towers attack; Wall Street was closed for 3 days to

this should have been stimulated avoid economy collapse.

commercial banks to borrow money but this

did not happen. Therefore, the monetary transmission mechanism (increasing/decreasing the

interest rate) was DEAD. Easing”.

So, Central Banks started to use an unconventional tool, called “Quantitative

3: De­Regulation

1933, Banks were divided into two categories

INVESTMENT BANKS COMMERCIAL BANKS

Have the right to invest (any expenditure by a firm Collect liquidity through checking accounts (even if

to increase its production capacity is considered a big portion goes to Central Banks)

an investment; any other expense is not) Cannot invest or buy financial assets; they can

Cannot open checking accounts only buy treasure bills or lend money

The Central Bank is not “lender of the last resort”;

Lehman Brothers got shut down because it could

not get liquidity anywhere and could not ask to the

CB

During years, commercial banks asked to the legislator (US Congress) the possibility to invest;

investment banks asked instead the possibility to open checking accounts. NO AND NO!

Universal Banks

After 60 years of struggle, the legislator gave up the born

Everyone started to act risky, especially when the interest rate were low (“unprofessional

behaviour of the banking system).

4: (Read something on google)

Financial Innovation

A few years ago, a new profession was invented: the FED WATCHER; they control the FED,

read every document the FED writes and study its behaviour.

If the FED is going to (or if I think that) increase the interest rate on bonds, I will sell European

ones taking €, I will change them in $ and then I will buy US Treasury Bills because they have

EXPECTATIONS

a high interest rate. EVERYTHING HAS TO DO WITH !

If we have an excess demand of US Treasury Bills, the $ is appreciating (I need more foreign

currency to have 1$).

_____________________________________________________________________

THE WORLD ECONOMY AFTER THE RENMINBI DEVALUATION

What is a devaluation?

Monetary policy tool of countries. It is a deliberate adjustment of the value of a country's

currency, relative to another currency, group of currencies or standard.

In 2015, the Central Bank of China surprised markets with three consecutive devaluations of

the Renminbi, decreasing its value with over 3%. The PBOC claimed they wanted to make the

exchange system more market­oriented. The Renminbi has a heavy influence from the USD,

which has been appreciating. Meanwhile, currencies of other developing countries are falling

(South China Morning Post), making China’s exports more expensive and thus less

competitive.

Devaluation implies a lower exchange of Renminbi per unit of foreign currency, making China’s

exports cheaper. Other developing countries’ exports in turn become less competitive.

_____________________________________________________________________

What happens when a crisis like this shows up?

Mainly, the GDP decreases!

In 2007, high per capita income countries were damaged by the crisis; low per capita income

countries “took advantage” from the crisis itself.

What can Policy Makers (Governments and Central Banks) do about that?

It depends on the economy theory they believe in; in any case, policy makers can do

something to revive an economy that is in recession. To understand what, let us introduce the

concept of NATION STATE.

A place will be called like this, if the authority on that place can manage 4 things:

COMMERCIAL POLICY: All legislative measures a government can take to regulate

1. the flow of goods and services with the rest of the world (international trade). Ex: Tax on

import to stimulate Made in Italy

NB: 28 European countries have no commercial policy anymore.

EXCHANGE RATE

2. NB: 19 of 28 countries do not have their own currency or Central Bank.

MONETARY POLICY

3. Setting interest rates, stimulate credit…

NB: 19 of 28 countries do not have these privileges.

FISCAL POLICY (GOVERNMENT)

4. Spend

- Tax

-

These are the two task of a government.

So, what may Central Banks and Governments do to face a crisis?

CENTRAL BANKS:

Injecting liquidity into the system at a low price

- Decreasing interests rate

-

GOVERNMENTS: Expansionary Collect more taxes or

Spend

- Monetary Issue more bonds

Tax

- Policy

If a government spends more than what it has:

DEFICIT SPENDING (portion of expenses in excess related to taxes incomes.

During the last crisis, China and USA kept spending over years and managed to re­

increase their GDP. We needed a positive shock by a huge country and the choice felt on

China (who had been asked to spend a lot); China exploited the possibility of deficit spending,

investing mostly on infrastructure (in order to stimulate producer to move to their country).

What about USA?

Here are some bipartisan decision taken by the Congress (2008):

Tax cuts (288 billion$)

• Local tax cuts (144 billion$)

• Infrastructure (111 billion$)

• Healthcare (53 billion$)

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In 2012, tax relief in USA:

Tax cuts on individual (375 billion$)

• Bonus depreciation for machinery and equipment (200 billion$)

• Tax cuts for enterprises (111 billion$)

• Unemployment benefits (56 billion$)

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The professor does not believe in tax cuts because money savings detract from aggregated

demand (subtract power from the economy). YOU SAVE? YOU ARE DAMAGING

SOMEBODY!

China and USA acted a lot in favour of aggregated demand (it represents the demand of goods

and services of the total economic system (households, firms, governments…) in a given

period. Therefore, it also represents the potentiality of exploiting the total production capacity of

an economic system.

Some data:

Deficit spending USA: 5,6% of GDP Deficit spending China: 16,1% of GDP

European governments have chosen to cut their spending (Austerity)

NO SENSE CHOICE UNLESS I AM AN

Tragic results (GDP, Unemployment rate…)

INDIVIDUAL/HOUSEHOLD. Europe is still in recession due to austerity choices.

1€ NOT SPENT 1 € SAVED 1 JOB LOST

NB: A person is considered unemployed when is not working but is actively looking for a job.

NB2: Policy makers do not make choice in favour of the whole country; they want to make

happy all the social groups that are going to support them (ELECTIONS)

What happened in Greece in 2009?

Greece went to elections after the resignation of its prime minister. Fitch (one of the debt

evaluation agencies as Standard & Poor’s and Moody’s) “attacked” Greece assigning its bonds

a certain degree of risk. IF IT IS TOO LOW (TRUSTWORTHY ECONOMY) THE INTERESTS

ARE LOW. Well, Fitch did not consider Greece trustworthy (high risk). Everyone sold Greek

bonds avoiding price decreases (that is what we call “Market Effect”.

Why did they sell? Besides the fear of price decreases, institutions usually have some

guidelines in the choice of their portfolio (for example, they are not allowed to own bonds with a

rating less than AAA).

So, institutions and individuals sold their bonds:

The price of bonds DECREASED

The interest on them INCREASED (today in Greece 35%; in Poland 2,7%)

Short selling

What happened to bonds?

Tali titoli, solitamente forniti da una banca o da un intermediario finanziario, durante lo short

selling vengono istantaneamente prestati dal loro fornitore al venditore allo scoperto (chiamato

anche scopertista o short seller oppure venditore a nudo) e quindi subito venduti da

quest'ultimo. Pertanto la vendita allo scoperto si configura come un prestito non di denaro

bensì di titoli e, come solitamente accade in quello di denaro, vi è un interesse da

corrispondere al datore del prestito. L'ammon