US CRISIS AND THE DOLLAR PRESENTED BY AKHIL CHAWLA AMAN ANAND DIPANNITA SEN DIPIKA TOSHINWAL MEGHA JAGGI
OUTLINE US CRISIS- REASONS. CURRENCY – US DOLLAR AND THE EURO. STEPS TAKEN BY THE CENTRAL BANK. MULTILATERALISM AND SUGGESTIONS GLOBAL IMBALANCES AND COCLUSIONS.
HOW IT ALL HAPPENED?? Printing of money for deficit financing Home Loans Mortgage backed securities Credit Default Swaps Collateral Market Obligation Collateralized Debt Obligation
TO RECAP, BY THE BEGINNING OF 2007: Home prices were at unprecedented levels. Home owners had more leverage than ever before. Mortgage quality had declined substantially. Asset-backed securitizations had spread well beyond the GSES. This sets the stage for the crisis.
US DOLLAR AND THE EURO
Crisis has broken the close correlation between differences in expected interest rates and the euro-dollar exchange rate. Sharp increase in risk aversion.
FLIGHT OF CAPITAL CAUSED BY:
Interest Rate Risk
Exchange Rate Risk
CENTRAL BANKS-RUNNING THE SHOW
ENDLESS SUPPLY OF MONEY End of the Bretton wood system in 1971 New paper standard TARP agreement Creating assets out of thin air
PRINTING CURRENCY A GLOBAL TREND
MISTAKES MADE BY FED lowered the interest rates to 1% in 2001 to soak the liquidity of the world after the dotcom bubble. The second is they tighten the rates too timidly in 2004 to 2006 first mistake again as they have lowered the fed funds rate again to 1% to get a solution for present day financial panic
DEBT TO GDP RATIO
OTHER FACTORS Rise in savings of emerging economies
BANK FOR INTERNATIONAL SETTLEMENTS Outstanding global contracts at the end of 07 $600 trillion Approximately 11 times the global GDP in 2005 it was merely 2.5 times Credit DEFALUT swaps alone had reached to 60 trillion dollars in a span of 12-15 years
MULTILATERALISM: The world needs coordinated policy that reaches beyond the financial system alone. The Fed, the ECB and Bank of England are flooding financial markets with the liquidity, lending heavy sums against all sorts of securities. Unfortunately, the central bankers alone can’t sort out this mess with the injections of liquidity.
QUANTITATIVE EASING: Lowering long and short term interest rates. Buying private asset. Fiscal authorities can run a deficit of any size they wish and then finance it by issuing short-term paper that the central bank would have to buy. Once inflation returns, the central bank will need to sell assets into the market, to mop up the excess money it has created in fighting deflation.
Restructure and Shrink the banking system. Governments must continue to facilitate the enormous task of sustaining credit flows and restructuring debt. The full force of fiscal policy needs to be deployed to contain the depth of the recession and credit losses and the impact on jobs and incomes.
GLOBAL IMBALANCES AND CONCLUSION
Imbalance between lending and borrowing between different countries
Temporary solution -government will replace private sectors as borrowers
Permanent solution- global economy will have to rebalance
If the surplus countries don’t expand the domestic consumption, the world economy may even break down.
Big Surplus countries are - China, Germany and Japan
Deficit countries are -US, Spain, UK, France, Italy and Australia
GLOBAL IMBALANCES CONT…. In 2008, according to IMF the aggregate excess of savings over investment in surplus countries will be just over $2 trillion In the entire world has surplus of $350 billion. Global Imbalance Crisis The world economy is to get through this crisis in reasonable shape if creditworthy surplus countries expand their domestic demand relative to the potential output
CONCLUSION : WHAT LIES AHEAD $8 trillion sufficient for debt contraction ? Solvency crisis not liquidity Rare crisis is the evident mispricing of convertible bonds The wide spreads prevailing at present between Treasury’s and corporate claims. No investment asset is considered as “Safe”- Government securities have become “toxic” like mortgages and corporate bonds
SOMETHING TO THINK ABOUT??? The entire world today has a surplus of $350 billion how is it possible?