From (US) financial crisis to eurocrisis: Why are       American houses connected to        Europes internal imbalances?  ...
Everything you need to know…
Euroland: an Optimal Currency Area?• Euro only works if Europe is an OCA• OCA needs:  – Essentially open financial markets...
Productivity vs average wage and average    income of top 1%, in US, 1979+
Rising US household debt compared to               incomes                               1:1                              ...
The 1991-2007 US growth cycle     Fed ↓ interest rates                                   ↑ Tax revenueDisinflation       H...
China’s growth cycle, 2000s                        ↓ domestic                       consumptionLow interest ratesNo welfar...
The 1995-2000s German growth trap                 Tight money                                   ↓ Tax revenue             ...
The 1995-2000s German growth trap        Tight money           policy                                 ↓ Tax               ...
All these cycles are linkedCHINA       USA         GERMANY
Euro16 balance with select countries (€bil)200                            100150                            80            ...
Germany produces but does not consume– final consumption expenditure growth as   % of German growth (Germany = 100) 240%  ...
Germany’s trade surpluses (€ bil)140120100 80 60 40                       Germany to EU27 20                       Germany...
EU member interest rates 1995 - 2011          EURO         Lehman          introduced   crash
Taylor rule interest rates
Export growth, xEU27, index, 1999 = 100300250200                                 Germany                                 S...
Import Growth xEU27, index, 1999=100350300250                                Germany200                             Spain ...
EU internal trade balances, € mils      More imports = rising “foreign” debt300,000250,000200,000150,000                  ...
External trade balance, € mils100,000 50,000      0           1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ...
US trade deficit (goods only, disaggregated, $bil.)200100  0                                          EU x Germany-100    ...
Central bank currency swap network                      2007-2010     FIG 6: Central Bank Currency Swap Network, 2007-2010
$100,000                                          $300,000                                                     $400,000   ...
EU member interest rates 1995 - 2011          EURO         Lehman          introduced   crash
Crisis Fiscal deficits (not the reverse) 4                                           Sweden                              ...
What if Greece (Spain) defaults?
Who owes and to whose banks1600                                   3501400                                   3001200       ...
The eurozone is a straw house
QUESTIONS?
Intra-EU debt, absolute, $bil. @ 3/111600140012001000                                                   ROW800            ...
Why the ECB won’t ease rates: Ideas[We are] calling upon [the] social partners to show a high level of  responsibility. . ...
…and Mario Draghi“The risk of inflation is rising. There is now  a greater need to proceed with  monetary policy normaliza...
Employment gains, 1991-2005           Share of OECD Population, 2005, %           Share of New Jobs, %60%50%40%30%20%10%0%
SIVs (phase 1 – money for nothing)             $640 in             Interest             RoE = 64%   SIV                   ...
SIVs (phase 2 – loan contraction)        Bank must        put in $60                              ABCP                    ...
SIVs ( phase 3 – bank collapses)                                     MMF wants whole                                     l...
Why SIVs’ collapse => AIG collapseBank              SIV                  MMF -$1000                                  ABCP ...
Ormand Quay (Sachsen Landesbank’s            gambling unit)Assets Balance Sheet, July 2007 term                      Liabi...
Adjustment
Adjustment            What?Trade                  TradeDeficit                SurplusCountry                Country       ...
Adjustment via labor flow          OutmigrationTrade                    TradeDeficit                  SurplusCountry      ...
Adjustment via time             FutureTrade        Exports                            TradeDeficit                     Sur...
Adjustment via exchange rate          Devaluation           moreTrade     exports       TradeDeficit                 Surp...
Adjustment via wage declines (1) Trade                   Trade Deficit Country (1)                         Surplus        ...
Adjustment via wage declines (1)                           Trade   Trade   Deficit                 Surplus   Country (1)  ...
Adjustment via wage declines (1)   Trade                   Trade   Deficit                 Surplus   Country (1)          ...
Adjustment via wage increases (2)Trade                        TradeDeficit                      SurplusCountry            ...
Adjustment via wage increases (2)          (2) Imports          more, exports TradeTrade          less          SurplusDef...
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Herman Schwartz UNC-CH 20121116

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From (US) financial crisis to euro crisis: Why are American houses connected to Europe's internal imbalances?: Presentation for UNC Center for European Studies Fall Lecture Series 2012, Beyond the Euro Crisis

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Herman Schwartz UNC-CH 20121116

  1. 1. From (US) financial crisis to eurocrisis: Why are American houses connected to Europes internal imbalances? Herman Schwartz University of Virginia 16 November 2012 UNC Chapel Hill / TAM
  2. 2. Everything you need to know…
  3. 3. Euroland: an Optimal Currency Area?• Euro only works if Europe is an OCA• OCA needs: – Essentially open financial markets (Yes) – Essentially open goods markets (Mostly, but…) – High internal labor mobility (No) – High fiscal transfers (No) – And – same ideas about proper policy• Result: regional instabilities that are magnified by national political structures
  4. 4. Productivity vs average wage and average income of top 1%, in US, 1979+
  5. 5. Rising US household debt compared to incomes 1:1 ratio
  6. 6. The 1991-2007 US growth cycle Fed ↓ interest rates ↑ Tax revenueDisinflation Housing Finance More Consumption SystemAsia RecyclesUS Dollars as new Faster USTreasury / MBS Debt Economic Growth US trade deficits  Global Growth
  7. 7. China’s growth cycle, 2000s ↓ domestic consumptionLow interest ratesNo welfare state State More investment Banks & for exports party Central bank elites Sterilizes $$ Issuing RMB Trade Surplus Central Bank buys $$
  8. 8. The 1995-2000s German growth trap Tight money ↓ Tax revenue policyWage restraint Low Domestic Less Domestic Demand ConsumptionSlower jobcreation Slower relative economic growth Less domestic investment
  9. 9. The 1995-2000s German growth trap Tight money policy ↓ Tax revenue German banks buy PIGS debtWage restraint Low Domestic Less Domestic Demand Consumption Export surplus Slower job creation Slower relative economic growth German banks Less domestic investment buy US Mortgage bonds
  10. 10. All these cycles are linkedCHINA USA GERMANY
  11. 11. Euro16 balance with select countries (€bil)200 100150 80 Norway100 60 Turkey 50 40 Japan Poland 0 20 Switzerland -50 0 Russia ChinaxHK-100 -20 United States United Kingdom-150 -40 EU 16-200 -60-250 -80
  12. 12. Germany produces but does not consume– final consumption expenditure growth as % of German growth (Germany = 100) 240% Ireland Greece Spain Italy Portugal 220% 200% 180% 160% 140% 120% 100% 80% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
  13. 13. Germany’s trade surpluses (€ bil)140120100 80 60 40 Germany to EU27 20 Germanyto ROW 0
  14. 14. EU member interest rates 1995 - 2011 EURO Lehman introduced crash
  15. 15. Taylor rule interest rates
  16. 16. Export growth, xEU27, index, 1999 = 100300250200 Germany Spain150 France Netherlands10050
  17. 17. Import Growth xEU27, index, 1999=100350300250 Germany200 Spain France150 Netherlands10050
  18. 18. EU internal trade balances, € mils More imports = rising “foreign” debt300,000250,000200,000150,000 Netherlands Germany100,000 France 50,000 Greece United Kingdom 0 Italy 1999 2000 2001 2002 2003 2004 2005 2006 2007 -50,000 Spain-100,000-150,000-200,000
  19. 19. External trade balance, € mils100,000 50,000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Germany -50,000 France Italy-100,000 Greece United Kingdom-150,000 Netherlands Spain-200,000-250,000-300,000
  20. 20. US trade deficit (goods only, disaggregated, $bil.)200100 0 EU x Germany-100 Lat. America Canada-200 Rest of world-300 Germany Japan-400 Middle East-500 China-600-700-800
  21. 21. Central bank currency swap network 2007-2010 FIG 6: Central Bank Currency Swap Network, 2007-2010
  22. 22. $100,000 $300,000 $400,000 $500,000 $600,000 $200,000 $02007-12-052008-01-02 Fig 5:2008-01-302008-02-272008-03-262008-04-23 Lehman2008-05-212008-06-18 bankruptcy2008-07-162008-08-132008-09-102008-10-082008-11-052008-12-032008-12-312009-01-282009-02-252009-03-252009-04-222009-05-202009-06-172009-07-152009-08-122009-09-09 Value Central Bank Currency Swaps With U.S. Federal Reserve2009-10-072009-11-04 Currency Swaps2009-12-02 (Weekly Average) -2009-12-30 of FED currency swaps ($mil) Multiplier = 1,000,0002010-01-27
  23. 23. EU member interest rates 1995 - 2011 EURO Lehman introduced crash
  24. 24. Crisis Fiscal deficits (not the reverse) 4 Sweden Denmark -1 2004 2005 2006 2007 2008 2009 2010 Germany Italy Netherlands -6 Euro area (16 countries) Spain United Kingdom-11 Greece-16
  25. 25. What if Greece (Spain) defaults?
  26. 26. Who owes and to whose banks1600 3501400 3001200 2501000 200 800 150 600 100 400 50 0 200 0 Spain Greece Portgual
  27. 27. The eurozone is a straw house
  28. 28. QUESTIONS?
  29. 29. Intra-EU debt, absolute, $bil. @ 3/111600140012001000 ROW800 ANY PIIGS FRENCH BANKS600 BRITISH BANKS GERMAN BANKS400200 0 ITALY SPAIN IRELAND PORTUGAL GREECE
  30. 30. Why the ECB won’t ease rates: Ideas[We are] calling upon [the] social partners to show a high level of responsibility. . . [I]t is clear that if one is not satisfied with the present level of unemployment, wage moderation should remain of the essence. . . [I]f you are in a position where there are doubts about your present level of cost competitiveness, then of course wage moderation remains absolutely of the essence.• Jean-Claude Trichet, 12 April 2007We have only one needle in our compass. That needle is price stability, our definition of price stability.• Jean-Claude Trichet, 7 August 2008
  31. 31. …and Mario Draghi“The risk of inflation is rising. There is now a greater need to proceed with monetary policy normalization so as to prevent expectations of higher inflation from becoming entrenched.”Mario Draghi, Bank of Italy’s annual meeting, May 2011
  32. 32. Employment gains, 1991-2005 Share of OECD Population, 2005, % Share of New Jobs, %60%50%40%30%20%10%0%
  33. 33. SIVs (phase 1 – money for nothing) $640 in Interest RoE = 64% SIV ABCP Bank $1,000 + (your money $1000 $19,000 = market money) $20,000 $19,000 dollars $760 in @ 4% $1400 in interest interest $20,000 of CDO and Payments from / or MBS Subprimeinvestment borrowers: $1400 @ 7%interest
  34. 34. SIVs (phase 2 – loan contraction) Bank must put in $60 ABCP SIVBank $1,000 + (your money$1000 $19,000 = market money) $20,000 $19,000 dollars $760 in @ 4% interest $20,000 of CDO and Payments from Only $700 in / or MBS borrowers fall: interest !! @ 7% $1400 => $700
  35. 35. SIVs ( phase 3 – bank collapses) MMF wants whole loan repaid SIV ABCPBank $1,000 + (your money$1000 $19,000 = market money) Bank must $20,000 $19,000 dollars put in $$$ $760 in @ 4% to cover re- interest payment of ABCP to $20,000 of Payments from MMF $700 in CDOs now borrowers fall: interest worth only $1400 => $700 $15,000 & foreclosures start => ↑ losses
  36. 36. Why SIVs’ collapse => AIG collapseBank SIV MMF -$1000 ABCP $20,000 of CDOs now Borrowers: worth only $20,000 mortgages $15,000 AIG $20,000 of CDS
  37. 37. Ormand Quay (Sachsen Landesbank’s gambling unit)Assets Balance Sheet, July 2007 term Liabilities (all short (guaranteed by Sachsen debt with maturity < 1Landesbank) month)Residential Mortgage ABCPBacked Securities $6.3 b $11.3 bCommercial MortgageBacked Securities $2.7 bConsumer Loans $0.5 bOther $1.8 b Total $11.3 b Total $11.3 b
  38. 38. Adjustment
  39. 39. Adjustment What?Trade TradeDeficit SurplusCountry Country Excess Exports
  40. 40. Adjustment via labor flow OutmigrationTrade TradeDeficit SurplusCountry Country Excess Exports
  41. 41. Adjustment via time FutureTrade Exports TradeDeficit SurplusCountry Country Excess exports (capital goods)
  42. 42. Adjustment via exchange rate Devaluation  moreTrade exports TradeDeficit SurplusCountry Country Excess Exports
  43. 43. Adjustment via wage declines (1) Trade Trade Deficit Country (1) Surplus Country Excess Exports
  44. 44. Adjustment via wage declines (1) Trade Trade Deficit Surplus Country (1) Country Excess Exports
  45. 45. Adjustment via wage declines (1) Trade Trade Deficit Surplus Country (1) Country Excess Exports
  46. 46. Adjustment via wage increases (2)Trade TradeDeficit SurplusCountry Country (2) Excess exports  Rising incomes in (2)
  47. 47. Adjustment via wage increases (2) (2) Imports more, exports TradeTrade less SurplusDeficitCountry Country (2) Excess exports  Rising incomes in (2)

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