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Part 9 milan finance class summer 2010 forum nexus


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Part 9 milan finance class summer 2010 forum nexus

  1. 1. Class #9 Milan 2 nd class
  2. 2. Brian David Butler Professor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan . Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes at the university Faculdade Boa Viagem . A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America. [email_address] LinkedIn/briandbutler Skype: briandbutler
  3. 3. Brian Butler is a specialist in international economic analysis, and is founder of the prestigious “GloboTrends“ ( ) online economics site, which has been featured as syndicated content on Nouriel Roubini’s RGE Monitor,, Business Week Exchange,, and other leading news outlets. http:// / , http:// /
  4. 4. Find my slides: <ul><li> </li></ul>
  5. 5. Lecture Schedule* * Does not include professional visits, *Subject to change, modification without warning <ul><li>Tues 22 th – boat to Greece </li></ul><ul><li>Mon 26 th – Athens </li></ul><ul><li>Tues 27 th – Rhodes </li></ul><ul><li>Wed 28 th – Rhodes </li></ul><ul><li>Thurs 29 th – Rhodes EXAM </li></ul>
  6. 6. Team Project <ul><li>Due date: last class before Final Exam </li></ul><ul><ul><li>3 week – Tues July 20 th </li></ul></ul><ul><ul><li>4 week – Wed July 28 th </li></ul></ul><ul><ul><li>Team project 25% of final grade </li></ul></ul><ul><ul><li>Peer review </li></ul></ul>
  7. 7. Italy – analysis <ul><li>Had 50 governments in 45 years </li></ul><ul><li>Gov’t seen as trouble, corrupt </li></ul><ul><li>Business learned how to get around + avoid </li></ul><ul><li>Berlusconi = 1 st president since 1948 to last all 5 years. Seen as break from tradition of corruption, seen as “professional” class, rich enough doesn’t need $ </li></ul><ul><li>Criticisms (from outside Italy) – press controls – Berlusconi controls all private TV, and state TV, so all you hear comes from same sorce </li></ul>
  8. 8. “ P.I.I.G.S”, A special report on the euro area, One size fits none, Jun 11th 2009
  9. 9.
  10. 10. Threaten the Euro? <ul><li>A steady accumulation of current-account deficits has left Greece, Portugal and Spain with net foreign debts of 80-100% of their GDP. These frailties are a threat to the stability of the euro area as a whole. </li></ul>, A special report on the euro area, One size fits none, Jun 11th 2009
  11. 11. Italy + debt – Similarity to Greece
  12. 12. Italy + debt – Similarity to Greece <ul><li>With a public debt of 115 percent of GDP and interest rates near 4 percent, Italy must spend about 4.5 percent of GDP a year just on interest—the equivalent of its public education budget this year. </li></ul>
  13. 13. Italy + debt – Similarity to Greece <ul><li>“ even if public revenues are able to cover all expenditures, interest costs will still lead Italy’s debt to grow faster than its sluggish economy—which consensus expects to grow at an average annual rate of 3 percent in nominal terms over the next seven years. </li></ul>
  14. 14. Italy + debt <ul><li>Since Italy’s debt is of relatively short maturity , Italy is potentially more vulnerable than other countries to a change in market sentiment. </li></ul>
  15. 15. discuss “How related?” <ul><li>Fiscal budget crisis in Europe (Greece, PIIGS) </li></ul><ul><ul><li>and </li></ul></ul><ul><li>Credit Crisis in USA (Lehman Bros failure, TARP, bailouts, etc) </li></ul><ul><ul><li>Are they related? How? </li></ul></ul>
  16. 16. Summary of problem + why important <ul><li>In recent history: </li></ul><ul><ul><li>First came the global economic crisis 2007-(10+?) </li></ul></ul><ul><ul><li>Contraction of credit, deleveraging </li></ul></ul><ul><ul><li>Governments step up to fill void of missing consumer demand – deficit spending, Keynes, stimulus </li></ul></ul><ul><ul><li>Credit continues to contract – less money to go around </li></ul></ul><ul><ul><li>Creditors punish weak countries with external funding requirements – Greece is 1 st in line (but likely not the last) </li></ul></ul>
  17. 17. External funding + current accounts <ul><li>Lesson from past- current account deficits = dangerous </li></ul><ul><li>Reliance on funding from foreigners </li></ul><ul><li>Short term funding </li></ul><ul><li>Pay off rolling debts </li></ul><ul><li>But, what happens if funding dries up? </li></ul><ul><ul><li>This is what happened to Lehman Bros in credit crisis (and Bear Stearns, etc) </li></ul></ul><ul><ul><li>It is also what happed to Greece </li></ul></ul>
  18. 18. What do these have in common?... Greece rolling over its debts EU banks borrowing from ECB Lehman Bros failure Investment Banking business model
  19. 19. <ul><li>All rely on short term money markets (borrow short) , re-financing short term debt, and took for granted that they could access cheap short term capital to finance longer term debt (or investments) </li></ul>
  20. 20. 0 3 6 9 12 months… Keep tapping short term borrowing (debt) markets, again and again. Works if… you can borrow at low rates AGAIN in the future … ..
  21. 21. Themes – 3 dangers <ul><li>Danger in borrowing abroad in foreign currencies </li></ul><ul><li>Danger in relying on short term finance – especially when foreign capital involved </li></ul><ul><li>Danger in changing rules of finance </li></ul><ul><li>* Solution: be aware, and hedge to protect! </li></ul>
  22. 22.
  23. 23. Revolving debts… <ul><li>For Spain… </li></ul><ul><li>‘ The July bond redemption of 16.2 billion euros is the last until April 2011, </li></ul><ul><li>leaving 32 billion euros of maturing treasury bills spread out over the rest of the year. </li></ul>
  24. 24. Credit Crunch = Result Assumes that short term markets will continue being LIQUID (will keep spinning, full of flowing cash) But, what happens if short term markets freeze up? This is what happened after Lehman Bros. failed (and almost happened again with Greece)…
  25. 25. Borrow LOW – Lend HIGH * rates Borrow LEND 1% 5% “ Carry Trade” - Make money on ‘spread’ Works well unless…
  26. 26. Borrow LOW – Lend HIGH * rates Borrow LEND 1% 5% LOSS!! What if borrow is also = short term , and what if the rates suddenly go UP?!?! 10%
  27. 27. But, how do you measure the health of the short-term credit markets? What indicators should you watch? Libor, OIS-spread, Credit Default Swaps
  28. 28. SPREAD Source: NY Times “Euro burdons some nations”, Jan 2009
  29. 29. Yield Premium <ul><li>The extra interest investors demand to hold Spanish debt rather than equivalent German bonds narrowed to 206 basis points . That spread surged to 221 yesterday, the highest since before the start of the euro, on speculation in the press that Spain would need to tap a European Union financial lifeline. The gap compared with 160 basis points at the end of May . </li></ul>
  30. 30. Yield spread vs. Germany
  31. 31. IMF involved … why?
  32. 32. <ul><li>Question for Class: </li></ul><ul><li>Why do you think the IMF should be involved in Greece (or any European) bail-out?? </li></ul>
  33. 33. Purpose of European Experiment… <ul><li>Nothing to be gained by having Greeks angry at Germans… </li></ul><ul><li>We need another “Bad-Guy” </li></ul><ul><li>But, who?? </li></ul>
  34. 34. The “bad-guy” we need Greeks to hate * Better than being angry at Germany!
  35. 35. Greece, Germany, EU + IMF <ul><li>Why did Germany wait so long to agree to the Greek bailout? Why did they want IMF involved? </li></ul>
  36. 36. Does the world need the IMF to be the “bad guy” in Europe? How about in SE Asia?
  37. 37. Legacy of the Crises (2 lessons) <ul><li>Danger in capital flows </li></ul><ul><ul><li>avoid current account deficits </li></ul></ul><ul><ul><ul><li>Result: countries try to run current account surplus + capital account deficits (sending $ abroad) </li></ul></ul></ul><ul><ul><ul><li>Due to FEAR (of current account deficits) money flows from poor to rich </li></ul></ul></ul><ul><li>Avoid IMF </li></ul><ul><ul><li>Conditionalities unpopular </li></ul></ul><ul><ul><ul><li>How to avoid the IMF? </li></ul></ul></ul><ul><ul><ul><li>Focus on self-insurance (build up own stock pile of reserves) </li></ul></ul></ul><ul><ul><ul><li>reserves </li></ul></ul></ul>Martin Wolf book, “Fixing Global Finance”
  38. 38. Legacy of the Crises - #1 (danger in capital flows) <ul><li>Goal: keep FX undervalued for: </li></ul><ul><ul><li>Avoid risk of devaluation in future (don’t get caught with debts in foreign currency) </li></ul></ul><ul><ul><li>Exports to increase </li></ul></ul><ul><ul><li>Avoid Current account deficit (keep imports low, exports high) </li></ul></ul><ul><ul><li>Never have to call on the IMF!!! </li></ul></ul>Martin Wolf book, “Fixing Global Finance”
  39. 39. <ul><li>“ currencies either pegged to the dollar or more or less actively managed against it (a group that includes Japan)” </li></ul><ul><ul><ul><li>Oil Exporters </li></ul></ul></ul><ul><ul><ul><ul><li>Bahrain </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Oman </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Qatar </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Saudi Arabia </li></ul></ul></ul></ul><ul><ul><ul><ul><li>UAE (Dubai included) </li></ul></ul></ul></ul>The “dollar bloc” <ul><ul><ul><li>China </li></ul></ul></ul><ul><ul><ul><li>Hong Kong </li></ul></ul></ul><ul><ul><ul><li>Taiwan </li></ul></ul></ul><ul><ul><ul><li>Japan </li></ul></ul></ul><ul><ul><ul><li>Singapore </li></ul></ul></ul><ul><ul><ul><li>Malaysia </li></ul></ul></ul><ul><ul><ul><li>Thailand </li></ul></ul></ul><ul><ul><ul><li>India </li></ul></ul></ul><ul><ul><ul><li>Others: Ecuador, Panama, more…. Used to be Argentina! </li></ul></ul></ul><ul><ul><ul><li>Sources: figure 6.6 from Wolf “Fixing Global Finance” </li></ul></ul></ul><ul><ul><ul><li>And,, May 23 2009, “Monetary Union in theGulf” </li></ul></ul></ul>
  40. 40. Competitive Devaluations Dr. Kishore Dash, January 20, 2007 Beggar thy neighbor
  41. 41. Legacy of the Crises – part 1 <ul><li>And, if ALL are determined to run current account surpluses…. </li></ul><ul><li>Question: </li></ul><ul><ul><li>Who MUST run current account deficits (remember, by definition SOMEONE must)!! </li></ul></ul>Martin Wolf book, “Fixing Global Finance”
  42. 42. Legacy of the Crises – Part I <ul><li>Answer: </li></ul><ul><li>The ONLY country on the planet that was willing and ABLE to run deficits (on a large scale) was the USA </li></ul>Martin Wolf book, “Fixing Global Finance”
  43. 43. What is unique about the USA? <ul><ul><li>Why is the US able to run large current account deficits? </li></ul></ul><ul><ul><li>If current account deficit = crisis, and if the USA has current account deficit for more than 20+ years why no crisis in USA? </li></ul></ul>
  44. 44. Devalue currency <ul><li>If the US were to devalue its currency… </li></ul><ul><li>“ an elegant, painless, and entirely legal way for the US to default” (without actually defaulting) </li></ul>Martin Wolf book, “Fixing Global Finance”
  45. 45. <ul><li>No threat of solvency crisis: </li></ul><ul><li>The US does NOT face a “ solvency ” crisis in the foreseeable future (due to excessive borrowing from abroad) </li></ul><ul><li>Who can explain this? </li></ul>
  46. 46. If devaluation of the US dollar… <ul><li>“ US…runs no danger of adverse currency mis-matches. …In the US, “currency mismatches work in exactly the opposite direction; the country has assets denominated in foreign currency and liabilities denominated in domestic currency… The more unwilling the rest of the world is to hold the dollar, the more solvent the US becomes” </li></ul>Martin Wolf book, “Fixing Global Finance”
  47. 47. The US Balance Sheet: (just looking at external financing) <ul><li>Assets </li></ul><ul><ul><li>Foreign currency </li></ul></ul><ul><ul><ul><li>Investment abroad </li></ul></ul></ul><ul><ul><ul><li>FDI </li></ul></ul></ul><ul><ul><ul><li>Portfolio </li></ul></ul></ul><ul><ul><ul><li>Earning foreign currency </li></ul></ul></ul><ul><li>Liabilities </li></ul><ul><ul><li>Local currency </li></ul></ul><ul><ul><ul><li>Foreign gov’t buy US Treasuries is US dollars! </li></ul></ul></ul>So, what happens if US dollar “depreciates”? (does US become more, or less “Solvent”?)
  48. 48. Solvency v Liquidity <ul><li>Insolvent: liabilities > assets (equity = 0) </li></ul><ul><ul><li>Person: I owe more than Im worth </li></ul></ul><ul><ul><li>Bank: assets loose value (subprime mortgages) </li></ul></ul><ul><ul><li>Country : cant pay debts…default </li></ul></ul>So, what happens if US dollar “depreciates”? (does US become more, or less “Solvent”?)
  49. 49. If devaluation of the US dollar… <ul><li>“ US liabilities that are denominated in currency units are measured in the countries own currency” </li></ul><ul><li>“ if it wishes to improve its balance sheet position (and so its solvency), all the US needs to do is allow the value of the dollar to fall against other currencies” </li></ul>Martin Wolf book, “Fixing Global Finance”
  50. 50. US Balance Sheet: with Depreciation of US currency <ul><li>Assets </li></ul><ul><ul><li>Foreign currency </li></ul></ul><ul><ul><ul><li>Investment abroad </li></ul></ul></ul><ul><ul><ul><li>FDI </li></ul></ul></ul><ul><ul><ul><li>Portfolio </li></ul></ul></ul><ul><ul><ul><li>Earning foreign currency </li></ul></ul></ul><ul><li>Liabilities </li></ul><ul><ul><li>Local currency </li></ul></ul><ul><ul><ul><li>Foreign gov’t buy US Treasuries is US dollars! </li></ul></ul></ul>If US dollar DEPRECIATES… US becomes MORE solvent!
  51. 51. Exorbitant privilege <ul><li>“ exorbitant”: </li></ul><ul><li>Back in 1965, Valery Giscard d’Estaing, then French finance minister, described the ability of the US to borrow cheaply and without limit in its own currency as an “ exorbitant privilege ” </li></ul>
  52. 52. Real threat to the USA <ul><li>Might loose “exorbitant privilege” </li></ul><ul><li>“ You Don’t know how luck you are, babe” </li></ul><ul><ul><li>Able to borrow (seemingly) unlimited </li></ul></ul><ul><ul><li>In own currency </li></ul></ul><ul><ul><li>At a very low rate </li></ul></ul><ul><ul><li>(and invest abroad at higher returns, and run NO risk of insolvency!) </li></ul></ul>
  53. 53. Why US needs this privilege (low rates, in own currency) <ul><li>Currently Funding </li></ul><ul><ul><li>2 wars. </li></ul></ul><ul><ul><li>Economics stimulus </li></ul></ul><ul><ul><li>Economic recovery </li></ul></ul><ul><ul><li>Massive Current account deficit </li></ul></ul><ul><li>Future </li></ul><ul><ul><li>Social Security / Health care reforms </li></ul></ul>
  54. 54. Demographics & the Debt By 2050; a third of the rich world’s population will be over 60 “ The demographic bill is likely to be (10x) ten times bigger than the fiscal cost of the financial crisis.” The Economist, June 2009
  55. 55. International IQ moment What is happening in Greece? - discussion
  56. 56. Athens Greece Athens Greece – at the heart of a European Crisis?
  57. 57. Athens Greece <ul><li>What is happening in Greece? – </li></ul>
  58. 58. Important notes Upcoming schedule
  59. 59. Lecture Schedule* * Does not include professional visits, *Subject to change, modification without warning <ul><li>Tues 22 th – boat to Greece </li></ul><ul><li>Mon 26 th – Athens </li></ul><ul><li>Tues 27 th – Rhodes </li></ul><ul><li>Wed 28 th – Rhodes </li></ul><ul><li>Thurs 29 th – Rhodes EXAM </li></ul>
  60. 60. Start studying for the exam now!! Find my slides: <ul><li> </li></ul>
  61. 61. Team Project <ul><li>Due date: last class before Final Exam </li></ul><ul><ul><li>3 week – Tues July 20 th </li></ul></ul><ul><ul><li>4 week – Wed July 28 th </li></ul></ul>
  62. 62. <ul><li>How to turn in: </li></ul><ul><li>- either (hand written, neatly!) or computer, email: </li></ul><ul><li>Resources: </li></ul><ul><ul><li>Lectures </li></ul></ul><ul><ul><li>Text Book: “An Introduction to Global Financial Markets” (Valdez), chapter 11, “European Economic and Monetary Union” 2007, (suggested focus: p. 287-305). Pay special attention to “EMU – the benefits” – p 287, and “The counter arguments” – p289 </li></ul></ul><ul><ul><li>Handout article: “Holding Together, A special report on the euro area”, from the Economist, June 13 th 2009 (p 1-16) </li></ul></ul><ul><ul><li>* Grad Students only: </li></ul></ul><ul><ul><li>Read handout: “Country Forecast, Economies in Transition, Eastern Europe”, from EIU, May 2009 (p. 5-10) </li></ul></ul>Group Project, “The Euro Zone – before, during and after the Global Economic Crisis”
  63. 63. <ul><li>Grading: </li></ul><ul><li>30% of final grade for course </li></ul><ul><li>comparative (one team compared to others) </li></ul><ul><li>there is no “right answer”, but grading will be based upon: </li></ul><ul><ul><li>Cover all required topics </li></ul></ul><ul><ul><li>Answer the questions asked </li></ul></ul><ul><ul><li>Additional insights </li></ul></ul><ul><ul><li>Strength of arguments (pro / con) </li></ul></ul><ul><ul><li>Depth of analysis </li></ul></ul><ul><ul><li>Be concise! </li></ul></ul><ul><ul><li>Ability to capture “heart” of issue </li></ul></ul>Group Project, “The Euro Zone – before, during and after the Global Economic Crisis”
  64. 64. Assigned Readings <ul><li>Martin Wolf book </li></ul><ul><ul><li>First three Chapters </li></ul></ul><ul><ul><li>Plus…other mini readings to be assigned later </li></ul></ul><ul><li>Finance book </li></ul><ul><ul><li>Chapter 9 – foreign exchange </li></ul></ul><ul><ul><li>Chapter 11 - European Economic and Monetary Union </li></ul></ul><ul><ul><li>Switzerland – p 288 </li></ul></ul><ul><ul><li>Euro – p 289, p304 </li></ul></ul><ul><li>Optional additional reading </li></ul><ul><ul><li>Chapter 2 – banking background p30-38 </li></ul></ul><ul><ul><li>Chapter 6 – the money and bond markets </li></ul></ul><ul><ul><li>Chapter 12 – traded options </li></ul></ul><ul><ul><li>Chapter 13 - Futures </li></ul></ul>