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Global Financial Crisis: The Aftermath Kenneth Matziorinis, Ph.D., CMC Canbek Economics & McGill University AHEPA, Ottawa, January.

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Presentation on theme: "Global Financial Crisis: The Aftermath Kenneth Matziorinis, Ph.D., CMC Canbek Economics & McGill University AHEPA, Ottawa, January."— Presentation transcript:

1 Global Financial Crisis: The Aftermath Kenneth Matziorinis, Ph.D., CMC Canbek Economics & McGill University AHEPA, Ottawa, January 27, 2010

2 What Happened? )US Housing market went bust and real estate prices started falling )Prices of complex financial securities that were created by Wall Street to underwrite the housing market collapsed )Institutions that issued these assets along with the investors that bought them suffered huge losses in many cases exceeding the capital of these firms )Losses along with collapse in confidence in these products trigerred a financial meltdown starting from Wall Street and rapidly spreading to London, Continental Europe, Asia and the Rest of the World )With the global financial system on the verge of total meltdown, governments stepped in to avert mass panic and an economic collapse that would result in a global depression worse than that of the 1930s Low interest rates, high leverage and overconfidence led to the creation of bubbles which then burst Canbek Economics

3 What Did Governments Do? ) Governments responded swiftly and decisively to save the system from collapse based on the hard lessons that were learned in the 1930s by applying Keynesian economics ) Central banks stepped in and provided liquidity to the banking system allowing it to keep functioning ) Slashed interest rates ) Expanded the money supply ) Governments provided bailouts for major financial institutions to avert their collapse or took them over outright ) Governments also cut taxes and raised spending to prevent the economy from falling into a deep recession or even depression Intervened in order to prevent a systemic collapse and an economic depression Canbek Economics

4 Did They Succeed? )The magnitude of the financial shock, loss of confidence, near panic was too large to prevent a hit on the real economy )The world economy went into a deep recession, the first since the end of WWII )But a global depression was averted! )Now much of the confidence has been restored and economic activity is rising around the world )There is real hope that by the end of 2010 the recovery will be on solid ground and self sustaining and that by 2011 we can enter a period of stability and re-newed growth in the global economy It appears they have for now, but it is still too early to tell Canbek Economics

5 We are Not Sure Yet )Although economies are rebounding around the world, the recovery is not even )The emerging economies of China, India, Brazil are faring better and leading the rebound )The economies of the USA, Europe and Russia are lagging behind )Canada is a special case -fortunately for us- but still tied too much on the US economy, thus still vulnerable )So far the recovery is still technical, driven by a restocking of inventories, a bounce back from the lows of 2009 )Recovery is still overly dependednt on government spending, bailout money and low interest rates )It is still too early to declare victory, the patient is out of the OR room but still in the ICU! Let us not forget this. The recovery remains too dependent on government support Canbek Economics

6 World Economic Growth, 2001-2009 and Projections for 2010 & 2011 Source: IMF WEO Update, January 26, 2010 20012002200320042005200620072008200920102011 0 1 2 3 4 5 6 7 8 9 10 -2 -3 -4 Percent (%) Growth Advanced EconomiesEmerging EconomiesWorld Average

7 This Intervention Comes at a High Price )We have been pulled out of the clutches of Scylla, but we may have fallen in the arms of Charibdis )Why? )Because the battle has been won at an enormous cost in terms of a) unprecedented expansion in the supply of money and b) unprecedented peacetime expansion in government deficits. )It is like we have gone on a giant shopping spree and charged all our purchases on our credit card. The bank that has issued the card will soon send us the bill, that is when we will begin feeling the cost of our purchases and the pain of paying it back! We have not received the bill yet Canbek Economics

8 Change in US Real GDP, 1948-2009 This has been the worst downturn since end of World War II Canbek Economics 19491954195919641969197419791984198919941999200420092014 0 5 10 15 -5 Percent (%) Change Growth Rate

9 Effective Federal Funds Rate, June 1954 - Jan 2010 Interest Rates have gone from 2% to 20% and then down to 0.12%, They have nowhere to go but up now 1955196019651970197519801985199019952000200520102015 0 5 10 15 20 Source: Federal Reserve Board of Governors Canbek Economics Fed Funds Rate

10 Adjusted Monetary Base, USA, 1925-2010 To save the financial system from collapse Federal Reserve had to expand the monetary base by an unprecedented amount Source: Federal Reserve Bank of St-Louis Canbek Economics 192519351945195519651975198519952005 0 500 1000 1500 2000 2500 Adj Monetary Base

11 Total Reserves Adjusted for Reserve Requirements, US, 1959-2010 They had to inject over 1 trillion in liquidity into the US banking system Source: Board of Governors of the Federal Reserve System 195919691979198919992009 0 200 400 600 800 1000 1200 Total Bank Reseves

12 MZM Money Stock (Broad Money Supply), US, 1959-2010 The money supply has risen less dramatically because banks are not as confident and have not been lending Federal Reserve Bank of St-Louis Canbek Economics 195919691979198919992009 0 2 4 6 8 10 Thousands 0 2 4 6 8 10 Thousands Money Supply

13 US Consumer Prices (CPI), 1959-2009 Consumer prices have remained remarkably tame so far in the face of such monetary expansion, but for how much longer? 195919691979198919992009 0 50 100 150 200 250 Source: US Dept of Labor, BLS Canbek Economics CPI

14 US Federal Budget Deficit as Percent of GDP, 1900-2010 It has led to the biggest budget deficit in peacetime US history Canbek Economics 190019101920193019401950196019701980199020002010 0 5 10 15 20 25 30 -5 Percent (%) of GDP Budget Deficit

15 Federal and Total (state & federal) US Government Debt as Percent of GDP, 1900 - 2010 Gross US public debt is now approaching 100% of GDP 190019101920193019401950196019701980199020002010 0 20 40 60 80 100 120 140 Canbek Economics StateFederal

16 Total US Debt Outstanding: Household, Business & Government, 1974-2009 Total private and public debt in the US is now 370% of GDP Source: Federal Reserve Board, Flow of Funds Accounts Z1 d3 Canbek Economics 19741979198419891994199920042009 0 100 200 300 400 Percent (%) of GDP 0 10 20 30 40 50 60 Trillions of US Dollars Total Debt to GDPTotal Debt

17 General Government Net Debt: 2003-2008 Actual, 2009-2014 Projections The US is not unique, it is happening in Europe as well and to a less extent here in Canada Source: IMF, WEO, October 2009 93-20022003200420052006200720082009201020122014 0 20 40 60 80 100 EuroUSAUKCAN

18 Government Budget Deficits, Percent of GDP, 2009 Budget deficits have exploded all over with the worst affected being in the advanced industrial world Source: The Economist, EIU, January 16, 2010 0246810121416 UKGreece SpainIreland USAPortugal FranceJapan RussiaTurkey BelgiumItaly Canada

19 Gross Debt-to-GDP Ratios, 2010 IMF Projections Debt-GDP ratios have been rumped up dramatically in many countries Source: IMF, World Economic Outlook, April 2009 & October 2009 050100150200250 JapanGreece ItalyUSA GermanyFrance UKCanada SpainAdvanced G-20 Emerging G-20

20 Where are we Headed from Here? ) Governments will stay the course by keeping interest rates low and policy stimulus high to nurse economy into self- sustaing growth ) Once this is achieved later in 2010 and 2011, they will start withdrawing stimulus packages ) Short-term interest rates will start to rise ) Government spending will start to fall and taxes will start to rise to bring deficits under control and stabilize high debt- GDP ratios ) Given the unprecedented size of stimulus intervention, it will take a long time to bring deficits under control and ) A meaningful self-sustaining expansion may be delayed until 2012 or 2013. We are navigating through Scylla and Charibdis Canbek Economics

21 What are the Risks Facing Us? ) Exit strategies of central banks might stumble or fail and this may trigger a loss of confidence in their ability to control the value of money, and may trigger a bout of inflation and exchange rate instability ) We may experience a sovereign debt crisis, with credit rating downgrades, drop in bond prices, rise in long-term interest rates and mortgage rates that will dampen housing values ) The public may balk at restrictive fiscal and monetary policies and precipitate civil unrest and political crises Uncertainty is very high and the risks are huge Canbek Economics

22 The Great Conundrum of our Time ) With all this monetary easing, expansion in liquidity and money supply, central banks will have to raise interest rates to prevent inflation ) Higher interest rates will slow down economic growth and raise the cost of funding public and private debts ) It may become extremely difficult for governments to bring down deficits and public debt especially in the face of public opposition and political instability and civil unrest ) In that case, the only exit strategy might be to allow inflation to rise To avoid inflation interest rates will have to rise; to avoid economic stagnation and rise in debt levels interest rates will have to stay low; but you can’t have it both ways! Canbek Economics

23 A Time for Reckoning ) No one can predict exactly the future ) What one can say for sure is that we are headed for a difficult and protracted period of undertainty, economic, social and political adjustments ) At least here in Canada, we will experience much less pain than others because we have gone through much of this adjustment already in the 1990s ) Yet we will still feel the storm ) THANK YOU ! ) A difficult period lies ahead

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