“A Minskyan analysis of commonalities between the financial crises of Mexico 1994 and Greece 2007. New problems versus old ills” Jesús Muñoz

“Philosophy is about unity”This analysis is for financial crises understanding and prevention. (A)

Minskyan crises arise from investment-debt mismatches in booms. Transit to busts is accelerated by lax regulation, asset creation and financial volatility

(B) Expenditure and debt cause them, speculation ‘ignite’ them, and recession and inequality are their result. Policies aggravate them. Long-term circuit breakers may avoid their socialization

Hence all crises exhibit a single internal pattern. For proving this, 1 describes ‘modern’ crises, 2 outlines orthodox and heterodox views, 3 explains all crises, 4 suggests globalized policies and 5 concludes

 “A Minskyan analysis of …” 1. Description

• Crises retard development. They are rooted in ´rapid´ globalization, governance, and productive fragility

• But ‘modern’ crises are primarily due to financial development, related to private and public indebtedness

• Risks fuel modern crises. They are ubiquitous, generate globalized contagion and face similar management

• External debt crises recur since 1982, and ‘modern’ crises since the mid-1990s (Table 1), socializing risks

1. Description

Table 1 Financial crises between those of Mexico and Greece

Country/region Date Causes Outline

East Asia July 1997 Pegs, private deficit,

banking crisis

Explosion and

‘contagion’

Russia August 1998 Under- performance,

default, speculation

Control and

‘contagion’

Brazil January 1999 Peg, weak

fundamentals, public

deficit, default

Control

Turkey September 2000 Budget deficit Control

Argentina December 2001 Collapsing currency

board

Recession and

‘contagion’

Source: Own elaboration.

‘1. Description

• 1.1 Mexico 1994: A currency crisis• Latin America enjoyed a boom, starting in 1989.

Confidence was restored after the Brady Plan

• Mexico received portfolio capital since 1988, ignoring risks. Positive expectations arose from NAFTA in 1994

• Mexican growth, prices and ratings improved between 1990-1993. In 1994 Tesobonos were issued to hide borrowing

‘1. Description

Table 2 Growth in Mexico and Greece

Year Real

growth

(%)

Year Real

growth

(%)

1994 4.4 2004 4.4

1995 -6.2 2005 2.3

1996 5.2 2006 4.6

1997 6.8 2007 3.0

1998 5.0 2008 -0.1

1999 3.8 2009 -3.2

2000 6.6 2010 -3.5

2001 0.0 2011 -6.9

1. Description

• After political events, the Peso was devalued in December 1994 and mini-devaluations ensued, speculation arose and K left. ‘Contagion’ arose

• The Peso was pegged to the $ in 1987, but the US economy diverged. Over-lending sustained growth after banks were privatized in 1991. Investment and GDP ↓. Debts soared

• Rescue came in March 1995. An insurance deposit was created, banks were recapitalized and $ credits were restructured

• Since 1995 the Peso floats and growth resumed. After 1997 inflation and interest rates ↓, while fiscal policy was reformed

1. Description

• 1.2 Similar subsequent crises• Elsewhere pegs promoted un-hedged inflows and

indebtedness circa 1995. Deregulation was going on but banks were undercapitalized

• The target was SE AsiaSE Asia with relatively developed finance and productivity. But problems in fundamentals and weak policies eventually brought about crises (Tables 2 and 3)

• There were massive K inflows into SE Asia before 1997 with high growth since the 1960s and peg-created appreciation in the 1980s

1. Description

• Booms inflated liabilities and current deficits. Low-quality private investment and debt became excessive. The bubble arose after poor supervision and corporate governance

• Soros-led speculation in forex markets soared. The Bath was left to float, soon MalaysiaMalaysia and IndonesiaIndonesia devalued. South South KoreaKorea was eventually affected due in part to perceptions

• Outflows proliferated, and debt was eventually repaid like in Mexico (but it was higher). Economies were full of public intervention (the chaebols)

1. Description

• Crises were aggravated by indecision and moral hazard. Economies ↓. Banks failed. The IMF aid was subjected to fiscal, monetary, financial and structural reforms. Supervision and foreign participation improved

Table 3 Real growth in SE Asia

1. Description

• In RussiaRussia the band regime became unsustainable. Public debt increased, and outflows ensued. ‘Contagion’ prevailed during late 1998

• The BrazilianBrazilian currency was pegged to the $. Speculation soared. In view of the Russian default it was allowed to float with a failing financial system in 1999

• ArgentinaArgentina chose an eventually unsustainable currency board in 1991. There was speculation. Fiscal expenditure caused devaluations and slumps in 1997 and more dramatically in 2001

• ‘External’ shocks were ‘impossible’ to be forecasted

1. Description

• 1.3 Greece-Europe-US 2007: A domestic-debt crisis?• Greece under-reported its budget deficit in 2000 (Figure 1)

• Financial products were developed but liabilities were hidden. The Euro-inspired boom fueled government spending and public debt soared

• After 2007 doubts arose about Greece payments of its debt and it became a speculative target

• Euro-zone countries ‘eventually’ agreed rescue. A 2 nd larger bailout was agreed in 2012, subject to austerity

1. Description, jesusmunoz_ban@yahoo.com

Figure 1

1. Description

• Recent activity in the Eurozone has been soft

• Policies in Greece attempted to avoid stagnation and new bubbles via financial reforms, like in Latin America

• The fiscal gap must have been closed as interest rates ↓ and debt got back to the country

As of 2013 Greece advanced in structural reforms and tax collection, but continued to adjust via recessions (Table 5)

1. Description

Debt must be ↓ to 124% of GDP by 2020. Greece modified its fiscal program more than SpainSpain (IMF 2012). Time was needed for reforms and debt relief

• Mexican and Greek crises were caused by excessive –public- expenditure, over-lending, underpriced risk and peg (to $ or the €). Mexico in 1994 and Greece –Spain and ItalyItaly- in 2007 possessed unstable finance

• Those crises were due to reduced confidence and investment. In developed countries mortgages as the speculative vehicle ignited -but not caused- the 2007 subprime crisis

1. Description

• 2007• The consequence in the US US was a gigantic a-la-Mexico bailout,

related to the Fed´s response and to the public safety net (cf. Wray, 2009) and losses were socialized. The UKUK faced a similar situation

• Debt rules were set in motion. The Eurozone was the concern in terms of increasing globalized risks, just like L.A. in the 1980s

• A Keynesian policy was necessary to counterbalance austerity, since non sovereign forex nations do not need wage or employment cuts

• Bailouts were granted to IrelandIreland and PortugalPortugal but further rescues were required from the IMF, the European Central Bank and the EU

1. Description

• Stimulus and stabilizers were needed with the inflexible €. Stable interest rates, central banks intervention and fiscal management generate stability and profits

• When entities paid their debts with borrowed $ they called for public bailout

• Recessions spread out across the region in 2009 and some countries approached default in 2010, resembling L.A.L.A. in the early 1980s. Dynamics were modified

2. Theories

• There are conflicting narratives about domestic crises. Nevertheless their common patternscommon patterns must be searched after 2nd thoughts on their causes, mechanics, prevention and policies arise

• As observed, crises (not only 1990s currency crises) are varieties of a single phenomenon. This must be confirmed by Orthodox, Minskyan and complex systems theories, focusing on qualitative and historical issues

• 2.1 Orthodox (exogenous) theory• For orthodoxy over-lending (McKinnon, 1996) coupled with pegs is a

main cause, although $ and debts have no place in the Neo-classical tradition EMH and laissez faire do

2. Theories of financial crises

• Main ‘external’ causes are excessive lending-spending, pegs, and failing industries and banks (Dornbusch, 1999). Moral hazard generates financial runs

• An inefficient financial system does not properly allocate real investment. More transparency is needed. Part of deregulation is still securitization

• Financial disruptions bring about recessions, altering distribution (Baldacci, 2002). They also increase short-run unemployment affecting expectations

2. Theories

• In 1st-generation ex-post models the currency is ‘externally’ devalued after domestic problems (Krugman, 1979). In 2nd-generation models devaluing is a policy choice (Obstfeld, 1994)

• In 3rd-generation models banking and currency crises occur simultaneously (Kaminsky & Reinhart, 1998). In 4th-generation models (Krugman, 1999) crises damage balance sheets

• Economies return to equilibrium. Vulnerability is an exception. Crises are exogenously caused. The solution is an ↑ in global assets cured by laissez faire (Tornell, 2004).

•

2. Theories, jesusmunoz_ban@yahoo.com

• 2.2 Heterodox (Minskyan or endogenous) Theory• There are heterogeneous risk takers (Wray, 2007) and

systems implode after booms

• Minsky’s operationalized Keynes’s uncertainty. Investment is halted and debt deflation and recessions arise. Minsky’s FFH (1982) on the debt side in I-D is relevant

• Heterodoxy mentions deficiencies in deregulation and excessive financialization ($-manager capitalism)

2. Theories

• Indebtedness progresses through the well known stages and busts arise. Big Government and the Central Bank soften impact (Minsky, 1982). A budget deficit is beneficial and recessions emerge whenever $ is retired from the income flow

• Triggering factors are de-supervision and bullish agents (cf. Wray, 2009), which arose in the 1970s revealing commonalities among nations. This is applicable to Mexico 1994 and Greece 2007

• • 2.3 Complex systems theory• Supposedly crises come from ‘exogenous’ events and policies.

But systems are internally comprehensive as in Keynes the ‘organicist’

2. Theories

Complexity explains phenomena. The whole differs from the sum

• Complex systems are comprised by heterogeneous causes, interrelations, mobiles (triggering factors in orthodoxy), effects and solutions

• Interrelations are pluralistic, but depart from indebtedness-investment. Mobile is speculation, say on exchange rates

• Orthodoxy is based on atomism. Homogeneous agents are linked by simple relationships with ´external´ deviations from equilibrium

3. Theory application and explanation

• If pieces are properly integrated, crises may be prevented. For ex. confusion among causes, triggering factors and symptoms or on the role of speculators are avoided

• Thus BP (1979), external debt (1982) and currency crises (in the 1990s) are varieties of financial crises (in the 2000s)

• Similarities between Mexico and Greece are found in genesis: Indebtedness. ≠ are related to practicalities, for ex. rescue efficacy, like in the EUEU

•

3. Theory application and explanation

• ≠ are superficial among emerging countries. In all of them finance and industries transformations make them vulnerable, the vehicle being situational (mainly exchange rates)

• All crises are aggravated by misleading policies (↑ interest rates in E. Asia). Inadequate surveillance of credit and market risks happened even in the UK in 2007

• Crises always reduce investment and activity, and debt makes finance fragile (for Minsky). Sectors are unequally affected (Tornell, 2004)

3. Theory application and explanation

• Stable investment (real and financial) is the pre-condition for stability

• While for Heterodoxy the Mexican, the Asian and the Greek crises were caused by internal -non-random- motives, events were comprehensive in the complex system paradigm

• 4. Policy suggestions • Orthodoxy suggests corrections to spending and assets

issuance. But national tight fiscal policies produce recessions, and halts in trade via contagion

4. Policy suggestions

• New common-factor orderings and prioritizing may avoid crises. For ex. speculative situations and development levels vary, but this is not relevant

• It is necessary to analyze rescue policies. Retiring $ ↑ uncertainty. More than risk propensities, uncertainty factors must be assessed

• Local but co-operative integral, qualitative solutions must prevail, for ex. in modernization, productivity, internationalization and reforms to banks and agencies

4. Policy suggestions

• Modernization takes time. In the 3 regions sudden liberalization generated rapid in(out)flows which revealed fragilities. ‘Obliged integration’ must be revised

• Regulators must limit assets issuance and central banks must intervene in cycles acting as circuit breakers

• Orthodox limits in foreign assets creation implemented in Greece were palliative. Long-term regulation softens crises. But policies must consider short term problems

4. Policy suggestions

• Use the Lender of Last Resort. Currency sustainability must be addressed instead of austerity

• Countering fiscal retrenchment and stabilizers for enhancing spending must be targeted, even if the budget is expanded

• Long-term interest rates must ↓. Financial innovation must ↑ household spending, instead of household indebtedness

• Tight policies are insufficient. Only controlled variables must be targeted (Hannsgen & Papadimitriou, 2012)

5. Conclusions

• Mexico, Asia & Greece experienced booms after pertaining to a pegged bloc. Fragile performance and finance propitiated sudden and huge busts

• Emergent economies implode for being K importers. Developed countries are vulnerable due to their sizes and homogeneity. Pattern equalization is confirmed

• This equalization is also related to the identification of ‘common fragilities’ (in heterodoxy and complex systems) instead of ‘random contagion’ (in orthodoxy)

5. Conclusions

• Disparities among country assets or external shocks do not cause crises. Disequilibria reign after volatility is caused by perceptions of fragility

• Crises have predictable common patterns, not being isolated speculative episodes. Solutions come from considering interrelated but heterogeneous real-financial variables, factors and agents

• Debt, spending and investment were hereby reviewed ex-post to detect a pattern based on 2 cases. Result: Endogenous crises are exogenously revealed

5. Conclusions, jesusmunoz_ban@yahoo.com

• ‘Modern’ crises unfold from investment-debt in Minsky (savings in Keynes). These statements equal the Mexican and the Greek crises

• The subprime crisis is not unique: sophisticated finance is vulnerable. Thus the evolution of internal-interconnected quantitative and qualitative variables must be monitored

• There always will be crises as long as economies are imperfect.

Thanks!Thanks!