Market Meltdown:Global Trends and the Cyclical Turn

Dr. Mark MullinsExecutive DirectorFraser Institute

April 21, 2009

“Prosperity, boom, crisis, slump, and recovery succeed each other with a regularity that suggest(s) inevitability”

Professor T. S. AshtonEconomic Fluctuations in England 1700-18001959

“If a panic were to pass a certain height, that system, which rests on confidence, would be destroyed by terror”

Walter BagehotLombard Street: A Description of the Money Market1873

HistoryMarket Meltdown

Past EpisodesYear Stocks Event1701 -41% Spanish Succession1721 -78 South Sea Bubble1722 -43 South Sea Bubble1797 -34 French Invasion1803 -32 Recession1826 -20 South America1837 -24 Foreign Investments1848 -28 Railways1866 -27 Bank Collapse1877 -34 Depression1893 -27 Gold Standard

1900 -32 Recession1903 -35 Rich Man’s Panic1907 -45 Bankers’ Panic1913 -24 War Threat1917 -38 WWI1920 -39 Post War Bust1921 -29 Post War Bust1929 -48 Crash1930 -46 Depression

1931 -60 Sterling1932 -74 Depression 1938 -48 War Threat1939 -22 War Threat1940 -27 WWII1941 -22 WWII1942 -28 WWII1946 -23 Post War Bust

1962 -27 JFK and Steel1966 -25 Credit1970 -33 Recession1974 -41 Oil Shock1978 -23 Stagflation1982 -22 Recession

1987 -36 Crash1990 -21 Recession1998 -19 Asian2002 -27 High Tech2008 -52 Credit

Source: MullinsSource: Mullins

Leading Stock Markets

1

10

100

1000

10000

1700

1750

1800

1850

1900

1950

2000

UK Index US Index

Source: S&P 500, Various Historical IndicesSource: S&P 500, Various Historical Indices

CausesMarket Meltdown

“A previous record of delinquency, foreclosure or bankruptcy; a credit score of 580 or below … and a debt service-to-income ratio of 50 percent or greater”

Professor Paul MizonThe Credit Crunch of 2007-2008Federal Reserve Bank of St. Louis Review

Subprime Borrower

US Housing Prices and Rates

60

120

180

240

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1995

= 1

00

3

5

7

9

Per

cen

t

House Prices 1 Year ARM 30 Year Mortgage

Source: S&P/Case-Shiller, HSH Associates, US Federal Reserve BoardSource: S&P/Case-Shiller, HSH Associates, US Federal Reserve Board

ScaleMarket Meltdown

US Housing Value

$0

$10

$20

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

$US

Tri

llio

n

Single-Family Housing Stock Mortgage Subprime

Source: Mortgage Bankers Association, Author’s CalculationsSource: Mortgage Bankers Association, Author’s Calculations

Global Stock Markets

$0

$15

$30

$45

$60

$75

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

$US

Tri

llio

n

Global Stocks US Housing Subprime

Source: World Federation of Exchanges, Mortgage Bankers Association, Author’s CalculationsSource: World Federation of Exchanges, Mortgage Bankers Association, Author’s Calculations

Credit CrisisMarket Meltdown

Interbank Lending Rates

0

1

2

3

4

5

6

7

2007 2008 2009

Per

cen

t

Overnight LIBOR 3 Month LIBOR

Source: British Bankers AssociationSource: British Bankers Association

Stock Market Comparison: I

40

80

120

1971 1972 1973 1974 1975 1976

Yea

r P

rio

r to

Pea

k =

100

Arab Oil Embargo 2008 Credit Crisis

Source: Dow Jones; MSCISource: Dow Jones; MSCI

Stock Market Comparison: II

40

80

120

1904 1905 1906 1907 1908 1909

Yea

r P

rio

r to

Pea

k =

100

Bankers' Panic 2008 Credit Crisis

Source: Dow Jones; MSCISource: Dow Jones; MSCI

Stock Market Comparison: III

0

100

200

1927 1928 1929 1930 1931 1932

Yea

r P

rio

r to

Pea

k =

100

1929 Crash 2008 Credit Crisis

Source: Dow Jones; MSCISource: Dow Jones; MSCI

Economic ConditionsMarket Meltdown

US Production and Jobs

-15%

-10%

-5%

0%

5%

10%

15%

1970

1980

1990

2000

2010

Industrial Production Private Employment

Source: US BEA, Federal ReserveSource: US BEA, Federal Reserve

Leading Economic Indicators

90

100

110

1990

1995

2000

2005

2010

OECD BRIC

Source: OECDSource: OECD

Leading Economic Indicators

70

90

110

2000

2005

2010

US Canada

Source: Conference Board; Statistics CanadaSource: Conference Board; Statistics Canada

Indicators of Coming Stability

0

4,000

8,000

12,000

2008 April July Oct 2009 April

0

30

60

90

Baltic Dry Index VIX Stock Options Volatility

Source: US Federal Reserve Board, British Bankers AssociationSource: US Federal Reserve Board, British Bankers Association

US Manufacturing

-60

-30

0

30

60

90

1970

1980

1990

2000

2010

Breadth Orders to Inventories

Source: NAPMSource: NAPM

Dr. Copper

-15%

-10%

-5%

0%

5%

10%

15%

1970

1980

1990

2000

2010

-120%

-80%

-40%

0%

40%

80%

120%

Industrial Production Copper Prices

Source: Federal Reserve; CRBSource: Federal Reserve; CRB

US Real Bill Rate Prediction

-15%

-10%

-5%

0%

5%

10%

15%

1970

1980

1990

2000

2010

-8%

-4%

0%

4%

8%

Industrial Production Real Bill Rate - 18 Months Ago

Source: Federal ReserveSource: Federal Reserve

US Yield Curve Prediction

-15%

-10%

-5%

0%

5%

10%

15%

1970

1980

1990

2000

2010

-500

-250

0

250

500

Industrial Production Yield Curve - 12 Months Ago

Source: Federal ReserveSource: Federal Reserve

The Real Leading Indicator

0

400

800

1200

1600

1970

1980

1990

2000

2010

World Stock Market Index

Source: MSCI BarraSource: MSCI Barra

Global TrendsMarket Meltdown

Economic FreedomGlobal Trend I

Economic Freedom of the World

Size of Government: Expenditures, Taxes, and Enterprises

Legal Structure and Security of Property Rights

Access to Sound Money

Freedom to Trade Internationally

Regulation of Credit, Labor, and Business

Based entirely on objective, third party data or independent surveys for 141 countries

Economic Freedom Over Time

6.15.5 5.4 5.5 5.7 6.0

6.4 6.4 6.4 6.4 6.4 6.6 6.6

0

2

4

6

8

10

Eco

no

mic

Fre

edo

m S

core

1970 1975 1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 2006

Top 10 Economic Freedom

0 2 4 6 8 10

Score (out of 10)

Hong Kong

Singapore

New Zealand

Average of top 10

Switzerland

United Kingdom

Chile

Canada

Australia

United States

Ireland

Source: The Fraser InstituteSource: The Fraser Institute

Economic Freedom of Canada

Size of Government: Expenditures, Taxes, and Enterprises 53

Legal Structure and Security of Property Rights 14

Access to Sound Money 6

Freedom to Trade Internationally 52

Regulation of Credit, Labor, and Business 11

Based entirely on objective, third party data or independent surveys for 141 countries

ChinaGlobal Trend II

World Economy

1,000

10,000

100,000

1,000,000

10,000,000

100,000,000

1 500 1000 1500 1800 1900 1950 2010

$199

0 P

PP

Ad

just

ed

China World USA

Source: Maddison; Conference Board and GGDC; Others; Author’s CalculationsSource: Maddison; Conference Board and GGDC; Others; Author’s Calculations

China’s Per Capita GDP

100

1,000

10,000

1 500 1000 1500 1800 1900 1950 2010

$199

0 P

PP

Ad

just

ed

China Rest of World

Source: Maddison; Conference Board and GGDC; Others; Author’s CalculationsSource: Maddison; Conference Board and GGDC; Others; Author’s Calculations

China’s Marketization Progress

Source: NERISource: NERI

0 2 4 6 8 10

Tibet 31Qinghai 30Gansu 29

Guizhou 28Shaanxi 27Ningxia 26Yunnan 25Xinjiang 24

Heilongjiang 23Jilin 22

Innermongolia 21Shanxi 20

Guangxi 19Hainan 18Jiangxi 17Hunan 16Henan 15Hubei 14Hebei 13Anhui 12

Sichuan 11Chongqing 10

Liaoning 9Shangdong 8

Tianjin 7Jiangsu 6

Fujian 5Guangdong 4

Zhejiang 3Shanghai 2

Beijing 1

2005

2004

2003

China’s Business Cycle

-20%

-10%

0%

10%

20%

1950

1960

1970

1980

1990

2000

2010

85

90

95

100

105

GDP Leading Indicator

Source: Wu and Maddison; OECDSource: Wu and Maddison; OECD

Chinese Stock Markets

0

50

100

150

200

1970

1980

1990

2000

2010

Global Hong Kong

Source: MSCI BarraSource: MSCI Barra

Public PolicyGlobal Trend III

Interventions

Source: Author’s CalculationsSource: Author’s Calculations

Central Bank Balance Sheets$US Trillion at current exchange rates

AnnualJapan Europe US Canada Total Increase

2000 $0.998 $0.769 $0.620 $0.026 $2.412

2006 $0.985 $1.435 $0.874 $0.043 $3.337 $0.154

2007 $0.902 $2.016 $0.894 $0.054 $3.865 $0.528

2008 $1.359 $2.891 $2.259 $0.064 $6.572 $2.707

2009 $1.136 $2.426 $2.188 $0.063 $5.814 -$0.759

Policy SummarySocial housing policy, Freddie and Fannie:regulation and underwriting standards

The monetary policy cycle

21st century bank runs: Lehman Brothers and others

Central Banks: lend freely to solvent entities at penalty rates

Prudential regulation: leverage, maturity matching and risk pricing

Market insurance

Social banking policy

Exit strategy – not “stimulus”

Numbers to PonderGlobal Wealth $254 TrBank Assets $85

Debt Markets $80Stock Markets $65OTC Derivatives $15

Global GDP $55US GDP $15

Central Bank Expansion $2.7US Treasury “Bailout” $0.8Obama “Stimulus” $0.8US Baseline Deficit $1.2Expected Canadian Deficit $0.03

Source: IMF Global Financial Stability Report, Davies et al, Author’s CalculationsSource: IMF Global Financial Stability Report, Davies et al, Author’s Calculations

Market Meltdown:Global Trends and the Cyclical Turn

Dr. Mark MullinsExecutive DirectorFraser Institute

April 21, 2009