overview of international crises. economic financial credit energy debt trade (or export) currency...

Overview of International Crises

International Crises

Economic Financial Credit Energy Debt Trade (or export) Currency All of the above

1970s

Oil Shock - 1974 (prices rose by 4x)

Oil Shock – 1979 (prices rose by nearly 3x)

Stagflation – high inflation and low growth and/or recessionary economy

Rising unemployment

A stagnant and/or falling stock market

Crude Oil Prices(1970 to to 2008)

Crude Oil Prices(1970 to 2010)

Crude Oil Prices(1970 to Present)

US Crude Oil Production

US Gasoline Prices(2007 to 2010) http://www.eia.gov/steo/

US Average Gasoline Prices($3.88/gallon)

France Gasoline Prices - $8.02/gallon

Natural Gas Prices - $/MMBTU (thousand cubic feet)

OPEC Total Production

US Crude Oil Imports

What Crisis?

• Prices– Too high?– Too low?

• Dependence on Foreign Sources

• OPEC Control

• Environmental

• CO2 output

• Sprawl

• Same for West and for Developing World

(No Easy) Solutions?

• Make crude oil no longer a strategic commodity

• More exploration in short term to keep prices down– Build up SPR

• Restrict exploration to keep prices high

• Boost alternative sources in long term

• New Taxes?

• Mandated fuel efficiencies?

. . . . . .

Strategic Petroleum Reserve

Country Risk Analysis

• GDP growth

• Per capita GDP

• Total foreign debt

• International Reserves

• Current account

• Fiscal policy

• Political stability

1. GDP Growth

• Derived from domestic currency, expressed in real terms

• Increasingly using PPP

• Can be too low . . . . or too fast

• From what sector of the economy – capital investment, consumer spending, government spending, net exports

2. Per capita GDP

• Typically calculated in domestic currency before conversion into US dollars

• Percent change not as often used

• Nations with rapid population growth have greater challenge in providing real growth per person

• Hard to compare nations based on per capita GDP because of cost differences

• More recently PPP valuations are being used

3. Foreign Debt

• Classically applies only to developing nations

• Referenced in US dollar terms . . .

• And often as percent of total GDP and in terms of balance of payments

4. International Reserves

• Usually denominated in US dollars

• Often expressed in terms of the number of days of imports

• A way of measuring a nation's ability to withstand an external trade shock

• Typically is meaningful to smaller nations more dependent on trade and with limited access to international capital markets

• Doesn't typically apply to larger more dynamic economies with ready access to capital markets

5. Current Account Balances• Looked at almost always in terms of US

dollars

• And/or as percent of GDP

• Composition of trade important– Commodity based economy?– Manufacturing based economy?– How important are services to the external

sector – How able is the economy to absorb export

receipts, i.e., its absorptive capacity

6. Fiscal Balances

• Budget balances and debt levels typically calculated

– domestic currency terms and – then as percent of nominal GDP

• No more than three percent of GDP for deficits

• No more than 60 percent of GDP for debt

• Often difficult to determine and reporting is uneven

• Often difficult to determine if figures are for government spending at the local or central or combined levels

7. Political Stability

• Usually looking for a strong democracy

• Many variables, including history, i.e., duration of democracy and the types of parties involved

• Paradox of one-party systems or one-man dictatorships

• Was the Soviet Union a great risk? China?

1980s

Recession – one of the worst in post-WWII period

High inflationHigh unemploymentHigh interest ratesEnergy prices roseEnergy prices plungedDeveloping country debt crisis – began 1982Global Stock market crash – October 1987

1982 Developing CountryDebt Crisis

August 16, 1982: Mexico defaults on $80 billion of external debt

October 1983: 27 countries with $239 billion in debt in default

Four Latin American debtors owed $176 billion

$37 billion owed to 8 largest US banksEqual to 147% of capital and reserves(Part of reason for basel accords in 1988)


BackgroundGlobal inflation began in 1960s and

accelerated in 1970sOil price shocks in 1974 and 1979G-5 Policy: “recycle petrodollars”


Background (continued)OPEC deposits oil earnings in international banks

which prompted many banks to boost sovereign lending

Higher crude oil prices also led to higher import costs for developing countries and need for higher borrowing from western banks

Higher crude oil prices led to recession in western countries which led to lower imports from developing countries which led to lower commodity prices which led to lower economic growth overseas

Higher crude oil prices led to inflation in west and higher interest rates which affected all borrowers tied to LIBOR and other adjustable terms


“Third World” lending that boomed during the 1970s led to high debt levels in 1980s

Global inflation beginning in mid-1970s led to higher rates (esp LIBOR)

Developing countries borrowed to pay interest rates (“ponzi” finance)Banks learned that sovereign risk does exist, i.e., defaults can happen .... at least in developing world

Higher borrowing costs moderated in 1980s, especially due to energy prices moderating along with much debt restructuring helped ease debt crisis

1982 Developing Country Debt Crisis


Solution:regulatory “forebearance” for banksGradual write-offs, build up of capital via

retained earningsRenegotiation of loans to developing countries

via “Brady Bonds”Conclusion:

A strategy economic development by debt failed

Contributing Factors to Debt Crisis

Excessive short-term borrowing by LDC governments, corporations and banks

Poor management of interest rate and currency risk by banks and business firms

Weak banking systems – management and capitalization

Weak central banks

Poorly developed securities markets

“Moral Hazard” - failure to penalize excessive risk-takers in previous crises

JAPAN 1990 - present

Crisis in Japan - The1990s

Japan's stock and property bubbles burstFirst Iraq war – 1991 to 1992Oil prices jumpedOil prices plungedAsian crisis 1997-1998Russian ruble crisis 1998Dot com bubble

Japan Jobs to Workers Ratio

Japan Land Prices(1976 through 2008)

Japan Official Overnight Rate

Japan 10 Year Govt Bond

Japan CPI (YOY)

Japan GDP

Japan Stock Market (Nikkei 225)

Risks in International Financial Management

For borrowers: lure of low interest rates on foreign currency borrowing

Indonesia, Thailand, Korea etc in 1997Eastern Europe 2005 to present

For investors: lure of high interest rates on foreign currencies

Russia 1997-98Turkey 2003United States 2005-2006

Factors in Current Crisis

A key similarity from 1980s to current crisis is that “imported dollars” from abroad have been unproductively recycled.

In this case from China and elsewhere in Asia export earnings needed to be recycled

Recycled into US markets, including equity, Treasuries and (more indirectly), housing

Led to “Irrational Exuberance” in first equity and then housing sectors

Drove (or allowed) interest rates to fall to unsustainable levels – under-pricing risk?

Causes

• World Bank officials said it was the “G2”:

– 1) Structural overconsumption in the United States and

– 2) oversaving in China• US is the largest destination for Chinese exports,

and China is the first or second largest foreign investor in US governement debt (with Japan).

• US trade deficit with China:

• 2009 $198b

• 2008 $297b

• 2007 $262b

US Exports to China

US Imports from China

Underlying SolutionsDiscussion Points

• US must boost savings and investment through reforms to assist stimulus.

• Regain control over expanding budget deficits

• US needs to avoid boosting US consumption based on easy money financed by overseas savings

• China must boost consumption by poorer consumers and by small and medium businesses – move away from almost total reliance on exports for growth

• China needs to improve income distribution

overview of international crises. economic financial credit energy debt trade (or export) currency...

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