financial crises - the core
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The Financial System in CrisisThe Financial System in CrisisLecture 9: International Political EconomyLecture 9: International Political Economy
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Financial crises
- Debt crisis (1980s)
- Asian crisis (1997-98)
- Subprime crisis (current)
Financial CrisesIPE Discussion Group
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Economist: World on the edge
Financial CrisesIPE Discussion Group
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Subprime crisis
- Lenders have spread risk over many investors
- Too much lending, too much risk
- Mortgage takers fail to repay
- Unexpected insolvencies: banks short of funds
Financial CrisesInternational Political Economy
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- Banks have higher outstanding loans to collateral ratio than previously estimated
- Banks need more funds
- Everyone needs more funds; no one trusts any bank with one’s money anymore
- Funds are withdrawn and credit dries up: - no new loans
Real economy dragged down- no new mortgages
- falling share prices More money evaporates in
financial sector- Bankruptcies
Credit crisis
Financial CrisesInternational Political Economy
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The political-economic impact of the bailout
- Bailout would reduce pressure on financial institutions, get credit flowing again
- Credit is necessary to avoid recession
- Bailout creates Moral Hazard problem- Should renumeration of ‘financial talent’ be capped?
- Bailout is transfer from poor to rich- Counterargument: government invests rather than spends
- Bailout amounts to socialism
Financial CrisesInternational Political Economy
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Is crisis the problem?
Structuralist perspective:
- Capitalism is inherently unstable- Profit-seeking causes overproduction, booms and busts- Speculation
- Question is: why did we believe the system was stable?- Central Banks have delayed big crisis (Niall Ferguson)
- Capitalism needs peaceful labour and willing consumers
- Tendency to think “this boom is different”
Financial CrisesInternational Political Economy
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Political-economic impact: Historical parallels
- Long waves?
Financial CrisesInternational Political Economy
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Historical Pattern: Crises followed by change in ‘economic regime’- 1870-1932: Neoclassical economics, Liberalism
- Free markets- Centred on entrepreneur- Focus on individual, micro-level
- 1936-1973: Keynesian economics, Welfare states/Development
Economics - Government steering- Centred on consumers and labourers- Focus on aggregate, macro level
- 1980-2008: Supply side economics, Neoliberalism- Created markets - Centred on entrepreneurs- Focus on individual, micro-level
- 2008- : ?- Government regulation
Financial CrisesInternational Political Economy
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Debt crisis (early 1980s)1970s: - Oil crisis: increasing costs of production & consumption- Stagflation in developed world- Cheap Credit-fuelled expansion in developing world
1980s: - Thatcherism & Reagonomics- Rising interest rates
Consequence: - Inflation tamed- Unemployment in developed world- Defaults in developing world (Mexico 1982): credit withdrawn
Financial CrisesInternational Political Economy
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Asian crisis (1997-1998): Causes- No Fundamental macro-economic problems
- Enough foreign reserves- Exports surpassed imports- Fiscal policies sound
- Institutional, regulatory problems- Fixed exchange rates had seemingly reduced risks of foreign borrowing- Short-term foreign borrowing, long-term domestic investment- Property market bubbles- ‘Streets of Asia are paved with gold’: Lack of detailed information- Lax oversight, close connections between investors and politicians
- Self-fulfilling speculation- Contagion
- ‘Consensus’: financial liberalisation without proper regulation
Financial CrisesInternational Political Economy
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Asian crisis (1997-1998): Development- What happened:
- Investors massively withdraw funds from Asia- Currencies devalue sharply- Domestic businesses see (dollar-denominated) loans increase- Credit crunch
- IMF response: - Let insolvent banks and financial institutions fail
- Avoid moral hazard- Avoid political interference in markets- Break up links politics & business
- Raise interest rates - Shore up currency- Penalize insolvent companies
- Allow foreign take-overs- Break up links politics & business: worldmarket efficiency instead
Financial CrisesInternational Political Economy
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Asian crisis (1997-1998): Consequences
- Political upheaval - Malaysia: DPM Anwar Ibrahim jailed for corruption and ‘sodomy’
- Indonesia: fall of Suharto
- Major recession- Took about 8 years to reach pre-1997 income levels again,
Indonesia even longer
- Alternative reactions?- Malaysia did not turn to IMF
- Imposed capital controls
- Came off relatively easy
Financial CrisesInternational Political Economy
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Questions
1. What way now for capitalism?
2. Financial systems and Capital flows: should they be regulated and limited?
3. Who was gaining from previous situation? How were they making sure situation persisted?
4. Has crisis caused a shift in power, making a change of regime likely?
Financial CrisesInternational Political Economy