Class #8Milan 1st class

Brian David ButlerProfessor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan. Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes at the university Faculdade Boa Viagem.

A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America.

briandbutler@gmail.com

LinkedIn/briandbutler

Skype: briandbutler

Brian Butler is a specialist in international economic analysis, and is founder of the prestigious “GloboTrends“ (www.globotrends.com) online economics site, which has been featured as syndicated content on Nouriel Roubini’s RGE Monitor, Emerginvest.com, Business Week Exchange, Wikinvest.com, and other leading news outlets.

http://globotrends.pbworks.com/ , http://blog.globotrends.com/

Find my slides:

www.slideshare.net/briandbutler

Lecture Schedule*

* Does not include professional visits, *Subject to change, modification without warning

•Tues 22th – boat to Greece

•Mon 26th – Athens

•Tues 27th – Rhodes•Wed 28th – Rhodes•Thurs 29th – Rhodes EXAM

Hedging problems

Hedging problem (Account Receivable):

fear = ?

Hedging problem (Account Receivable):

fear = you will receive LESS than expected…

Hedging problem (Account Receivable):

• Assume that you are a French Wine producer, and that you sold a full container of wine to an importer in the USA for $1.5 million dollars, to be paid in 6 months. Assume that today’s exchange rate is $1.5 US dollars to 1 Euro. (assume that the buyer always pays on time)▫If the exchange rate were to remain the same,

how many Euros would you expect to receive?

▫In 15 words or less, describe the foreign exchange risk (what are you afraid of?)

Hedging problem (Account Receivable):

•Assume that you are a French Wine producer, and that you sold a full container of wine to an importer in the USA for $1.5 million dollars, to be paid in 6 months. Assume that today’s exchange rate is $1.5 US dollars to 1 Euro. (assume that the buyer always pays on time)▫If the exchange rate were to remain the same,

how many Euros would you expect to receive? 1 mm Euros

▫In 15 words or less, describe the foreign exchange risk (what are you afraid of?) USD depreciate / Euro appreciate

▫If the exchange rate were to change from $1.5 US dollars per 1 Euro, and become $2 US dollars per 1 Euro;

How many US dollars would you expect to receive in 6 months?

How many Euros?

▫If the exchange rate were to change from $1.5 US dollars per 1 Euro, and become $2 US dollars per 1 Euro; How many US dollars would you expect to receive in 6 months? 1.5 MM USD (1 point)

How many Euros? 0.75 MM Euros (2 points)

▫Assuming that you DO want to sell wine abroad (From France to the USA): In 20 words or less, describe one way you could limit this foreign currency risk? (be specific about what currency to buy / sell)

▫Assuming that you DO want to sell wine abroad (From France to the USA): In 20 words or less, describe one way you could limit this foreign currency risk? Forward /futures/optionsSell dollars, buy euros

Review

Review Questions

•Why are current account deficits “dangerous”?

National “Balance Sheet”

•GROUP:

▫So…If imports are > exports… what must be happening in the “capital account”?

National “Balance Sheet”

•GROUP:

▫Does USA have capital account surplus? or deficit? (over past 20+ years)

Group Question

• If you have a current account deficit, you must have a capital account (_______)?

•But, do foreigners HAVE to send you money? (do they need to buy US treasuries)?

•What happens if foreigners decide NOT to send you money? (what must happen to the current account)? When?

Answer:

▫You must then dip into the Reserves (if you have any) and pay the difference… (gold, foreign currency)

Follow up question:▫What if you don’t have enough reserves? Then what? What can you do?

(What happens if you are running a current account deficit, and if foreigners SUDDEN STOP supplying capital, but… you do not have enough reserves to pay the bill?)

What if devaluation doesn’t solve the problem (not enough time to structurally change imports v exports)?

1. Question:

▫ Who can you turn to if your country faces situation outlined above (running a current account deficit, and if foreigners SUDDEN STOP supplying capital, but… you do not have enough reserves to pay the bill?)

▫ Who is there to “help”?

Call for help!

•IMF▫Lender of last resort▫The IMF (international monetary fund)

came into existence after WWII in what was called the Breton Woods agreements that created both the IMF and the World Bank.

IMF

IMF Lending in Europe

http://www.imf.org/external/region/eur/map/index.htm

(from North to South)•Latvia: $2.35b Dec 23, 2008•Belarus: $2.46b Jan 12, 2009•Poland* $20.58b May 6, 2009•Ukraine: $16.4b Nov 5, 2008•Hungary: $15.7b Nov 6, 2008•Romania: $17.1b May 4, 2009•Bosnia + Herzegovina $1.57b 2009•Serbia: $4b, May 15, 2009•Greece* 2010 $145 b, May 2010

Others:•Turkey 2009•Iceland 2007

IMF – “business model”• IMF as a "Bank" (not a "fund")

▫Its interesting that the IMF (international monetary fund) acts more like a bank, but the World Bank acts more like a fund.

▫Actually, the IMF acts more like a "credit union”...the 185 member countries put money in on deposit, and they receive interest payments back. The interest payments are small, because the IMF is seen as a high quality borrower (and there is a social cause behind the mission). The money borrowed then gets re-loaned out to countries in trouble.

IMF – “business model”•The IMF receives its major inputs of funding

from the member countries (quotas), but then sustains itself by making loans (investments).

•“carry trade”: In a simplified sense, the IMF gets money from its members at very low interest rates, and then turns around and loans that money out to countries in trouble at higher interest rates (short term loans at higher rates).

Criticism of the IMF

•What are some of the main criticisms of the IMF?

http://thetruthorthefight.files.wordpress.com/2009/04/imf-trapping-countries-in-debt.jpg

Is the IMF really the “bad guy”?

Democracies + unpopular choices…•Countries that are democracies are often

reluctant to make the hard structural reforms that are necessary to fix their own internal balance of payments problems.

•Raising interest rates and taxes might help the governments books balance, but it would effectively slow down the economy and put people out of work.

Criticism of the IMF “business model”•Profits from Crisis?•In a strange way, the IMF is only

profitable when there is a period of economic uncertainty or turmoil. If there is not a crisis, then there is no one taking the loans, and the IMF can not call on the quotas from its members.

IMF – “conditionalities”

•The first thing is that a country will have to make guarantees to the IMF that they will make hard policy changes to fix the underlying structural problems that caused the crisis

• to fix the imbalance in the current account, they may have to raise taxes, raise interest rates, and other drastic measures…

•Why is this controversial?

“Conditionalities” – why?

•You can think of the IMF as the tip of the iceberg in international lending.

•They are the most visible part, but behind them there are government and commercial loans that makeup a bulk of the debt package to a developing country.

“Conditionalities” – why?

•IMF conditionalities and structural adjustment programs are necessary to give international confidence to the capital markets that a country is implementing the necessary structural changes that will ensure that future loans to the country will not be made in vain.

“Conditionalities” – why?• For example, without an IMF agreement, the

Paris club in international lending governments will not meet with a debtor nation to reschedule (reduce) the debt payments.

• It’s only after a country has already made a deal with the IMF (and accepted their conditionalities) that the other lenders will agree to meet with the country to reschedule their debt.

• IMF loans are extremely important in that they send a signal (to the rest of the iceberg of international lenders).

Greece, Germany, EU + IMF

•Why did Germany wait so long to agree to the Greek bailout? Why did they want IMF involved?

Conditionalities - controversial

•To many…these conditionalities are seen as a weapon of the developed western nations to force the developing countries to conform to liberal economic policies (such as privatizations, lowering of trade barriers, deregulation of industries, floating exchange rates, increasing FDI, balancing budgets, removing price controls, and fighting corruption).

•Google search“Washington Consensus

Conditionalities - controversial

•The mercantilists of the borrowing nations argue that the conditions dictated by the IMF limit their national sovereignty by placing external controls on how they are supposed to run their internal economy.

Conditionalities - controversial

•One of the most controversial conditions of the loans is that borrowing nations must cut back on government spending.

•These “austerity” measures are often blamed for the cutting of social programs that benefit the poor.

•For this reason, many blame the IMF for placing the needs of the rich over the needs of the poor.

Conditionalities - controversial

•By requiring the borrowing nations must balance their budgets, the IMF is often blamed for the cut backs in social programs in these countries (such as education, public health, and other development projects for the poor).

Conditionalities - controversial•Another criticism of the IMF is that they

often recommend that a country should raise taxes and cut spending in order to balance their budgets.

•But economists of Keynesian school of thought argue that this is the exact opposite of what a country in recession needs. Keynes would argue that in order to jump start the economy, they actually need to do the opposite – cut taxes and increase government spending.

Conditionalities - controversial

•The IMF is therefore often criticized for making an economic recession into a depression as increased taxes and decreased spending slows the economy and decreases the chances for a quick recovery.

After ‘97-98 SE Asian Crisis…

•Why is the IMF avoided “at all costs” by borrowers?

▫Why are countries so reluctant to turn to the IMF for help?

IMF & Asian Crisis ‘97

•Key lessons…

•What do you think was learned?•Who was watching?•What has changed?

What conditions did the IMF tie to its loans after SE Asian Crisis of ‘97-98?

Raise taxes Cut spending Goal of IMF: recipe to balance budget

why this was unpopular?

Unpopular: Higher taxes + lower government spending = drag on economy, slower growth

Lesson: avoid the IMF at all costs!!! Trouble….. Shift from collective insurance to self-insurance (accumulation of reserves)

Legacy of the Crises (2 lessons)1. Danger in capital flows

▫avoid current account deficits▫ Result: countries try to run current account

surplus + capital account deficits (sending $ abroad)

Due to FEAR (of current account deficits) money flows from poor to rich

2. Avoid IMF▫Conditionalities unpopular

▫ How to avoid the IMF? ▫ Focus on self-insurance (build up own stock pile

of reserves) reserves

Martin Wolf book, “Fixing Global Finance”

Legacy of the Crises - #1 (danger in capital flows)

•Goal: keep FX undervalued for:▫Avoid risk of devaluation in future (don’t

get caught with debts in foreign currency)▫Exports to increase▫Avoid Current account deficit (keep

imports low, exports high)▫Never have to call on the IMF!!!

Martin Wolf book, “Fixing Global Finance”

Legacy of the Crises – part 1

•But, if “dollar bloc” ALL fight to keep currency LOW vs Dollar

▫See chart next page…

Martin Wolf book, “Fixing Global Finance”

•“currencies either pegged to the dollar or more or less actively managed against it (a group that includes Japan)”

Oil Exporters Bahrain Oman Qatar Saudi Arabia UAE (Dubai

included)

The “dollar bloc” China Hong Kong Taiwan Japan Singapore Malaysia Thailand India Others: Ecuador,

Panama, more…. Used to be Argentina!

Sources: figure 6.6 from Wolf “Fixing Global Finance”And, Economist.com, May 23 2009, “Monetary Union in theGulf”

Legacy of the Crises – part 1

•And, if ALL are determined to run current account surpluses….

•Question:▫Who MUST run current account deficits

(remember, by definition SOMEONE must)!!

Martin Wolf book, “Fixing Global Finance”

Legacy of the Crises – Part I

•Answer:

•The ONLY country on the planet that was willing and ABLE to run deficits (on a large scale) was the USA

Martin Wolf book, “Fixing Global Finance”

Dollar bloc:

•What is the impact on the Euro-zone?•How does the “dollar bloc” effect

exporters in Spain? France? Germany?•How about countries outside of the bloc,

such as Brazil?

Important notes

Upcoming schedule

Lecture Schedule*

* Does not include professional visits, *Subject to change, modification without warning

•Tues 22th – boat to Greece

•Mon 26th – Athens

•Tues 27th – Rhodes•Wed 28th – Rhodes•Thurs 29th – Rhodes EXAM

Start studying for the exam now!! Find my slides:

www.slideshare.net/briandbutler

Team Project

•Due date: last class before Final Exam▫3 week – Tues July 20th ▫4 week – Wed July 28th

How to turn in:- either (hand written, neatly!) or computer, email:

Resources:1. Lectures2. Text Book: “An Introduction to Global Financial Markets”

(Valdez), chapter 11, “European Economic and Monetary Union” 2007, (suggested focus: p. 287-305). Pay special attention to “EMU – the benefits” – p 287, and “The counter arguments” – p289

3. Handout article: “Holding Together, A special report on the euro area”, from the Economist, June 13th 2009 (p 1-16)

*Grad Students only:▫ Read handout: “Country Forecast, Economies in Transition,

Eastern Europe”, from EIU, May 2009 (p. 5-10)

Group Project, “The Euro Zone – before, during and after the Global Economic Crisis”

Grading:• 30% of final grade for course• comparative (one team compared to others)

• there is no “right answer”, but grading will be based upon:

▫ Cover all required topics▫ Answer the questions asked▫ Additional insights▫ Strength of arguments (pro / con)▫ Depth of analysis▫ Be concise! ▫ Ability to capture “heart” of issue

Group Project, “The Euro Zone – before, during and after the Global Economic Crisis”

Assigned Readings

•Martin Wolf book

▫First three Chapters

▫Plus…other mini readings to be assigned later

• Finance book▫ Chapter 9 – foreign

exchange ▫ Chapter 11 - European

Economic and Monetary Union

▫ Switzerland – p 288▫ Euro – p 289, p304

• Optional additional reading▫ Chapter 2 – banking

background p30-38▫ Chapter 6 – the money and

bond markets▫ Chapter 12 – traded options▫ Chapter 13 - Futures