THE TRASFORMER ASSOCIATION SPRING MEETING

LESSONS FROM THE RECENT CRISIS AND CURRENCY MARKETS

byTassos Malliaris

Loyola University Chicago

May 12, 2010

OUTLINE

1. Brief Evaluation of the Global Crisis

2. Emphasis on Lessons

3. Discussion of the Currency Markets

4. Problems with the Euro

Causes of the Financial Crisis

1. The Unpredictability of Crises2. Macroeconomic factors (housing)3. Microeconomic factors (rating agencies,

subprime loans, derivatives)4. Banking and Shadow Banking (leverage,

securitization)5. Monetary Policies6. Government Policies

The Nature of Crises

1. Currency Crises

2. Banking Crises

3. Financial Crises

4. Economic Recessions

The Financial Crisis of 2007-09

• What caused the real estate bubble?• Easy Monetary Policy for 2002-2005• Why such an easy monetary policy?• Irrational exuberance and the internet

bubble• The bursting of the internet bubble

10-Year S&P 500 Performance

10-Year NASDAQ Composite Performance

Actual and simulated housing demand

Growth of the Finance Industry as % of GDP

Development of the Crisis

• Subprime Problems with Bear Sterns• Highly Leveraged Financial Institutions• Bankruptcy of Lehman Brothers• Troubled Asset Relief Program• Liquidity Provided by the Fed• Stress Testing of Top 19 Banks

Federal Reserve Lending

Lending Facilities

http://www.bos.frb.org/news/speeches/rosengren/2009/100209.htm

Real GDP

Relative Global Unemployment Rates

Figure 1: Global Outlook (Real GDP; percent change from a year ago)

Global GDP Growth

Lessons

• Crisis started in the U.S.• Irony: Moderation Breeds Exuberance• High Leverage and Risk Taking• Regulatory Failures• Uncertainty Leads to Market Failures• Fed: Lender of Last Resort • Action: Fast, Decisive, Forceful

Global Currency Markets

• Global Financial Crisis

• U.S. and EU

• China was affected Less

• Some Emerging Nations were also affected less

China/US Exchange Rate

Balance of Current Account

Price of Gold During 2 CenturiesGold

0

100

200

300

400

500

600

700

800

900

1000

Date

Pric

e (U

S $)

10-Year Performance of Gold

Three Scenarios

1. Moderate Stability in the U.S. and EU.

2. EU Destabilizes; Prospects for the Euro

3. Inflation or Deflation?

Concluding Remarks:Current Challenges

• Financial Innovation vs. Financial Stability• New Wave of Financial Regulations• Equity vs. Growth• Drivers of Future Growth• Global Co-Leadership• The New Worrisome Bubble: Public Debt

0

10

20

30

40

50

60

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

China (1990-2008) Germany (1955-1975) Japan (1955-1975)

Foreign currency reserves, % of own GDP

Chinese Gender Ratio

China’s Challenge:The over 65s