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Dr. Mark Ellyne UCT Summer School 2012. South Africa In A Changing World : Current World Economic Trends And Crises . Lecture Outline. Some general world trends of the last 30 years Economic transmission of crises International imbalances The Sub-Prime financial crisis - PowerPoint PPT Presentation
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1
SOUTH AFRICA IN A CHANGING WORLD:
CURRENT WORLD ECONOMIC TRENDS AND CRISES
2012/16/27
Dr. Mark EllyneUCT Summer School 2012
2
Lecture Outline
• Some general world trends of the last 30 years• Economic transmission of crises• International imbalances• The Sub-Prime financial crisis• The Euro crisis and Greece• Implications for South Africa2012/16/27
3
I. The World Is Growing Rapidly19
6019
6219
6419
6619
6819
7019
7219
7419
7619
7819
8019
8219
8419
8619
8819
9019
9219
9419
9619
9820
0020
0220
0420
0620
0820
10
0
200
400
600
800
1000
1200
1400
1600
1800
0
1000
2000
3000
4000
5000
6000
7000
8000Population (millions)European UnionSouth AsiaLatin America & Carib-bean (all income levels)Sub-Saharan Africa (all income levels)World
World
World (right)
Asia (left) SSA (left)
EU (left)
Re-gions
2012/16/27
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Living Standards Are Rising1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
50,000Current GDP per Capita (US$)
World (left)
Latin America (left)
USA (right)
East Asia (incl China) (left)
South Asia (incl india) (left)
Sub-Saharah Africa (left)
$ per annum USA, $
2012/16/27
5
II. Economic Geography of the World Economy is Shifting
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
0.0
10.0
20.0
30.0
40.0
50.0
60.0
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000Shares of World GDP$
% S
hare
Cuur
ent P
PP $
, bn
G7
Asia
LATAM
World $GDP (left)
SSA
ME CIS & EE
$ billions% of World
2012/16/27
6
Geography of World Economy is Shifting
1980 % Share
2010 % Share
USA 2,888 26.0 14,527 23.1European Union
3,652 34.1 16,242 25.8
South American
845 7.9 4,834 7.7
Asia 667 6.2 9,536 15.2 China 203 1.9 5,878 9.3Africa 277 2.6 1,049 1.7 South Africa
81 0.8 364 0.62012/16/27
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III. The World Economy is More Integrated
•World trade is growing 50% faster than nominal GDP• International capital flows are
growing faster than trade• Telecommunications/internet
makes international investment opportunities more easily available
2012/16/27
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IV. Is the Economy is More Volatile?
Reinhart and Rogoff, This Time Is Different“... financial crises are nothing new.”“There have been at least 250 sovereign
default episodes during 1800-2009”“ Today’s emerging market countries did
not invent ... repeated sovereign defaults. Rather, a number of today’s now-wealthy countries had similar problems when they were emerging markets.” 2012/16/27
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Volatility Remains in Commodities19
8019
8119
8219
8319
8419
8519
8619
8719
8819
8919
9019
9119
9219
9319
9419
9519
9619
9719
9819
9920
0020
0120
0220
0320
0420
0520
0620
0720
0820
0920
1020
11
0
20
40
60
80
100
120
140
0
50
100
150
200
250
300Commodity Prices
Food Price In-dex
Oil Price/barrel (left)
Metals Index
US$/barrrel Index
2012/16/27
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V. More Economic Convergence?1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
-15
-10
-5
0
5
10
15 World GDP Growth and Range Among Regions
%
Lowest re-gional growth
Highest regional growth
2012/16/27
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Inflation Has Been Variable but Converging
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
-10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0% Inflation %European UnionSouth AsiaLatin America & Caribbean (all income levels)Sub-Saharan Africa (all income levels)
2012/16/27
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Observations
1. World growing strongly2. Economic geography changing3. World is more integrated4. Volatility remains5. More convergence?
2012/16/27
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VI. Economic Transmission Mechanisms
How are shocks transmitted internationally? Trade-related (traditional) linkages
Financial and Contagion linkages
2012/16/27
14
Traditional Shock Transmission to Africa – Foreign Demand
• Lower demand from Rest of World —especially advanced economies — reduces demand for African exports (and vice versa)• IMF estimates that a 1% slowdown
in GDP in the rest of the world leads to a 0.5% slowdown in SSA
2012/16/27
15
Traditional Shock Transmission to Africa - Other
• International prices affect African import and export prices• Economic conditions in advanced
economies affect foreign aid levels• Economic conditions in advanced
countries affect worker remittances to Africa
2012/16/27
16
Financial Transmission
Interest rate is key mechanism for international economic
transmission•With capital mobility, interest rates of small
countries tend to move toward the interest rate of large open economies.• Raising the interest rate in a small country
tends to strengthen the exchange rate, and/or increase capital inflows.
2012/16/27
17
Balance Sheet EffectsCommercial Risk
Assets LiabilitiesCommercial Loans DepositsGovernment Bonds
= Net Worth (>0) (Shareholder capital) (Reserves/past profits)
Bad loans → Net Worth ↓Reduce Capital2012/16/27
18
Balance Sheet Effects:Foreign Borrowing & Exchange Risk
Assets (Rand) Liabilities (Rand)Commercial Loans DepositsGovernment Bonds
Shareholders Capital
Domestic Loans Borrow $ FundsValuation Effect (-)
2012/16/27
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Balance Sheet EffectsForeign Investment & Exchange Risk
Assets LiabilitiesCommercial Loans DepositsGovernment Bonds
Invest in Foreign AssetsBad Loans (-)Valuation Effect (-) Net Worth ↓
Shareholders Capital ↓2012/16/27
20
Contagion
• A liquidity crunch in an advanced economy can spread to smaller markets as economic agents (individuals + companies) look for cash.• A contagion effect may result when
economic agents believe that a crisis in one country will occur in other similar countries.
2012/16/27
21
VII. Global Imbalances Problem
• The exchange rate should adjust to ensure the tendency toward current account balance, so country’s current account balance cycles around 0 for stability.• Sustained deficits (or surpluses) for long
periods indicate some other serious structural problem.
2012/16/27
22
Persistent Current Account Surpluses And Deficits are a Problem
2012/16/27
23
Implications of Current Account Balance
• Current account Deficit → capital account borrower, or debtor
(and vice versa: Surplus → Creditor)•Deficit → Currency depreciates [Surplus → Currency appreciates]
• But what about China and USA?2012/16/27
24
China - USA Symbiosis
• China has large surpluses so its currency should appreciate• China loans USA large amounts of
money (by buying US government treasury bills) to continue trade imbalance without adjusting• And, China’s exchange rate is fixed
to US$2012/16/27
25
Is China Adjusting
1980 Q1 1983 Q1 1986 Q1 1989 Q1 1992 Q1 1995 Q1 1998 Q1 2001 Q1 2004 Q1 2007 Q1 2010 Q10
500
1,000
1,500
2,000
2,500
3,000
3,500
0.00
0.10
0.20
0.30
0.40
0.50
0.60China: Foreign Reserves Res/GDPUS$ bn
$ Reserves (right)
Reserves/GDP (left)
2012/16/27
26
Is China Adjusting?
1980 Q1 1983 Q1 1986 Q1 1989 Q1 1992 Q1 1995 Q1 1998 Q1 2001 Q1 2004 Q1 2007 Q1 2010 Q10.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80China: Exchange Rate, US$/Yuan (Down=Depreciation)US$/Yuan
2012/16/27
27
Same China Story with South Africa?
2012/16/27
Jan-
80Au
g-80
Mar
-81
Oct
-81
May
-82
Dec-
82Ju
l-83
Feb-
84Se
p-84
Apr-
85No
v-85
Jun-
86Ja
n-87
Aug-
87M
ar-8
8O
ct-8
8M
ay-8
9De
c-89
Jul-9
0Fe
b-91
Sep-
91Ap
r-92
Nov-
92Ju
n-93
Jan-
94Au
g-94
Mar
-95
Oct
-95
May
-96
Dec-
96Ju
l-97
Feb-
98Se
p-98
Apr-
99No
v-99
Jun-
00Ja
n-01
Aug-
01M
ar-0
2O
ct-0
2M
ay-0
3De
c-03
Jul-0
4Fe
b-05
Sep-
05Ap
r-06
Nov-
06Ju
n-07
Jan-
08Au
g-08
Mar
-09
Oct
-09
May
-10
Dec-
10Ju
l-11
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00Rand/$ (dash) and Rand/Yuan (line)
(Up = depreciation)R/Yuan R/
US$
28
Is China Helping or Hurting Us?
• Persistent large surplus → exports are too cheap?
•Who receives the benefits?
2012/16/27
29
VIII. 2008-09 Financial Crisis
What happened?•US and international banks invested in
US subprime mortgage bonds because they provide good return•Quality of those bonds deteriorated•Banks have balance sheet imbalance —
fewer assets than liabilities (deposits)Liquidity Crunch
2012/16/27
30
2008-09 Sub-Prime Financial Crisis
What to do?• Raise more capital from shareholders
o Takes money out of system• Stop lending and call in loans
o Fewer loans mean less economic growth• Issue: Is this systemic risk that
requires official intervention?
2012/16/27
31
“Moral Hazard” Question
• Let them go bankrupt• Bailouts
encourage bad behaviour of banks• Must be
consequences for risky behaviour
• Bailout needed• To protect others
and prevent panic widespread financial meltdown• Must restore
profitability of banking system
2012/16/27
32
Official Response to Financial Crisis
• Central bank buys bad assets at full value; i.e. swaps bad bonds for good government treasury bills, thereby improving solvency of banks• Fed reduces interest rates to stimulate
lending• Government provides fiscal stimulus to
offset reduction in private sector activitySide effects: rising government debt
2012/16/27
33
Consequences
• Banks stop lending to reduce risk, become profitable, and rebuild their balance sheets: reduce bad debts, increase capital and cash, raise profits. Result is recession.• Government stimulus creates rising
government debt and fear of debt crisis.Should we be fighting recession or
debt crisis?2012/16/27
34
IX. Greece & the 2011 Euro Crisis
What Happened• Rising Greek government debt service created
an expanding budget deficit•Market perceived government inability to pay
debt service•Government can no longer sell treasury bonds
at same low interest rate thus making deficit worse•Debt trap: need to run fiscal surplus just to
get out of debt; Can’t grow out of your debt/GDP ratio
2012/16/27
35
2011 Euro Crisis
What to do• Cut government deficit → raise taxes and cut
spending (ouch!)•Have European Central Bank buy Greek
treasury bonds at low interest rate = “Bailout”•Make all holders of Greek debt take a “Haircut”
(i.e. forgive debt)•Greek must leave Euro and devalue currency
to reduce domestic demand and stimulate exports
2012/16/27
36
Why Leave the Euro?Flexible Exchange Rate Adjusment
• If country has high inflation or its production costs become uncompetitive at the existing exchange rate, it should depreciate to make exports cheaper and imports more expensive
Depreciation→ M↓ and X↑2012/16/27
37
Adjusting With a Fixed Exchange Rate
• To stimulate private sector activity while contracting public sector, must reduce unit labour costs to make Greek economy more internationally competitive• If you can’t devalue currency,
must cut wages2012/16/27
38
But…Is This Just a Greek Problem?
•Who is holding Greek debt? EU commercial banks are threatened• Is this a European sub-prime crisis?• If the EU is current account is in
balance, should surplus countries in EU also be adjusting?• How to ensure that Greek
government behaves in the future?2012/16/27
39
Meaning for South Africa
• SA is an open economy that has a current account deficit and financial account surplus, owing to its large financial sector and stock exchange.• It is subject to international trade
shocks and financial contagion.• Thus, good economic policy is
necessary to avoid contagion effect.
2012/16/27
40
Characteristics of South Africa Economy
• South Africa’s fiscal deficits are 3-5% of GDP, which are moderate.• Government debt is about 48% of
GDP, which is a safe level.• Inflation is moderate (4-7%) and
the real interest rate (interest rate-inflation) is low.• The exchange rate is volatile.2012/16/27
41
Questions and Discussion
•World trends – is anything new?•Global imbalances – who’s fault is it?• The subprime crisis and financial
asset shocks – can we prevent another one?• The Euro Crisis – who will save the
euro?
2012/16/27