part 10 athens finance class summer 2010 forum nexus

Class #10

Greece

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.

[email protected]

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

Team Project

•Due date: last class before Final Exam▫3 week – Tues July 20th (are they helping?)

▫4 week – Wed July 28th

•Team project 25% of final grade•Peer review

exam

•Note – didn’t include last lecture(s) from Milan, but final exam will!

International IQ moment

What is happening in Greece? - discussion

Athens GreeceAthens Greece – at the heart of a European Crisis? Observations??

Athens Greece

•What is happening in Greece? –

•Is the crisis done? Can you feel it?

2 main industries

•Tourism•Shipping

•Both suffered during 2007-9 crisis•Government spending (stimulus + other)

•2 Deficits…

Understanding Greek challenges•In a macro sense: Facing 2 deficit challenges

1.Current account deficits – 2.Budget deficits

What is the difference?

1. Current account deficits

Current account deficit; Greece importing more than exporting.

Current account deficits – line of trucks on boats from Italy –

So, by definition… capital account must be in surplus to pay for current account deficit.

1. Current account deficits• little $ in FDI, much $ came in from tourists.

Tourism = importing capital (capital account surplus).

• Importing $ capital = ok, as long as foreigners keep supplying capital

• But, remember what has to happen if the capital account switches from surplus to deficits? The current account must move from deficit to surplus. How? If currency can devalue (as they are apart of Euro zone)… then competitiveness must increase – either more efficient or lower wages… politically and socially painful process that could take YEARS!!

2. Budget deficits

Budget deficits - remember national balance sheet ? assets (income) and liabilities (spending).

• For Greece, a big part of income came from tourism, which dropped off significantly with the crisis. But, spending remained “too high”. Structural, difficult to bring down

2. Budget deficits

Governments weak, short term thinking. Difficult to fix structural troubles with budget. Need to cut costs. But, strong unions, and impatient democratic voters. Politicians that try to raise taxes or cut spending (fire teachers) are thrown out

As opposed to governments in countries like Ireland that have made steps to address difficult structural troubles

Budget dilemma• The welfare state's death spiral is this: Almost

anything governments might do with their budgets threatens to make matters worse by slowing the economy or triggering a recession.

• By allowing deficits to balloon, they risk a financial crisis as investors one day -- no one knows when -- doubt governments' ability to service their debts and, as with Greece, refuse to lend except at exorbitant rates. Cutting welfare benefits or raising taxes all would, at least temporarily, weaken the economy. Perversely, that would make paying the remaining benefits harder.

Robert J. Samuelson, Monday, May 10, 2010 http://www.washingtonpost.com/wp-dyn/content/article/2010/05/09/AR2010050902443.html?hpid=opinionsbox1

Problem with democracy (need for IMF as “bad guy”)

•“we all know what to do, but we don’t know how to get re-elected once we have done it!”

▫Jean-Claude Juncker, Prime minister of Luxembourg, 2007

Economist Magazine, “Can anything perk up Europe?”, July 2010 “

Fears- Contagion

•There are many other countries that are running deficits.

•What happens if credit markets freeze up - stop funding?

•PIIGS of Europe▫Portugal, Italy, Ireland, Greece, Spain▫Threaten to tear apart Euro

•US, UK are the big ones

Other countries – BIGGER Debts

http://www.economist.com/world/europe/displayStory.cfm?story_id=16003661&source=most_commented

Greece to global

•“All the financial markets are now in turmoil,” Japanese Vice Finance Minister Rintaro Tamaki, the country’s top currency official, said in an interview in St. Gallen, Switzerland.

•“The impact of the Greek crisis has gone beyond the border of the euro area. This is a global issue.”

http://preview.bloomberg.com/news/2010-05-07/eu-leaders-under-pressure-to-broaden-response-to-greek-crisis-as-g-7-meets.html

European banks

•Royal Bank of Scotland reckons that foreign banks own about €1 trillion of the sovereign debt of Greece, Portugal and Spain.

•There would be a risk of another crisis in the style of 2008, in which the markets would be uncertain which banks were most exposed to the defaulting assets, and would therefore apply a general boycott.

http://www.economist.com/displaystory.cfm?story_id=16216443

Rush to “safety”•Concern that European leaders will need

to bail out more countries than just Greece flared from New York to Sydney last week, prompting investors to shun all but gold, dollars, yen and the safest government securities.

http://preview.bloomberg.com/news/2010-05-09/bank-funding-crunch-deepens-as-default-swaps-reach-records-credit-markets.html

Don’t blame the Euro (for the Greek mess)

•But the central cause is not the euro, even if it has meant Greece can't depreciate its own currency to ease the economic pain.

•Budget deficits and debt are the real problems; they stem from all the welfare benefits (unemployment insurance, old-age assistance, health insurance) provided by modern governments.


Greek short term debt trouble

•Problem was relatively short maturity of debts making Greece vulnerable to a change in market sentiment.

http://thegovmonitor.com/world_news/united_states/greece-italy-and-europes-sovereign-debt-crisis-28846.html

Demographics

•Aging populations make the outlook worse. In Greece, the 65-and-over population is projected to go from 18 percent of the total in 2005 to 25 percent in 2030. For Spain, the increase is from 17 percent to 25 percent.


demographics

Economist Magazine, “Staring into the Abyss”, July 2010 “

Review

USA – unique position

discuss “How related?”

•Fiscal budget crisis in Europe (Greece, PIIGS)

and

•Credit Crisis in USA (Lehman Bros failure, TARP, bailouts, etc)

Are they related? How?

What do these have in common?...

Greece rolling over its debts

EU banks borrowing from ECB

Lehman Bros failure

Investment Banking business model

All rely on short term money markets (borrow short), re-financing short term debt, and took for granted that they could access cheap short term capital to finance longer term debt (or investments)

Assumes that short term markets will continue being LIQUID (will keep spinning, full of flowing cash) But, what happens if short term markets freeze up? This is what happened after Lehman Bros. failed (and almost happened again with Greece)…

Credit Crunch = Result

Greece, Germany, EU + IMF

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

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”

What is unique about the USA?

▫Why is the US able to run large current account deficits?

▫If current account deficit = crisis, and if the USA has current account deficit for more than 20+ years why no crisis in USA?

Devalue currency

•If the US were to devalue its currency…

•“an elegant, painless, and entirely legal way for the US to default” (without actually defaulting)


No threat of solvency crisis:

The US does NOT face a “solvency” crisis in the foreseeable future (due to excessive borrowing from abroad)

Who can explain this?

If devaluation of the US dollar…•“US…runs no danger of adverse currency

mis-matches. …In the US, “currency mismatches work in exactly the opposite direction; the country has assets denominated in foreign currency and liabilities denominated in domestic currency… The more unwilling the rest of the world is to hold the dollar, the more solvent the US becomes”


The US Balance Sheet: (just looking at external

financing)

• Assets

▫Foreign currency

Investment abroad FDI Portfolio Earning foreign

currency

•Liabilities

▫Local currency

Foreign gov’t buy US Treasuries is US dollars!

So, what happens if US dollar “depreciates”?

(does US become more, or less “Solvent”?)

Solvency v Liquidity

•Insolvent: liabilities > assets (equity = 0)▫Person: I owe more than Im worth▫Bank: assets loose value (subprime

mortgages)▫Country: cant pay debts…default

So, what happens if US dollar “depreciates”?

(does US become more, or less “Solvent”?)

If devaluation of the US dollar…•“US liabilities that are denominated in

currency units are measured in the countries own currency”

•“if it wishes to improve its balance sheet position (and so its solvency), all the US needs to do is allow the value of the dollar to fall against other currencies”


US Balance Sheet: with Depreciation of US currency•Assets

▫Foreign currency Investment abroad FDI Portfolio Earning foreign

currency

•Liabilities

▫Local currency Foreign gov’t

buy US Treasuries is US dollars!

If US dollar DEPRECIATES… US becomes MORE solvent!

Exorbitant privilege

“exorbitant”:•Back in 1965, Valery

Giscard d’Estaing, then French finance minister, described the ability of the US to borrow cheaply and without limit in its own currency as an “exorbitant privilege”

Real threat to the USA•Might loose “exorbitant privilege”

•“You Don’t know how luck you are, babe”

▫Able to borrow (seemingly) unlimited ▫In own currency▫At a very low rate

▫(and invest abroad at higher returns, and run NO risk of insolvency!)

Why US needs this privilege (low rates, in own currency)

Currently Funding ▫2 wars.▫Economics stimulus▫Economic recovery▫Massive Current account deficit

Future ▫ Social Security / Health care reforms

Demographics & the Debt

By 2050; a third of the rich world’s population will be over 60

“The demographic bill is likely to be (10x) ten times bigger than the fiscal cost of the financial crisis.”

The Economist, June 2009

Discussion

2000-2007 “STABILITY”

•Why were there no emerging market financial crises between 2000-2007?

•What role did the US play in stability?

Class discussion:

•Problem = bigger than Greece•All countries with current account deficits•Signal trouble (financing needed)•Need to “fix” global finance•Allow $ to flow from rich to poor (without

devastating results)•US debt – sustainable? •Inflate / devalue -- risk to China / foreign

investors

Class discussion:

•Inflate / devalue -- risk to China / foreign investors

•US dollar “flawed” vs. Euro•Cant bet against both! Gold•US “power” / powerless – Savings glut

part 10 athens finance class summer 2010 forum nexus

Education

athens greece athens

definition capital account

capital account switches

budget dilemma

brian butler

countries bigger debts

final exam

european crisis