Global Financial Crisis

Keith Rankin Unitec 29 April 2009

a Global Village Market as an analogy of the Global Economy

Traditional Village Market

• Imagine a traditional pre-industrial market.– Place to exchange goods and services

• In principle, no money is required. Useful lubricant, though.– Individual Benefit and Cost:

• Benefit: People come into “town” on market day to buy goods or services they want or need. [eg 1 unit of food]

• Cost: As payment they bring items that are of lesser value to themselves to sell. [eg 1 sheep]

– Market clears:• Items exchange at market prices• Each participant gains• Only reason to sell is to buy

Over-selling / Under-buying Behaviour (Saving)

• Unintended oversupply of sheep– Market has more sheep than usual

• Market may clear: price of sheep falls, rise in food price.• If oversupply of sheep is small, sheep & food may exchange

for usual price. Market requires credit in order to clear.

• Someone plans to sell more than they intend to buy (eg brings 2 sheep; only wants 1 food). Irrational ???– balances if someone else happy to buy more than sell

• credit/debit mechanism – IOU – requiredcreditor-driven process, rather than debtor-driven

– market doesn’t clear if no willing debtor wants to over-buy– someone returns home without making a purchase (unemployed)

Settling IOUs following Over-selling• Case 1 – Market Correction

– On a future market day, creditor buys extra food from debtor.settling a debt means creditor buying something from the debtor

• Case 2 – Habitual Credit Accumulation– What happens if the creditor once again brings 2 sheep, and

wants only 1 unit of food?• further, because his sheep are well presented (“marketed”)

– buyers want creditors’ sheep; creditor ends up with 2 IOUs

– and again, and again?• Result: credit spiral: IOU-rich creditors; sheep-rich debtors

– opportunity to sell financial services in market (ie trade in IOUs)

• Debtor(s) can only repay by selling extra things to creditors

Rationale for Creditor (Miser?) Behaviour

• In a future “rainy day”, creditors have more claims than everyone else on whatever amount of produce there might be.– credit accumulation source of relative rather than absolute

economic security– credit accumulation can itself be the cause of the future

rainy day

• Should creditors be rewarded with Interest?• eg additional credit accumulation

– interest only makes societal sense when "investors" borrow• investors are people who purchase capital goods

Note that mortgaged debt makes creditors materially richer if liquidation involves the transfer of land.

Societal Implications

• Debtors have more wealth; creditors more claims– Situation caused by creditors’ behaviour

• Creditors, eventually, must use it or lose itcreditors must buy more than they sell to defuse credit bubble– can do this in two ways (but neither sits well with their culture)

• substantially increase their buying• substantially reduce their selling

• If creditors do not change behaviour– credits/debts written off (liquidated) in some other way

– eg China 1949; France/Russia 1917

– what if fearful creditors exacerbate their behaviour?

International Economy

• 200 countries rather than peasant farmers– “mercantilist” countries have become habitual creditors

• eg China; Japan (there are deep-seated cultural traditions)– global economy prospered so long as other countries

became willing debtors• eg USA, UK, NZ, Australia• willingness to be a debtor is indicated by interest rates set by

central bank (eg Reserve Bank)– USA and UK have ceased to be willing debtors

• consider China/USA & Japan/UK as creditor/debtor partners– creditor countries now required to sell less than they buy– "use it" rebalancing vs. "lose it" rebalancing

The Great Depression

• 1920s was a period in which debtor countries had to cut back their spending, but creditor countries refused to increase there’s– problems linked to

• the gold standard of fixed exchange rates preventing debtor country depreciation; required creditor country inflation

• WW1 reparations (on Germany) and unpaid war loans

• floating exchange rates supposed to address this problem, but failed comprehensively

• in 2000s, many debtor currencies became overvalued• creditor currencies undervalued

Global Economy

• about 5½ billion adult human beings– many of these habitually sell more than they buy

• creditor community that is “joined at the hip” to its debtors– includes Japanese housewives, Belgian dentists, pension funds

– how do these terms differ? spot the spender• "lender"• "hoarder"• "miser"• "saver"• "investor"• "speculator"

– investors are purchasers of capital goods or services

(word commonly misused; investing is spending)(contrast "sunny day" and "rainy day" savers)

Sustainable Global Future

• Creditors must “Use it or Lose It”– creditors (at global, national, or village level) required to

• buy from debtors• become net spenders

• More spending overall (consumerist solution) is environmentally unsustainable

• Attitude required has to be:– “if you don’t want to buy much then don’t sell much”

• Income distribution has to change in favour of those with spending needs