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From (US) financial crisis to eurocrisis: Why are American houses connected to Europe's internal imbalances? Herman Schwartz University of Virginia 16 November 2012 UNC Chapel Hill / TAM
From (US) financial crisis to eurocrisis: Why are American houses connected to Europe's internal imbalances?
Herman Schwartz University of Virginia 16 November 2012
UNC Chapel Hill / TAM
Everything you need to know…
Euroland: an Optimal Currency Area?
• Euro only works if Europe is an OCA
• OCA needs:
– Essentially open financial markets (Yes)
– Essentially open goods markets (Mostly, but…)
– High internal labor mobility (No)
– High fiscal transfers (No)
– And – same ideas about proper policy
• Result: regional instabilities that are magnified by national political structures
Productivity vs average wage and average income of top 1%, in US, 1979+
Rising US household debt compared to incomes
1:1 ratio
The 1991-2007 US growth cycle
Asia Recycles US Dollars as new Treasury / MBS Debt
Disinflation Housing Finance System
More Consumption
US trade deficits Global Growth
Faster US Economic Growth
↑ Tax revenue Fed ↓ interest rates
Low interest rates No welfare state
China’s growth cycle, 2000s
Central bank Sterilizes $$ Issuing RMB
State Banks & party elites
More investment for exports
Central Bank buys $$
Trade Surplus
↓ domestic consumption
The 1995-2000s German growth trap
Slower job creation
Wage restraint
Low Domestic Demand
Less Domestic Consumption
Less domestic investment
Slower relative economic growth
↓ Tax revenue Tight money
policy
The 1995-2000s German growth trap
Slower job creation
Wage restraint
Low Domestic Demand
Less Domestic Consumption
Less domestic investment
Slower relative economic growth
↓ Tax revenue
Tight money policy
Export surplus
German banks buy PIGS debt
German banks buy US
Mortgage bonds
All these cycles are linked
CHINA GERMANY USA
Euro16 balance with select countries (€bil)
-80
-60
-40
-20
0
20
40
60
80
100
-250
-200
-150
-100
-50
0
50
100
150
200
Norway
Turkey
Japan
Poland
Switzerland
Russia
ChinaxHK
United States
United Kingdom
EU 16
Germany produces but does not consume – final consumption expenditure growth as
% of German growth (Germany = 100)
80%
100%
120%
140%
160%
180%
200%
220%
240%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Ireland Greece Spain Italy Portugal
Germany’s trade surpluses (€ bil)
0
20
40
60
80
100
120
140
Germany to EU27
Germanyto ROW
EU member interest rates 1995 - 2011
EURO introduced
Lehman crash
Taylor rule interest rates
Export growth, xEU27, index, 1999 = 100
50
100
150
200
250
300
Germany
Spain
France
Netherlands
Import Growth xEU27, index, 1999=100
50
100
150
200
250
300
350
Germany
Spain
France
Netherlands
EU internal trade balances, € mils More imports = rising “foreign” debt
-200,000
-150,000
-100,000
-50,000
0
50,000
100,000
150,000
200,000
250,000
300,000
1999 2000 2001 2002 2003 2004 2005 2006 2007
Netherlands
Germany
France
Greece
United Kingdom
Italy
Spain
External trade balance, € mils
-300,000
-250,000
-200,000
-150,000
-100,000
-50,000
0
50,000
100,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Germany
France
Italy
Greece
United Kingdom
Netherlands
Spain
US trade deficit (goods only, disaggregated, $bil.)
-800
-700
-600
-500
-400
-300
-200
-100
0
100
200
EU x Germany
Lat. America
Canada
Rest of world
Germany
Japan
Middle East
China
FIG 6: Central Bank Currency Swap Network, 2007-2010
Central bank currency swap network 2007-2010
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
20
07
-12
-05
20
08
-01
-02
20
08
-01
-30
20
08
-02
-27
20
08
-03
-26
20
08
-04
-23
20
08
-05
-21
20
08
-06
-18
20
08
-07
-16
20
08
-08
-13
20
08
-09
-10
20
08
-10
-08
20
08
-11
-05
20
08
-12
-03
20
08
-12
-31
20
09
-01
-28
20
09
-02
-25
20
09
-03
-25
20
09
-04
-22
20
09
-05
-20
20
09
-06
-17
20
09
-07
-15
20
09
-08
-12
20
09
-09
-09
20
09
-10
-07
20
09
-11
-04
20
09
-12
-02
20
09
-12
-30
20
10
-01
-27
Fig 5: Central Bank Currency Swaps With U.S. Federal Reserve
Currency Swaps(Weekly Average) -Multiplier = 1,000,000
Value of FED currency swaps ($mil)
Lehman bankruptcy
EU member interest rates 1995 - 2011
EURO introduced
Lehman crash
Crisis Fiscal deficits (not the reverse)
-16
-11
-6
-1
4
2004 2005 2006 2007 2008 2009 2010
Sweden
Denmark
Germany
Italy
Netherlands
Euro area (16 countries)
Spain
United Kingdom
Greece
What if Greece (Spain) defaults?
Who owes and to whose banks
0
200
400
600
800
1000
1200
1400
1600
Spain Greece Portgual
0
50
100
150
200
250
300
350
The eurozone is a straw house
QUESTIONS?
Intra-EU debt, absolute, $bil. @ 3/11
0
200
400
600
800
1000
1200
1400
1600
ITALY SPAIN IRELAND PORTUGAL GREECE
ROW
ANY PIIGS
FRENCH BANKS
BRITISH BANKS
GERMAN BANKS
Why the ECB won’t ease rates: Ideas
[We are] calling upon [the] social partners to show a high level of responsibility. . . [I]t is clear that if one is not satisfied with the present level of unemployment, wage moderation should remain of the essence. . . [I]f you are in a position where there are doubts about your present level of cost competitiveness, then of course wage moderation remains absolutely of the essence.
• Jean-Claude Trichet, 12 April 2007
We have only one needle in our compass. That needle is price stability, our definition of price stability.
• Jean-Claude Trichet, 7 August 2008
…and Mario Draghi
“The risk of inflation is rising. There is now a greater need to proceed with monetary policy normalization so as to prevent expectations of higher inflation from becoming entrenched.”
Mario Draghi, Bank of Italy’s annual meeting, May 2011
Employment gains, 1991-2005
0%
10%
20%
30%
40%
50%
60%
Share of OECD Population, 2005, %
Share of New Jobs, %
SIVs (phase 1 – money for nothing)
Bank $1000
$20,000 of CDO and / or MBS @ 7%
SIV $1,000 + $19,000 = $20,000
ABCP (your money market money) $19,000 dollars @ 4%
$1400 in interest
Payments from Subprime borrowers: $1400
$760 in interest
$640 in Interest RoE = 64%
investment interest
SIVs (phase 2 – loan contraction)
Bank $1000
$20,000 of CDO and / or MBS @ 7%
SIV $1,000 + $19,000 = $20,000
ABCP (your money market money) $19,000 dollars @ 4%
Only $700 in interest !!
Payments from borrowers fall: $1400 => $700
$760 in interest
Bank must put in $60
SIVs ( phase 3 – bank collapses)
Bank $1000
$20,000 of CDOs now worth only $15,000
SIV $1,000 + $19,000 = $20,000
ABCP (your money market money) $19,000 dollars @ 4%
$700 in
interest
Payments from borrowers fall: $1400 => $700 & foreclosures start => ↑ losses
$760 in
interest
Bank must
put in $$$
to cover re-
payment of
ABCP to
MMF
MMF wants whole
loan repaid
Why SIVs’ collapse => AIG collapse
Bank $1000
$20,000 of CDOs now worth only $15,000
SIV MMF - ABCP
Borrowers: $20,000 mortgages
AIG $20,000 of CDS
Ormand Quay (Sachsen Landesbank’s gambling unit)
Balance Sheet, July 2007
Assets (guaranteed by Sachsen Landesbank)
Liabilities (all short term debt with maturity < 1 month)
Residential Mortgage Backed Securities $6.3 b
ABCP $11.3 b
Commercial Mortgage Backed Securities $2.7 b
Consumer Loans $0.5 b
Other $1.8 b
Total $11.3 b Total $11.3 b
Adjustment
Adjustment
Trade Deficit Country
Excess Exports
What?
Trade Surplus Country
Adjustment via labor flow
Trade Deficit Country
Excess Exports
Outmigration
Trade Surplus Country
Adjustment via time
Trade Deficit Country
Excess exports (capital goods)
Future Exports
Trade Surplus Country
Adjustment via exchange rate
Trade Deficit Country
Excess Exports
Devaluation more exports Trade
Surplus Country
Adjustment via wage declines (1)
Trade Deficit Country (1)
Excess Exports
Trade Surplus Country
Adjustment via wage declines (1)
Trade Deficit Country (1)
Excess Exports
Trade Surplus Country
Adjustment via wage declines (1)
Trade Deficit Country (1)
Excess Exports
Trade Surplus Country
Adjustment via wage increases (2)
Trade Deficit Country
Excess exports Rising incomes in (2)
Trade Surplus Country (2)
Adjustment via wage increases (2)
Trade Deficit Country
Excess exports Rising incomes in (2)
(2) Imports more, exports less
Trade Surplus Country (2)
