FIN410 Exam 3 Study Guide
FIN410 Exam 3 Study Guide FIN410
Popular in Financial Institutions and Markets
Popular in Finance
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World Trade Organization p340 I End of the war in 1945 state of nature in Europe was that everyone had prohibitive tarifst little or no foreign trade 0 Purpose of tariffs is to protect jobs 0 Depression in 1930s no nation would allow tariffs to displace any jobs during the depression I In 1945 during the reconstruction of Europe they formed all of these international organizations 0 World Bank purpose was the reconstruction of Europe loans for infrastructure 0 IMF purpose was to finance temporary balance of payments deficits O GATT General Agreement for Tariffs and Trade formed with the idea of reducing the prohibitive tariffs in Europe and the world that had been built up over the decade of the depression I Before the war and depression there were mature foreign trade relationships between European states they had long ago sorted out who had a comparative advantage in what I Export goods they had a comparative advantage in import goods they didn39t have a comparative advantage in I Natural trading relationships between tiny European states everyone specialized I Idea of GATT in 1945 was to restore this foreign trade as a way of promoting reconstruction in continental Europe and the UK I Take down the tariffs and trade will ow these countries will once again specialize manufacture and people will have jobs I Rerationalize foreign trade in Western Europe I No one was going to unilaterally come out alone and start to reduce its tariffs because they could not be sure that the others would follow suit solution all became members of the GATT I Delegates from each member country had orders from their governments and met GATT Round I One country said it were in and said who else is with me O Said they would reduce tariffs by 2 across the board 0 Other countries pitched in and said they would reduce 2 0 There was a round and tariffs were reduced I Then the another country said it would reduce by 3 and countries followed I They continued to have these rounds and before you knew it you had 20 reduction in tariffs I This was necessary method because no one would unilaterally reduce tariffs here they were sitting around a table with orders to reduce tariffs so the delegates felt obliged to take part I As a result of these rounds all these nations figured about how far they could go down 0 Soon countries started to say they were out and the tariff rounds stop 0 But tariffs had already been reduced substantially and free trade started to owl countries started to recover quickly I As trade owed and prosperity returned tariffs started to creep up again due to lobbying by labor groups trying to protect jobs against imports trade started to slow down This would happen every 67 years and there would be a need for another tariff round to reduce the tariffs Labor unions were reestablished in Europe to protect the family worker there was constant lobbying Need to reconvene GATT every 68 years to lower tariffs and get trade owing again I At first these venues where the GATT members met were at prominent international locations In Seattle we had the Seattle AntiGlobalist demonstrations p343 explains radical position Students and young professional activists were trying to disrupt the GATT meetings because they disagreed with what they were doing which was free trade multinational corporations importexport which they thought was evil Found that the police in Seattle had a terrible time because there were so many people that arrived including labor unions P341 important article that explains a lot of this Ministers at these meetings found they could no longer allow the meetings to be disrupted so they started to locate in primitive out of the way places places where locals could protect the proceedings and protesters would not want to venture I After quite a few rounds there was an international bureaucracy that developed international civil servants that were employees of the GATT An international organization that was selfserving for bureaucratic purposes as well After another 68 years the leaders of the GATT called for another meeting 2003 Cancun But members said there was no need for trade reduction because trade was owing no reason for the meeting But bureaucracy said they make a lot of money for the agency at these meetings so decided to have the meeting anyway Members attended tiny amounts of ante ups but not much tariff reductions O Went on for years people asked why they were there 0 With so little being accomplished delegates could not return and report so little 0 Solution reinvent the GATT called it World Trade Organizationl this is what was reported as what they accomplished 0 This is the reason for the formation of the World Trade Organization no singular need for this Tariffs are no longer rising much and the real reason for WTO may be anachronistic obsolete 0 Original purpose of the GATT probably has lost its purpose don t see tariffs rising much 0 But international organizations don t die they are eternal 0 I They had to reinvent themselves What happened during George W Bush presidency he noticed that the BRIC Brazil India China countries of the world were growing rapidly and becoming in uential 0 He said maybe they should have a voice 0 G8 was against this because they had been running the world for so long 0 Reinvented and we have a G20 world now 0 G8 lost interest in the WTO just like the powers have lost interest in the UN because it is dominated by the developing world 0 This is the big change that is going on with the G8 Tariff reduction has become a minor part of the WTO agendas have changed 0 G20 want northsouth dialogue agenda 0 Northern hemispheric countries of the world are the rich and the southern hemispheric countries are the poor 0 G20 dominated by the poor want redistribution social justice equality O G8 hardly interested in this 0 G20 thinks at least that the northerners can open up their markets to their goods 0 G20 produce agricultural exports O Developed countries America France etc have huge tariffs against these goods because trying to protect domestic agricultural interests 0 G20 says these farms are dominated by corporate interests that lobby in a corrupt manner to make corporations richer why don39t you have the political courage to face these corporate farms to reduce the tariffs allow us to export and therefore develop G20 main argument 0 G8 represent a lot of multinational corporations and they want the Singapore issuesagenda Wants to have greater investment opportunities in these countries More control over foreign corporations and subsidiaries more ownership less taxes more openness to insurance and law practice What the G8 is interested in in the developing world Developing world is not giving any of this Singapore agenda up G20 demands that the farm subsidies and tariffs be reduced but G8 are not interested because of food security G8 and G20 are not getting anywhere with each other cannot agree WTO isn t accomplishing anything because of this massive change in its agenda WTO s purpose has morphed so much from its original purpose of the GATT that it is a functional perfunctory international organization Food security issue 0 O EuropeanAmerican farmer cannot produce and sell at the world price of wheat cotton and rice Their costs of operating these farms is above the world price Should the western countries shutdown their farms and import from the developing countries This is food so maybe we should be selfsufficient regardless of the cost food security Therefore it is necessary for all these countries to give price supports to the farmers so that artificially these farmers can make some sort of minimal return I Price supports means the government is doing the buying as well as the market I Expenses of the farms are subsidized by the government so that they can be maintained and the countries can maintain food security I Farms are supported through crop supports Purpose for agricultural subsidies and tariffs Conservative argument we need to cut these crop supports to cut down on our deficit allow for more cheap imports from developing countries I Why have all these corporate welfare subsidies I This is where we should start in reducing the size of government the size of the department of agriculture and the size of debt I Problem it is very necessary to have these crop supports and tariffs so we can have a reliable domestic food supply 0 Foreign trade is only in items that you can get along without not things that you really need selfsufficient in goods that you need essentials O G20 is demanding that these crop supports and tariffs be removed because they are welfare to corporate America making them richer and adding to their greed but we know that we need food security 0 May let in exotic foods from other countries but we do not import anything that is essential to the food supply Occupy Wall Street 0 In this crash there were no jobs especially in Europe 0 O O 0 People were going to university and coming out and not being able to get a job Who is to blame for this Occupy Wall Street until these banks hire us It seems like this comes from a view held in western democracies that the government has a huge in uence upon the economy meaning it can turn business cycles and generate jobs I People can t believe why the government isn t doing this if they are capable of it so they will protest until the government moves I We know the government cannot turn business cycles or generate jobs through public policy changes I Government isn t powerful enough to cause turns in economic cycles I Fatal criticism of the points of view of the occupiers is that what they are demanding is not deliverable by the government Asian Currency Crisis p369 0 July 1997 0 Effects 0 Started in Thailand and followed in Korea and primarily in Indonesia 0 Huge collapse in their currencies and huge recessions O Followed in the Philippines to a small extent in Taiwan to a greater extend in Malaysia 0 Almost no effect in Singapore or Hong Kong 0 No effect in China or India 0 So why did all of this happen 0 Early part of 1990s period of extremely low interest rates in the USI money managers seeking higher returns 0 Mexico 0 Initial effort was to move money into Mexico Mexico became part of NAFTA so all the legal challenges were removed and they became integrated with the Americans and Canadians I Mexico had to form stock market to manage this money central purpose of stock market is to organize capital that the economy doesn39t need This avalanche of capital went into Mexico way beyond what the Mexican economy could absorb If the money that was owing in could have been absorbed by Mexican industry and American multinational industry in Mexico and used in the real economy there would have been no need for a stock market Problem far more capital owing in chasing higher returns than the Mexican economy could use Mexican stock market soared exploded and had big years and it was the beginning of the emerging market stocks I The Mexican currency was fully convertible to the dollar 0 The crash came when interest rates normalized in the US and money managers therefore jerked this money out of these economies repatriation of investment I The subsequent selling of the Mexican peso caused it to devalue 700 I Mexico went through a free fall and took years to recover 0 Asia 0 Asian countries wanted to industrialize so they generally pegged their currency to the dollar and made them fully convertible to facilitate this investment and money ow I Hot money ew in excess money that the system does not need Asia had its economic miracle I Some rather substantial microeconomic problems were being established In ation was igniting Banks were concerned These tiny economies could not absorb all of this capital 0 Thailand and Malaysia had to form stock markets to store the capital 0 And there was still so much capital that it went into real estate speculation THIS IS KEY This is the beginning of the Asian currency crisis I Huge buildup of condos commercial space warehouses Especially in Thailand the Thai baht is pegged to the dollar Thai commercial finance companies borrowed in dollars and lent locally in Thai baht with the fixed exchange rate at a nice margin It became evident that they were overbuilding not enough commercial demand for the industrial space and nobody could afford the condos So foreign banks shorted the baht in a massive bet and the Thai central bank tried to defend the currency peg as long as it could but it did not have enough international reserves and had to let the currency oatl it collapsed and capital was jerked out of the country 0 This spread and everyone lifted their pegs and all massively devalued Asian currency crisis I These countries went through rapid growth through all of this investment Asian Miracle before 1997 I This was their first experience with capitalism na39139ve adolescence I Asian currency crisis started in Thailand and spread into Korea Indonesia the Philippines Taiwan and Singapore to some extent 0 China and India did not allow foreigners to hold their currency never experienced the currency crisis 0 Hong Kong had become so rich in foreign exchange earnings that it was able to defend the Hong Kong dollar against speculative attack and the crisis did not extend into Hong Kong 0 As Asia was burning to the ground it jumped to Russia what we think caused the great Russian collapse Federal Reserve System amp Independence of the FED P292a General feeling that the Federal Reserve doesn39t do very well and that in fact it is too powerful 0 It sets interest rates 0 Doesn39t regulate properly otherwise we wouldn39t have had the crisis of 2008 0 Doesn39t seem to be able to turn around the business cycle 0 It just does not seem to do very well Since it has all this power but is not really able to get us going don39t we need some external government supervision of the FED Is the independence of a central bank an outdated concept Should the FED be subject to the political class At least have congressional oversight Major set of arguments for taking away the independence of the FED Political class believes this Given rise to the so called Taylor Rules John Taylor 0 This is an intellectual structural effort by an economist that basically gives the government some tools and structure for going ahead and legislating oversight O Gradually taking away the independence of the FED Alan Blinder believes in the independence of the FED Legislators are not really sure what they should do Taylor goes through Blinder s arguments and rebuttals article 0 Everything Blinder has said is inconceivable 0 Demolishes Blinder as being incompetent Volker Rule p293 Street does not agree with this at all All proprietary trading for the house account should stop Banks cannot invest for own account can only broker I Major change for the way banking is done Corporation Reform p296 0 Intellectual liberal establishment is trying to take away the independence of a corporations I Incorporation is a legal effort to say that a corporations has to be thought of as an independent corporate person separate from the owner the incorporation represents a legal person that can be sued and pursued but only limited to the assets of this corporate person I Liberals argue that corporations are not people but organizations and they are trying to break down the law of protection personal fortunes of the owners can be touched when corporation is sued I Radical remaking of America in the legal structure I Argument is these may be necessary changes so that it is a fairer more just nation these changes are necessary to bring about a better nation that takes care of everyone on a perfectly fair basis redistribution and taxing the rich 0 It s True Corporations Are People Article 0 A corporation is a limited liability organization I The owners of the corporation have shares I If something bad happens to the corporation the creditors cannot reach in to the shareholders personal fortunes 0 These corporations are incorporated as corporate persons that stand alone 0 The attack on upon the idea of a corporate person is to break down this idea of a corporation being incorporated so that is as far as the creditors can go I They are trying to break it down so that they can go into the net worth of investors I Very critical attack on the foundation of capitalism I If these liberals can succeed in this it would be a major step in dismantling capitalism I There is a view that there is a group of people that want to dismantle capitalism and replace it with something else 0 Senator Elizabeth Warren says corporations are not persons 0 Welch is responding to Warren I When corporations fail in doing good p298 0 Are they supposed to do good They think so 0 They think we need to reform this system so that corporations are not just profit seeking efficiency based and rational economic units But that they also take on a humane and social conscious purposel Major effort to transform the purpose of the corporation to do good versus just servicing the shareholders 0 Do we need to rethink what corporations are for What these arguments are about Fundamental rethinking of the purpose of corporations 0 Investors will say that you cannot spend money that does not increase the stock price can spend money to do good as long as it increases the stock price 0 0 Major effort to transform the purpose of the corporation to do good versus just servicing the shareholders 0 If you have a closely held corporation like Starbucks you can basically do stuff like this if the stock is highly traded will have a difficult time satisfying portfolios 0 These do good corporations without a positive NPV get good press but the corporation will do poorly 0 If spend a nickel on a project that doesn t have a positive NPV you are wasting resources 0 Will not survive as widely traded corporation if you spend serious resources on these social projects because the competition will simply eat you alive 0 Creating a class of do good companies Articlel Bcertification I Want to become a do good corporation because don39t want to be asked by the press why your corporation is one of the few which is not a benefit corporation 0 Milton Friedman vs Paul Krugman p312 0 Krugman is basically one of the intellectual leaders of this great reform of the corporation and the relationship between government and markets 0 Friedman is a markets man and believes in more independence and smaller government involvement in the markets Federal Reserve Policy Since 2008 0 Traditional FED policy 0 Yield curve cross section of US treasuries 0 As an economy advances in a bull market the yield curve has a parallel shift up I Increase in the demand for credit increase all interest rates rise as the economy continues to advance the yield curve shifts up on its own I As the economy is becoming fully occupied demand curve shifts out and supply is trying to keep up 0 All of the machines are occupied for 24 hours a day and industry cannot produce anymore economy is at full capacity 8993 is considered to be full capacity 0 But demand continues to rise supply starts to fall behind and the only way to clear the markets is to have prices rise in ation 0 Only at this time does the FED actually intervene 0 Towards the end of the upcycle of the business cycle we tend to have in ation only at this time does the FED intervene I FED intervention twisting of the yield curve I Since the FED always operates at the short end of the yield curve historically it is bidding up the short term interest rate by contracting the money supply through reserve requirement rediscount rate and the FOMC monetary policy tools I Idea is that rising of short term interest rate will cool off the economy cool off in ation 0 FED is not active much in the parallel shifts of the normal rising yield curve 0 When it intervenes at the short end the yield curve twists because it is only acting at one end It defeats the in ation and soon the yield curve humps meaning you re at the onset of a recession This recession continues yield curve parallel shifts as the recession deepens and we have this helpful process of beating out of the economy the in ationary expectations overoptimism and bringing the consumer back to reality 0 At the bottom the FED intervenes again Expand the money supply through monetary tools causing interest rates to drop at the bottom of the recession Encouraging companies to borrow for inventory and consumers to buy durables As soon as the recovery is underway the FED exits the markets and lets the recovery go As the recovery takes form begin to have again parallel shifts of all maturities rising in interest rates with parallel shifts the FED is not active 0 FOMC is still somewhat active to make these parallel shifts smooth but they are not doing much fine tuning 0 FED targets Ml or M2 in this process and is always working on the short end traditional way of executing monetary policy 0 What was different in 2008 and thereafter 0 The twist of 2008 is different from the twist referred to in traditional policy 2008 twist is called operation twist O 2008 crash was startling to the government Not a normal humping yield curve that then entered a recession gently This was a big crash FED response was to open the fire hydrants of liquidity to try to calm the markets there is a lot of money here do not get excited The money supply was increased and then the FED said maybe the conditions are a little different 0 Maybe try some new stuff because under immense pressure and criticism from the political class to do something and for not having prevented it with their allpowerful tools as they saw it coming which has given rise to the idea that the FED is incompetent 0 FED is not going to come out and say they do not have that much power because it would have a tremendous market effect 0 FED was not sure it could do much but the political class wanted them to try quantitative easing 0 Increase the money supply ease the constriction on the money supply old concept new name lower interest rates to get things going 10 0 In politics no one cares what you do they care about how it appears FED has to appear as though it is responding to the political class 0 QEl QE2 and QE3 did not work too well FED knew this would be the effect but they had to try for public consumption 0 Criticism FED did QE123 and we are still in a recession when are you going to get it right Do you know what you re doing Maybe you don t maybe we need the Taylor Rules to make sure that you know what you re doing 0 Counter claims that there is no recovery despite the fact that unemployment has fallen from 10 to below 6 the market is at 1700 there is job growth 0 Criticism FED criticized for having all this money out there and people are worried that we are going to have runaway in ationl need to have tapering of the money supply to prevent uncontrolled money balloon out there that eventually does go into in ation I Political class asks when Will begin to taper when certain numbers are reached I Want more in ation which indicates recovery I Tapering has been halfhearted and FED is still trusting monetary lags no reason for price increases I People think FED is trying to turn the business cycle around but the FED is actually trying to protect it from going down further FED is scared 0 Operation twist I Instead of operating at the bottom end of the yield curve FED operates at the middle section I Go in and buy mortgage backed securities 0 Buying up this midsection of the term structure FED buys up the price at the middle maturities lower the middle maturities interest rates hope that this will stimulate construction and mortgages because construction industry is super sensitive to interest rates get construction going to get the economy going 0 Lower cost of capital for companies maybe more positive NPV projects maybe companies expand their plans 0 Trying to stimulate the real estate industry which makes up a third of the economy This was all new and experimental More consumers can afford the mortgage payments more can qualify stimulate construction I FED knew all this was not going to do much but they had to at least appear as though they were trying regardless of what they thought because the political class was threatening major reformation of the FED I If the FED buys the middleterm mortgage backed securities the middle interest rate will drop FED will be able to twist the yield curve this will 11 extrapolate out lowering the long term maturities maybe this will stimulate the economy I FED is trying to stall congress from acting in a radical manner dissolving the FED I As economic indicators improve the political class slowly relaxes so the FED is counting on its luck because this is the biggest threat they have seen Brazil Argentina amp Japan Case Studies p363 0 Brazilian Experience 0 All these decades of hyperin ation 20005000 a year 0 Developed a crawling peg so that the currency continued to devalue by the in ation to keep their exports competitive I If you have domestic hyperin ation you cannot export I The only way to correct this is to devalue the currency by the amount of the in ation to keep your export price competitive I Reason for the Brazilian crawling peg I Brazil continued to prosper exportwise even with hyperin ation O The reason for the hyperin ation in in Brazil as in all Latin American countries is not primarily due to policy incompetence rather due to a huge country with a huge population but with a smaller economy I Picture of a developing country I Purpose of economic development is to have the economy grow faster than the population so that the economy fits the population and we have a developed economy I Since they are so poor all output is consumed there is no savings no domestic investment and they cannot develop I Only way to develop is to encourage foreign direct investment from multinationals in ow of external capital 0 Multinational corporation brings in massive amounts of capital allows for investment economic development economy to grow faster than the population 0 In Asia Taiwan Korea Hong Kong Singapore and Malaysia all became newly industrialized economies grew so fast that they fit the population I China put the one child policy in place to make this work forced abortions which American and European Churches are against but is the reason that China is taking off I Don39t see this happening in Latin America except for Chile Why 0 Latin American population is Catholic big families 0 All of these big families have made it more difficult for the economies to outgrow the population all these highpotential countries are still not highly developed especially Mexico which is so close 0 Hyperin ation is caused by the necessity for the government to have huge budget deficits and huge amounts of external debt to pay for it so that the government can 12 generate huge amounts of shovel ready jobs to provide for full employment of the people These huge deficits and external debt are incredibly in ationary all this spending by the government on the economy So much so that it became structural indexed into the currency into labor union contracts automatic increases in wages Asia did not have to generate these jobs to provide for full employment because they were not democracies 0 In a democracy the politician had to do something for the people to be elected promised jobs 0 In Asia there was no democracy so they did not have to provide for the people These structures in Latin America can be thought of in democracies as responsible public policy because the people were protected and had jobs 0 Development periods in Asia vs Latin America Latin America was middle class while Asia was dirt poor during its development period 0 Brazil defeated hyperin ation How read article in packet Finance ministers figured out that they were open trading societies exporters and huge importers People did not want domestically produced goods wanted imports Meanwhile there was the crawling peg of the Brazilian currency ever devaluing making exports cheaper and imports more expensive to try to balance their payments Figured out that the hyperin ation was primarily imbedded in the consumer price index CPI due to its high content of in ation due to imports as the currency devaluedimport prices went up a lot import prices are the reason for this hyperin ation this crawling peg had destroyed Brazil What they did p366 0 Brazil said that their problem was an undervalued currency which was causing hyperin ation due to import prices being too high 1994 they converted from the cruzeiro to the real in an attempt to attack this import price effect on the consumer price index Converted to the real at a tremendously overvalued rate real was much more valuable than the cruzeiro 0 They knocked about 68 zeros off of the value of the cruzeiro O Immense amount of cruzeiro needed for 1 real Currency through this conversion became overvalued overnight making exports more expensive and import prices drop dramatically defeated the in ation Formed the foundation for today s Brazilian takeoff 13 O O 0 Because the real was converted at such a widely overvalued rate it broke the back of the import price and defeated the in ation went down to single digit on an annual basis This overvalued real made Brazilian exports hard to sell and since it was organized as an export economy trade deficit started to create a recession I How long are you going to keep your currency overvalued I Industries screamed as the government held on to the overvalued currency I Government wanted to make sure that hyperin ation was dead important that they permanently broke the back of in ation once and for all structurally and the psychology reason government kept the overvalued currency Brazil s largest trading partner was Argentina combined in the Mercusor Trade Agreement Brazil Argentina Uruguay and Paraguay Brazil and Argentina dominate I Brazil was trying to export to Argentina with an overvalued real I Import prices in Brazil were so cheap that Argentina continued to thrive as it exported to Brazil while Brazil was falling into a recession with high export prices Finally the political pressure this was a democracy with competitive elections was too much that the government had to give in and devalued the real to about 1618 real I As they allowed the real to oat and it devalued exports surged and the economy was able to recover I Brazil s in ation remained dead even after the real oated Brazil is now wellstabilized and has had explosive growth by getting their currency stabilized Then Argentina started to struggle half of the story for the Argentinian bust Brazil s story 0 Argentinian Experience p363 0 0 Also defeated hyperin ation but used a different method because there was a different cause Argentinian analysis was that rather than having an undervalued currency the Argentinian peso causing high import prices what they figured out was that Argentina s hyperin ation was due to excess money printing In a democracy when the public is concerned and afraid economically you increase the money supply with a little in ation to help them out I Here was a democracy with competitive elections and there was a need to basically in ate to give people support and sustain them I Give them some sort of little pain killer I Classic way that all governments use from time to time to ease the pain of a difficult economy Their formula to defeat this was different passed a constitutional amendment through referendum that said that there will be a permanent peg to the dollar of 1 l4 peso and the amount of money had to equal the amount of foreign exchange plus gold Could not print anymore money All administered by a currency board Central bank went in and soaked up all the extra money This was called The Convertibility do this to facilitate free trade because then you can exchange monies easily to settle your exports and imports Overnight this stopped the excess money printing and they defeated hyperin ation 0 Meanwhile all of this stuff is going on in Brazil Mercusor Trade Pact Before Brazil allowed the real to oat it was overvalued which made imports into Brazil incredibly cheap and Argentinian exports to Brazil exploded Seemed that the convertibility in Argentina was successful defeated in ation and export market exploded When the Brazilians allowed the real to oat and devalue this opened up Brazilian exports and made imports expensive Brazilian exports owed into Argentina displacing Argentina s export economy as well The peg of 1 peso was an overvalued rate but not as overvalued as the real was real was far more overvalued 0 Argentinian s found that with this peg they could not export to US or Europe because currency was too strong 0 And most of all as the real devalued Argentina could not export to Brazil which was a 13 of the Argentinian economy 0 As Brazil was recovering Argentina started to slip into a recession 0 The logical thing would have been to devalue the peso so that it would correct the overvalued state and allow this export driven economy in Argentina to export again and grow would have normalized trade and allowed for full recovery 0 Unfortunately the Argentinians had no authority to devalue the currency because under the constitution it had to remain pegged to the dollar by law the government could not do anything Government asked for a referendum to change the constitution But Argentina did not want to lift the peg because they had finally defeated in ation So year after year the Argentinian economy on its own slipped into deep recession and the politicians were screaming as they watched it happened Finally when Argentina was in this deep recession and Brazil was booming and the rest of the world was normal the people finally realized that they had probably defeated in ation and should agree to change the constitution allowing the currency to oat and devalue 0 Finally after 45 years the people voted to allow the currency to oat 15 0 But it was too late and Argentina remains today in nonrecovery structurally in a liquidity trap 0 As the Argentinian economy does not function anymore it gives rise to radical leaders Reason Cristina is the leader because people have lost confidence in the economic system Need a strong leader who will tell them what to do Someone who will blame the companies and banks This is not a primitive country like others in Latin America that need strong leaders like this A leader like this it makes no sense considering Argentina s history 0 Japanese Experience 0 1944 Americans massing troops offshore preparing for an invasion of Japan Japanese would stop the Americans at all costs Americans decided instead to drop bombs in Nagasaki Here is a country that had 2 nuclear weapons dropped on it and they resigned from the war 0 Postwar Japan Reconstruction Tremendous amounts of US aid and support and Japan developed rapidly Japan would be given special access to the American markets no tariffs and even subsidies McArthur created a democracy 0 But a democracy cannot work without a thriving economy under it 0 So needed Japan to get manufacturing and exporting to the US under a special trade arrangement this is the reason Japanese got such a huge foothold in the US Japanese economy grew rapidly and recovered Parliamentary democracy emerged 0 The emperor became a figurehead and prime ministers and speakers became the leaders 0 A modern westernized democracy came about Export driven economic recovery and thriving democracy Other part of this postwar arrangement Strategic Frontier the west primarily Americans were not only concerned about the recovery of Japan but also about national defense 0 The Americans would create a strategic frontier of bases maintain that strategic defense 0 This barrier would be maintained so that the Americans would not have to fight battles off of Washington and California they would fight from the frontier I That39s the reason for the Korean War being fought over there I And the Vietnam war being fought over there 16 I The reason for those wars and their locations to defend the frontier 0 There was a concern that the communist were interested in expanding communism and that the communist were very interested in expanding their interests militarily I So there was the idea that communism had to be contained I Idea was that they had to contain the expansion of communism during this period it was felt real or otherwise through the strategic frontier I Idea that the Vietnam and Korean Wars were to contain the expansion communism I Idea of the Pacific eet in here and US military bases were to for the same purpose 0 These bases are being slowly dismantled I With the dissolution of the Soviet Union 1991 the major threat was over I China was opening to the west starting in 1978 I There was no longer a threat of the expansion of communism I The military threat was considered to be severely reduced so these bases could be dismantled fully or partially I Now the question is if Taiwan would be defended if China decided to move on them could be taken in about 18 hours I Okinawa has been reverted to Japan I All Philippine bases have been closed I Ideas of closing the Japanese bases Japanese government has resisted this because they want those bases there I Japan has been heavily subsidized and protected since 1945 and has as a result become the second largest industrial nation in the world 0 This is exactly what the US was after 0 That meant there was a democracy there supported by a thriving economy democracy has checks and balances on power moderate the Japanese with a democracy Since the Japanese economy was built as an export driven economy primarily sending goods to rich Americans they were paid in foreign exchange and it became the richest country in the world in terms of its foreign exchange reserves I Indicates how successful this reconstruction was I Central idea was that the Japanese political system must remain a well functioning democracy with checks and balances a rigorous press freedom open democracy l7 0 Even further proof of this came in the late 1980s where we had what is called the New Japanese Swagger where they are openly criticizing American culture and making fun of it I A lot of political cartoons about American political leaders I This is very unJapanese and Americans were surprised I Shouldn39t the Japanese be grateful for all the Americans have done I No their arrogance and selfconfidence in their system is what we were looking for Their pride is back because of the wellfunctioning economy democracy this is total reconstruction of Japan in the way the Americans wanted it I This restoration of national pride is part of reconstruction and shows how successful it was 0 Japanese Yen I American recession of 1982 where it all started 0 The world followed the American recession 0 Americans recovered first and the rest of the world followed caused the dollar to appreciated by about 60 0 Made Japanese goods 60 cheaper in the US reason Japanese got such a big market share in the USI Japanese exports exploded during this period 0 Dollar has been going through a secular decline ever since I What we are trying to explain is that this period of 198285 was the critical reason why the Japanese gained a large market share in the US 0 It was a currency effect 0 With the an opentrading economy everything depends upon the exchange rate I Everyone is worried about the trashing of the dollar currency will crash and become worthless with this huge money bubble out there and debt almost 100 of GDP what is going to happen to us Iconservatives are worried about the dollar I Except for maybe the dollar has been ever so slowly taking its overvalued condition and brining back it to its correct value condition back to around 1979 levels 0 Is the devaluation of the dollar such a bad idea How can we export with an overvalued dollar 0 Argument here is the dollar is simply correcting itself to the proper value just taking a long time I But that doesn39t take the conservative from looking at this and thinking the currency is lost while the government does nothing and the country is going to be wrecked I But could argue that this is just a normalization of the exchange rate 18 The Japanese story was that they had a large market share when dollar appreciated 60 in 1985 electronics and cars As the dollar devalues Japanese exports become more expensive and the Japanese companies have not allowed for the pass through of the dollar s decline 0 The Japanese have simply lowered the yen price by the amount of the dollar devaluation in order to maintain market share in the US 0 As the dollar declines year after year the Japanese companies have had to take lower profit margins in yen to keep the US market share And finally the Japanese companies are sitting next to break even 0 Datsun failed along with hundred of other companies 0 The Datsun failure was so total that they had to reinvent the brand as Nissan As this reduction of profit margins continued and took its toll on Japanese companies the problem is they cannot export 0 That means the Japanese yen relative to the dollar is overvalued 0 They cannot export and they have organized as an export driven economy 0 Naturally they are in a longterm funk Japanese have tried everything to get the economy going fiscal stimulation interfere in currency markets to cause the yen to devalue against the dollar but when step out the yen pops back up 0 Why doesn39t this work Because the Japanese are wrapped up in the American economy and the dollar is recapturing its old valuation and the Japanese can do nothing about it I Regardless of their efforts the yen continues to rise as the dollar devalues I Currency oats and is determined by the markets Now we have these handsome Japanese prime ministers and first ladies wives of prime ministers in Japan have never been public figures indicative of a system that cannot accomplish much with its problems so to be elected they have shifted to appearance China has been an insular communist socialist economy absolute control by the government Now China has become a global economy and subject to global business cycles competing globally to sustain this economy Means the Chinese government has much less control Cannot produce the results they used to Indicates that even the Chinese are having trouble executing power and getting franchises 19 Milton Friedman vs Paul Krugman Debate p312338 0 Friedman monitorist policy dominated European and US policy for 2025 years 0 Krugman is a political economist now part of the left providing intellectual explanation 0 It would be asserted by the radical right that the left is interested in demolishing the US as it is must destroy it first and then rebuild 0 If that is true Krugman is on the left and it is important for him to discredit Friedman before he can build this new structure of policy thought 0 Question here is Is this what Krugman is doing Or is it just an honest intellectual debate of issues 0 Friedman feels that monitorists matter it is the amount of money mattersl expansion money and monetary policy can turn business cycles 0 Keynesian says the amount of money is not primary and government spending is corporations will not expand just because their cost of capital drops and they can now borrow money more cheaply because of an expansion of the money supply that is an old fashion classical view where business cycles automatically adjusted when factor prices fell below product prices 0 A corporation will not expand regardless of the factor price until the demand curve of the consumer expandsl corporations will expand if the price goes up as they chase higher prices which are caused by the consumer increasing his demand 0 Generally speaking we have to sort of wait on the mood of the consumer to shift out the demand curve we don39t think the consumer can be prodded he has to get in the mood 0 Government is pretty much unable to turn the business cycle 0 But Krugman argues that we can artificially move the demand curve out by government spending I Big government spending programs and job creation is a Keynesian idea this is what Krugman argues I We need a much larger government that spends money I The corporations see prices rise and the demand curve shifting out regardless of how artificial it is and might be willing to expand I How well does this work Or does the corporation simply view this as temporary spending 0 The people that put this in place would say this is priming the pump which will get the economy going 0 And the artificial spending can be taken out slowly O This is the foundation of Keynesian business cycle spending 0 Krugman goes back to the depression the New Deal and the Keynesian cross and says that didn39t Keynes prove that you needed to add G to get us out of this After the depression there is no selfadjusting business cycles anymore 0 This is government spending in shovel ready jobs 0 Fiscal spending not monetary ideas 0 This is the great debate does money matter Or do we need spending 20 0 Krugman without government spending isn t that what led us to equilibrium with 23 unemployment And wasn39t it government spending that brought us to full employment 0 This is the great tension between the right monitorists with smaller government and less spending and the left with government spending 0 With more government spending that requires higher taxes and the right sees this as impedingdisrupting the markets 0 As we have seen in J apan tried all this kind of Keynesian spending and Japan remains in funk 0 Government is roundly criticized reckless spending this money and not turning the business cycle 0 Japanese public are getting worked up about this 0 Are we prepared to say that the liberal democrats who executed these spending programs were wrong That the fiscal had no effect on the recovery that is occurring 0 As a conservative can you dare to say it was a mistake I All we know is the numbers are slowly recovering and the consumer is slowing coming bank 0 Was Krugman wrong 0 We know that these fiscal and monetary policy activities during business cycles are not the reason for the turns however we do not deny that they may have some effect 0 We do know that if the consumers get in the mood and the tax revenues explode then we will be able to pay off the debt why are you worried The problem is not overspending the problem is we don39t have enough tax revenue yet 0 What we seem to find today in the execution of government response to economic crash is a mixture of Friedman and KeynesianKrugman thought mixing the ideas using them together as tools 0 Need shovel ready jobs and government spending when we are in trouble 0 But we also need to rescue banks and to ood the money supply 0 Keynes and monitorism is not wrong they work together as tools 0 Krugman says the monitorist part of this is not necessary banks should ve been allowed to fail Keynesianleftist thinking But monitorists would say you cannot allow banks to fail 0 Left would say that if you increase the money supply too much we39ll have a money bubble 0 But monitorists would say that we need the ooding of money to prevent depression 0 Chile also had hyperin ation it was the first to become newly industrialized 0 One party would suggest was that the Chicago SchoolFriedman intervention in Chile set the stage for its takeoff and it allowed it to become the only newly industrialized country Friedman s actions in Chile are very controversial and heavily criticized O Allende was thrown out in Chile and a new government came in headed by Pinochet I Economists at the time there were taught by the Chicago School 0 O 21 I Pinochet s use of this monitorist thought is said to have saved Chile I The first case where you have a movement towards communism replaced by a movement towards free markets 1982 Banking Crisis 0 This was real estate 0 The American economy is a real estate economy 0 The way we grow is to go into a forest and put up housing developments 0 Commercial banks are primarily real estate lenders why we have all this trouble 0 Do the construction loans 0 Do not hold final mortgages those are held in a pool by insurance companies and pension funds institutional investors 0 We have a business cycle that is real GDP where the jobs are and superimposed upon this is the real estate cycle that it far more volatile and violent 0 If banks only did line of credit business loans commercial loans they would be lending in the real business cycle only and there would be far less bank failure 0 But the fact is that banks are major real estate lenders so that banks really live in the real estate cycle 0 This is important to understand 0 When real estate crashes it really crashes and naturally banks crash when there is a crash it is typically a real estate crash so we lose a lot of banks this is fairly normal 0 198283 recession we lost 400500 banks 0 In 1982 in ation 16 had to be stopped which was due to the prior run up of oil prices 0 Government strangled the economy and in ation went from 16 to 3 in about 23 quarters 0 In ation is real estate typical real estate values go up much faster than in ation and naturally decline much faster 0 If housing was just a question of demand by workers then the real estate cycle would be much more benign 0 But real estate has a major component of investment which corrupts it and causes these huge speculative bubbles and crashes 0 If somehow we could legislate that investors could not participate for speculation in real estate investment then this thing would be reduced back to the real business cycle and the real estate cycle would be less volatile and have a lower probability of crashing 0 Because of speculative investment property values rise dramatically until they cannot be sustained and then they crash don39t just decline banks which are primarily real estate lenders also crash 0 What happened in 1982 was simply another banking crisis 0 The bank reform act that came out of this caused banks to increase the amount of capital and a lot of regulation was imposed 0 Government came in to rescue these banks and formed a resolution trust corporation 22 Resolution trust corporation had funding from congress and if a bank failed its assets were taken in by this government corporation and the debts were paid off and then the assets were auctioned Bank reform is not unusual During this period when the resolution trust corporation was in place a typical way that they work out bank failures is they got another bank to merge they do not like banks to fail 0 To preserve the deposit base and not cause disruption 0 The way these mergers work is the acquiring bank will look at the balance sheet and say they are interested in these good assets and these toxic assets will have to be separated out absorbed by the government rescue agency and they will auction them for whatever they can get the good assets are what are merged the entire liability structure and the net worth is the market value of the acquisition after you take out the toxic assets 0 Mergers needed to be arranged this way otherwise will not get a bank to merge because won t take on troubled assets This is the way they did it in 2008 0 They have learned through Lehman Brothers and other instances where they have allowed banks to fail that there is tremendous systematic economic fallout that spreads laterally into the economy a tremendous psychological shock When the government steps aside and lets a bank fail this is a real shock to the market It is presumed that government will rescue banks large banks are too big to fail because they have such systemic risk across the economy and too much psychological in uence on the economy The too big to fail doctrine is absolute There are lot of challenges to this 0 Liberals and even conservatives are saying that too big to fail has to be repealed that these banks should be allowed to fail if they malfease that badly and had no credit standards at all they should be allowed to face the discipline of the markets just like industrial companies 0 That is the basic argument to do away with too big to fail The decision by George W Bush to come in and facilitate the merger of Bear Sterns by taking a portion of its toxic assets worked Lehman Brothers therefore then failed subsequently 0 Barclay s was willing to merge with Lehman Brothers but of course Lehman Brothers had certain toxic assets that were separated out and they were assumed to be taken over by the government and the remaining good assets would be merged 0 But W Bush sent an official over during the process of this merger and announced that the government would not take the toxic assets and the merger fell apart 23 I Considered to be a huge mistake by W Bush I Apparently the merger With Bear Sterns caused such a political fall out that he did not feel he could do it again with Lehman Brothers 0 As part of a merger the government intermediary corporation is talking to the O merger partner and the merger partner says they like the good assets but actually only want to acquire 80 of the face value of these good assets I Like the good assets but going to need a haircut and the remaining principal they can deal With I Haircuts sometimes are necessary to facilitate mergers and rescues I The liabilities of the bank the people owed this money have to agree to a haircut to preserve their positions in this failed bank I Merger bank has to feel that the assets and liabilities are workable don39t want to acquire a problem When they themselves are a sound bank causing the Whole thing to failimproper rescue All these rescues wherein the government is involved at the end of the day the government is never in the hole I Typically the government makes money in the rescue I So it is quite improper to call this a tax payer bailout When it is really a tax payer investment With a positive return I And the rescue has prevented the economy from collapsing into a depression by disrupting the markets so the tax payers have a pretty good deal When it comes to an industrial company that is not particularly bad off the problem is the commercial paper debt is supporting the assets 0 O O 0 Commercial paper market is hypersensitive to risk in prices So When this company is in trouble the commercial paper market is the first thing to freeze All these companies are living on commercial paper So the treasury has to step in and take over the financing previously done by commercial paper I The government charges interest I In this particular rescue the government asks for stock in the company as collateral As the company recovers the commercial paper market says it could get involved but they need a treasury guarantee I So as treasury is exiting the position Which it wants to do it Will stop funding the company from the budget and commercial paper will come in and replace it and there Will be a treasury guarantee in this transition I As the company continues to recover at some point the commercial paper investors Will say there is no longer a need for the treasury guarantee and it is quietly backed off By the time this extracts itself into the press or taken on by Senator Warren it is publicized as evil and as something that should be absolved these companies should fail 24 0 Another thing that has come up in these bank failures is moral hazard O This concept comes from the idea that bank lenders know that the major sources of funds that support loans are deposits and they know that the government will support the depositors through deposit insurance therefore the depositors are not going to be making sure that the bank is making proper loans allows bankers to make reckless loans without any consideration of risk for the pure purpose of high returns and greed A lot of academic literature about this argument that makes a lot of sense The only thing we would say is that the lenders of these banks say they don39t think that way we don39t make reckless loans we control with rigid credit culture So while this argument has been around it sounds strange to a commercial lender Huge rupture between what bankers think is common practice at banks and what politicians think is reckless lending Political class thinks that moral hazard prompts the need for greater regulation because since we have moral hazard the political class as a regulator would say they need more control over these banks to watch the loans they are making and engage in micromanagement of their loan portfolios I All comes from moral hazard assumptions I We have regulated capitalism with boundaries that are maintained by the regulators within the boundaries there is free market transactions and risk taking and only when the market reaches a boundary does the regulator get involved I What we re are seeing now is the government coming in and micromanaging transaction by transaction within the boundaries of regulated capitalism and being very severe about it because they do not trust the banks because of moral hazard I Micromanaging the interior of the daily risk taking by the banks 0 The finance is being divided between the regulated market and the unregulated market 0 0 Russia Unregulated market asset based lenders and the factors that finance receivables commercial finance company What is happening in our markets is the finance company sector is exploding in growth as the banking system retracts because regulations are so cumbersome 0 Late 1980s early 1990s there was the Washington Consensus O O Idea for economic development that if you re going to develop you should do so with markets not through government programs During this period yields in the US was quite low and the big money was looking for higher yields and was interested in going abroad At the same time these developing countries one after the other including Russia became convinced that they had to acquire foreign capital what they had to do I 1 Make their currencies convertible and tradable I 2 All this foreign money will come in and must have a temporary place to put it until it can be used in the real manufacturing economy of the 25 developing country form stock marketl Moscow Brazilian Mexican stock exchanges were formed Currency was pegged to the dollar these currencies were as good as the dollar so Americans could buy foreign stock 0 By 23 years the Moscow stock exchange was the best performing stock market in the world Then the soviet union was dissolved and the state run enterprises would be privatized O The dissolution of the soviet union was primarily a budget decision the out ows were much greater than the in ows and the system was ready for collapse financially The idea of state run enterprises with large running operative deficits made public finance even worse so they had to privatize them sell them to make room in the budget which was in deficit There were also a number of soviets the Ukraine Georgia Uzbekistan and others that were net deficits to the system could not afford to support them as the Russian Republic had all the resources why did they have to subsidize them So the decision was made that they would privatize and let these deficit soviets become independent and what remained was the Russian Republic which made a lot more sense budget wise With privatization the central bank maintained the peg to the dollar Norilsk Nickel O O O O 0 Why don39t we give the shares to the workers Oligarchs came up and formed capital groups and bought the assets from the govemment this is what gave rise to all these financial oligarchs These workers did not know what to do with these shares Going to take this company and do an IPO on the Moscow stock exchange buy the shares from the workers at a tremendous discount and oat them at a 100 gain This worked pretty well The communist Russians were highly suspicious of this but the majority was taking over so they sat back and waited Russia and its markets grew and this was working beautifully this Washington Consensus Meanwhile Asia was burning to the ground with the Asian currency crisis 0 After it burnt down Asia with the exception of China and India then the wildfire just at the critical time when Russia was doing so well the had opened elections had beginnings of press freedom ew in and hit the Russian currency These big banks and money funds are moving from country to country and doing huge shorts on the currency and waiting for the government to pull away and abandon the peg They took a huge short on the Russian rubble and the government said it would not abandon the peg and used its international reserves to defend it I But then it started to run low and they turned to the IMF for help I IMF said they were out of money I So then they turned to the Americans Clinton and Americans said no to loans for the Russians major failure of the Clinton administration 26 1998 the Russian central bank let the currency oat and it devalued 600 800 and that was the end of their experiment with capitalism and markets and their democracy and it gave rise to Putin The Americans did not have a lot of money to make loans but it is felt that it would have just taken a public statement by the American leaders that were supporting the Russians and the markets would have lifted their shorts on the currency and this would not have occurred 0 We know this because after burning down Russia it jumped to Brazil and they shorted the Brazilian currency and the Clinton administration said they had to stop it in Brazil because if not it would move to the US economy 0 And they supported Brazil and that means they made a huge mistake in not supporting the Russians 27
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