‘News’ Category Archives
by Riaan Nel in News
By Savita Iyer
Here is the link to the article on thinkadvisor.com: http://www.thinkadvisor.com/2013/07/28/mandelas-health-exacerbates-south-africas-fragile?page=1
The 2008 Global Financial Crisis – A Political Economy Analysis Using Minsky’s Financial Instability Hypothesis
by Riaan Nel in News
Here is my updated Chapter 1 of my thesis. Feel free to comment.
“…the credit crunch of 2007, the financial crash of 2008 and the recession of 2009 are all aspects of a much wider crisis…This crisis can be viewed from a number of perspectives: as a crisis of the banking system, as a crisis of regulation, as a crisis of the continued hegemony of the United States over the global economy and the political crisis of the legitimacy of the global order. Taken together these add up to … the idea of a crisis of capitalism” (Gamble, 2009:42)
On Thursday, August 9, 2007, traders in the international money markets in New York, London and other prominent financial centers experienced a sudden and dramatic surge in interest rates for overnight and term interbank loans. On Friday, August 10th the Federal Reserve Bank of New York infused the market with liquidity resulting in a decline of the overnight rate, but interbank term rates increased even more. It was as if term lending for Libor one- and three-month rates became disconnected from the overnight rate. Banks all of a sudden demanded more liquidity or did not want to lend to one another. The immediate spark igniting the surge in interbank rates was the announcement on August 9th by French bank BNP Paribas that it froze $2.2 billion in three of its investment funds. The reason was due to an inability to determine the value of the underlying securities after suffering severe losses the preceding two weeks. This unsettling event followed on the heels of the announcement the previous month by US investment bank Bear Stearns that two of its subprime mortgage hedge funds lost almost all of their value. The cause of these losses and uncertainty was the increasing delinquencies and defaults on subprime mortgage loans in the United States – mortgage loans that have been securitized and were owned by investment funds and banks all over the world. This surge in interbank term rates was the beginning of a global financial crisis that resulted in what many now refer to as The Great Recession.
It is the aim of this study to explain the causes of the 2008 global financial crisis from a political economy perspective. This chapter will review the background, historical context and importance of the crisis. I will formulate a specific research question that will guide the study, offer an explanatory hypothesis regarding the crisis, and outline the theoretical framework within which the crisis will be analyzed. Issues of ontology will be addressed, as well as a discussion of the delimitations and limitations of the study. Lastly the structure of the study will be outlined.
1.1 Background and Importance
The period of time between 1987-2007 is known as the Great Moderation. This refers to a trend of reduced volatility in business cycle fluctuations in the advanced economies. It was an extended period of impressive economic growth that was attributed to free-market economic policies and globalization. As Casey (2011) notes, post-war economic history began with the Long Boom – 30 years of full employment and unparalleled economic growth. This period was characterized by Keynesian macro-economic policies and the creation of the social welfare state in the developed world. When an economy was in recession Keynesian theory recommended spending; however, many advanced economies, specifically the US, found it hard to stop spending in good times. Increased government spending, especially US spending to finance the Vietnam war, led to higher prices, and lower productivity and profits. The Long Boom’s end coincided with the oil crisis in the early 70’s as well as the end of the Bretton Woods global monetary arrangement in 1971 when Nixon ended gold convertibility. The Western world entered an era of stagflation. Governments tried to intervene with more spending which just fueled the inflationary spiral. The Keynesian approach came into disrepute, opening the door for the rise of neoliberalism. Reagan and Thatcher were at the vanguard of a switch from a state led global political economic system to a market led system. Gamble refers to this newly emerging system as the financial growth model.
“This new financial growth model used tax cuts to stimulate the economy, and it promoted privatization of public assets and deregulation of the private sector, particularly the financial sector. It sought to expand credit, not restrict it, and to enlist the financial sector as the most important driver of growth and competition in the economy. It led to the rise of the investment banks and the rating agencies to their commanding position in the global economy at the beginning of the twenty-first century, and the proliferation of new financial vehicles and instruments, a readiness to ‘leverage’ every asset whether in the public or private sector, and to make all citizens and organizations ‘financial subjects’ “ (Gamble, 2009:15).
The Great Moderation coincided with the end of the cold war, reforms in China, increased globalization, and the dominance of monetarist free-market economic theories, fueling an unprecedented economic boom largely driven by new technologies and increased productivity in the US. With communism discredited, capitalism became the dominant global system. From Southeast Asia, India, Eastern Europe, China and Latin America, nations competed to attract investment capital. Even though there were peripheral financial crises, the financial growth model became widely adopted. One of the most salient characteristics of the Great Moderation was globalization – the increasingly close integration of national markets. Cohen (2008:79-80) refers to globalization as a fundamental transformation of economic geography. In place of territorially distinct economies we now have a more unified global marketplace. Production processes and financial markets are transcending space, with economic networks spreading without regard for distance or borders. Transaction times are being compressed, and relations are growing more and more intense, deepening linkages. The global integration of finance through electronic interconnectivity, facilitated unrestricted capital flows and speculative investments. The financial sector grew disproportionately large compared to other industries. More and more complex and innovative financial vehicles were being created, blessed by the regulators in the US as instruments that will decrease risk by spreading it throughout the system. As prosperity continued to spread to hitherto underdeveloped areas, large financial institutions started using leverage and securitization to create astonishing wealth for their organizations. As mentioned there were economic and financial crises during the Great Moderation, but they were easily contained without any major setbacks for global growth. This all came to an abrupt and dramatic end one fateful weekend in September 2008 (Casey, 2011).
The crisis manifested in the global money markets which represent the first stage of the monetary transmission channel where monetary policy connects with the financial system and the global political economy. Term money market rates, like the 3-month Libor, influence a host of rates throughout the economy, and poorly functioning money markets impinges on the availability and cost of credit to businesses and households in the global economy (Taylor & Williams, 2008:1). The three-month Libor Overnight Index Swap (OIS) for August 2007 dramatically illustrates the extent of the developing crisis. The three-month Libor-OIS spread is a measure of what the markets expect the US federal funds rate to be over a three-month period compared to the three-month Libor. The Libor-OIS spread is used to indicate those factors, other than interest rate expectations, that influence interbank rates, such as risk and liquidity (Taylor, 2009:15). Historically, the spread on average was 11 basis points, but on August 9, 2007, the spread surged to 34 basis points, fluctuating wildly between 30 basis points and a maximum of 106 basis points over the following months (Taylor & Williams, 2008:10-11) (see Figure 1).
by Riaan Nel in News
Tim Duy’s Bottom Line on all the recent Fed announcements, I can’t agree with him more: Assuming current data holds, the beginning of the end of QE is coming. But not immediately. Maybe three meetings out in September assuming that the impact of fiscal drag remains largely contained to the GDP data. The Fed does not want us to jump to conclusions about future policy moves based on that initial shift. But I am hard-pressed to see a forecast that would allow for up-and-down moves once the Fed pulls the trigger. Up-and-down moves cannot be their expected policy path.
To read Tim’s post: http://economistsview.typepad.com/timduy/2013/05/more-fed-it-never-ends.html.
by Riaan Nel in News
Bill Gross from PIMCO wrote an excellent article recently titled “Credit Supernova!”. It is a great, but at times a little technical, read. Bill posits that the current global financial system is fragile due to its structure based on fractional reserve banking. He explains how the system evolves toward crisis, and he shares some thoughts on what investors potentially could do.
The global financial system is based on a fractionally reserved credit system. A “fractional reserve system” refers to monetary policy requiring banks to hold only a fraction (typically 10%) of depositors’ funds as cash reserves. The remaining 90% of deposits can be loaned out to create new deposits which in turns create new loans, and so forth. This is known as the multiplier effect. In other words, what Bill is saying is we are living in a world where money is “created” through credit creation – or a little more precise, the money supply is expanded when more and more credit is created.
Bill compares the global fractional reserve financial system to the force of entropy in the universe. The universe is expanding so rapidly that everything will end with a “big freeze” (luckily for us a few trillion years from now.) According to Gross:
“…the advancing entropy in the physical universe may in fact portend a similar decline of “energy” and “heat” within the credit markets.”
Bill references the political economist Hyman Minsky’s financial instability hypothesis (which serves as the theoretical framework of my Master’s thesis examining the 2008 global financial crisis.) Minsky’s main argument was that our current capitalist system was inherently unstable. “Good” economic times eventually produce financial crises.
Bill describes some implications for investors with regard to this fragile financial system. I cannot agree more that credit is currently funneled increasingly into market speculation as opposed to productive innovation. Asset price appreciation is now critical to maintain the system’s momentum and longevity. Again let me quote:
“…our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time.”
Bill has the following suggestions for how savings should be positioned:
- Position for eventual inflation.
- Move money to currencies and asset markets in countries with less debt and less hyperbolic credit systems.
- Consider global equities with stable cash flow.
- Start transitioning from financial asset to real assets.
Click here to read the entire article: http://www.pimco.com/EN/Insights/Pages/Credit-Supernova.aspx.
by Riaan Nel in News
Now that the election is over I ask myself What now? A total of $6 billion was spent on the election (Presidential and Congressional elections combined), and we basically end up with the same result we had yesterday. A Republican controlled House of Representatives, with an intransigent Tea Party contingent and an equally ideologically naive Progressive wing of the Democratic Party. We have the same Democrat controlled Senate, which will be dysfunctional by the misuse of the filibuster rule. And we have Barack. When I dropped off my ballot yesterday I finished listening to the last sentence of Bob Woodward’s audio book “The Price of Politics” detailing the negotiations around the nation’s debt ceiling increase last year – or should I say the fiasco around the debt ceiling debate. The book is a brilliant piece of modern political history, and I want to urge everyone to read it.
The bottom line for me, based on my read of the book, is that neither Obama nor Boehner were particularly good at rising above partisan politics to negotiate a ‘grand bargain’ to address the country’s unsustainable finances. Many will focus on the intransigence of the Tea Party, and the Republican obsession with not raising taxes; however, it is clear to me that the left wing of the Democratic Party is just as much to blame for their willful ignorance of the reality that America’s demographic trends will crush the current structure of our entitlement system. There has to be deep structural reforms. There is just not enough wealthy people to tax to pay for it all!
I am a centrist with a libertarian streak. I prefer devolution over centralization. I love this country because it is a free republic – people should be free to pursue their happiness in any way they see fit. The collective has no place in defining social issues for free citizens. When it comes to social issues like abortion, gay rights, religion, drug use etc. I am philosophically a staunch libertarian – these issues have nothing to do with governments. For me freedom necessitates personal responsibility. Freedom presupposes that some people will make bad choices and should live with the consequences. This notwithstanding, I believe as a society we have to take care of the poor, the marginalized, and the unfortunate amongst us. As humans we have a moral obligation to care for one-another. Although I lean more toward private welfare, there is a role for government. Don’t get me wrong, I don’t believe in a small government. I don’t believe in a big government either. I believe in an efficient government. I believe in competitive free markets and entrepreneurial capitalism; however, government has a critical role to play in establishing the regulatory framework of the economy. Lastly, I believe there is a time to spend and a time to save – sometimes we’ll have budget surpluses and sometimes we’ll need deficits.
In sharing these views on society and politics it should be clear that I am neither a Republican nor a Democrat. My beliefs though are guideposts to the things I hope the newly elected Congress and President will do. I also believe my views represent the center of American politics (well most of them anyway). Back to Woodward’s book and the failure of Obama and Boehner to reach a deal. For the record, I blame both. Also, for the record, I like both, and it is obvious to me they both had the best intentions, and really wanted a workable deal. They both had integrity. And they both were prepared to make compromises to reach a deal. What they lacked were leadership and courage, and in Obama’s case experience. Read the rest of this entry »