The Market Analogy: Understanding the Global Financial Crisis

1. Global Financial Crisis Keith RankinUnitec 29 April 2009 a Global Village Market as an analogy of the Global Economy

3. 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

4. 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 – required creditor-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)

5. 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

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

7. Societal Implications • Debtors have more wealth; creditors more claims • Situation caused by creditors’ behaviour • Creditors, eventually, must use it or lose it creditors 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?

8. 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

9. 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

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

11. 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