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Lecture III. All that goes up comes crashing down Do you want to grow? Then give it a big push. Money and the Real World. Money is created by the banking system Conditionally to a congruous amount of reserves Bank credit and bank deposits: a chain with some leakages.
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Lecture III All that goes up comes crashing down Do you want to grow? Then give it a big push
Money and the Real World • Money is created by the banking system • Conditionally to a congruous amount of reserves • Bank credit and bank deposits: a chain with some leakages. • The problem: long-term assets and short-term liabilities • How to assess whether reserves cover liabilities?
A bubble • Credit creates money since it generates deposits • ...but deposits must be trustworthy. • Banks finance members of the public to buy other people’s debt (debentures or equity) by accepting as collateral newly issued debentures or equity. • People repay back by issuing more debt underwritten by members of the public • Banks finance yet more debt...banks directly underwrite debt
Bursting the bubble • A member of the public is unable to finance his or her debt. • He or she must sell:..selling begins with few willing to buy: stock value goes down. • Collateralised bank credit loses value: bank assets flounder. • Trust on bank deposits weakens • More sales to attempt to pay debt back: more losses.
The stock exchange comes down • Black Thursday (Black Friday in Europe because of the time lag), October 24, 1929 Wall Street crashes. • Some banks lose their creditworthiness and suffer a run on their deposits. • Wall Street keeps on plunging.... • Banks stop extending credit to firms and other institutions (other banks at home or abroad)
Spreading the panic • Most European countries are involved • Even developing countries are involved: commodity prices plunge • Firms, short of credit, stop investing...other firms stop producing.....unemployment • Unemployment and falling effective demand. • Can we ever trust the banks any more? • Strengthening the Central Banks • The Glass-Steagall Act in the U.S.: separating commercial banking from investment banking.
Towards World War II and Development Economics • The world economy never recovered before WWII. • Franklin D. Roosevelt and the New Deal • Economic theory tried to grapple with the problem by providing new concepts and new tools. • The former: Keynes theory of effective demand • The latter: the macroeconomic approach and national accounts: economic policies
World War II, the aftermath • Rosenstein-Rodan and the plan to develop Southern Europe • The supply and demand sides: low level equilibrium traps. • Then, act on both sides; increase incomes and increase capacity. • If this is the approach: one needs nothing short of a full-fledged plan.
The New Order • Pre-war failures and the international monetary order: Bretton Woods. • IMF and the World Bank: what for? • The failures of the pre-war period cast a sombre shadow on the development outlook. • Can openness to trade be relied upon? • The world splits up in two...actually in three
Market or plan? • The Soviet Block • But is there a third way? The non-aligned movement and the Bandung Conference. • India’s way: a very mixed.. yet an almost closed economy • Plans and the State: betting one’s own stakes on fast industrialisation starting from the heavy industries. • Agriculture: the Achilles’ heel of Indian planning • Key: Eric Hobsbawn (1994): ‘The Age of extremes: the short tewnthieth century’. Michael Joseph, London
The Centre-Periphery Argument • Countries in the centre and countries in the periphery • Unequal exchange: strengthening the non-aligned countries’ case. • Prices of raw materials and commodities and prices of manufactured goods • Wages in raw materials producing countries and wages in the Centre.
A lopsided deal • The upshot of productivity increases in raw-material producing countries and in manufactured goods producing ones • The terms of trade • Protecting raw materials producers: the buffer stock idea • UNCTAD is ushered in • Nice principle, scarcely effective.
If credit is plenty why not borrow? • Borrowing to invest or borrowing to consume? • Can debt be repaid? • Yes, out of investment proceeds • No, if you use for consumption purposes unless you squeeze somebody and make him/her bleed to death. • ....or else roll it over • A mounting debt crisis: interest rates go through the roof (for some countries and some currencies)
Debt in US dollars? Then repay in US dollars • Turn a balance of payments deficit into a balance of payments surplus. • Trust the Washington consensus to do that • Become competitive and start at once exporting what you can produce now and what the world market wants • Get rid of all consumption directly controlled by the government: cut down subsidies, public expenditure and public services
...continued • Make sure that domestic money be supported by foreign money (i.e. U.S. Dollars), hence rein in the Central Bank and keep under strict scrutiny. • Reschedule the debt at a sustainable interest rate • Keep the economy under the strict supervision of international organisations (IMF) and committee of creditors (banks).
Forging ahead...falling behind • Some developing countries did forge ahead: • Those that: • mobilised internal resources for investment, • promoted the growth of technological capabilities, • implemented policies that enhanced productivity levels and competiveness • Protected for a period of time but vigorously engaged in international trade.
A great divide .... Lasting perhaps only 200 years!!! • China and India • Incredibly fast development: quite different countries. • What did it?? • The ‘world’ never learns: yet another financial crisis. • Where do we go from here??
