Global Financial Crisis: The Aftermath

1. Global Financial Crisis:The Aftermath Kenneth Matziorinis, Ph.D., CMC Canbek Economics & McGill University www.canbekeconomics.com AHEPA, Ottawa, January 27, 2010

2. What Happened? Low interest rates, high leverage and overconfidence led to the creation of bubbles which then burst • US Housing market went bust and real estate prices started falling • Prices of complex financial securities that were created by Wall Street to underwrite the housing market collapsed • Institutions that issued these assets along with the investors that bought them suffered huge losses in many cases exceeding the capital of these firms • Losses along with collapse in confidence in these products trigerred a financial meltdown starting from Wall Street and rapidly spreading to London, Continental Europe, Asia and the Rest of the World • With the global financial system on the verge of total meltdown, governments stepped in to avert mass panic and an economic collapse that would result in a global depression worse than that of the 1930s Canbek Economics

3. What Did Governments Do? Intervened in order to prevent a systemic collapse and an economic depression • Governments responded swiftly and decisively to save the system from collapse based on the hard lessons that were learned in the 1930s by applying Keynesian economics • Central banks stepped in and provided liquidity to the banking system allowing it to keep functioning • Slashed interest rates • Expanded the money supply • Governments provided bailouts for major financial institutions to avert their collapse or took them over outright • Governments also cut taxes and raised spending to prevent the economy from falling into a deep recession or even depression Canbek Economics

4. Did They Succeed? It appears they have for now, but it is still too early to tell • The magnitude of the financial shock, loss of confidence, near panic was too large to prevent a hit on the real economy • The world economy went into a deep recession, the first since the end of WWII • But a global depression was averted! • Now much of the confidence has been restored and economic activity is rising around the world • There is real hope that by the end of 2010 the recovery will be on solid ground and self sustaining and that by 2011 we can enter a period of stability and re-newed growth in the global economy Canbek Economics

5. We are Not Sure Yet The recovery remains too dependent on government support • Although economies are rebounding around the world, the recovery is not even • The emerging economies of China, India, Brazil are faring better and leading the rebound • The economies of the USA, Europe and Russia are lagging behind • Canada is a special case -fortunately for us- but still tied too much on the US economy, thus still vulnerable • So far the recovery is still technical, driven by a restocking of inventories, a bounce back from the lows of 2009 • Recovery is still overly dependednt on government spending, bailout money and low interest rates • It is still too early to declare victory, the patient is out of the OR room but still in the ICU! Let us not forget this. Canbek Economics

6. World Economic Growth, 2001-2009 and Projections for 2010 & 2011 Percent (%) Growth 10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Advanced Economies Emerging Economies World Average Source: IMF WEO Update, January 26, 2010

7. This Intervention Comes at a High Price We have not received the bill yet • We have been pulled out of the clutches of Scylla, but we may have fallen in the arms of Charibdis • Why? • Because the battle has been won at an enormous cost in terms of a) unprecedented expansion in the supply of money and b) unprecedented peacetime expansion in government deficits. • It is like we have gone on a giant shopping spree and charged all our purchases on our credit card. The bank that has issued the card will soon send us the bill, that is when we will begin feeling the cost of our purchases and the pain of paying it back! Canbek Economics

8. Change in US Real GDP, 1948-2009 This has been the worst downturn since end of World War II Percent (%) Change 15 10 5 0 -5 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014 Growth Rate Canbek Economics

9. Effective Federal Funds Rate, June 1954 - Jan 2010 Interest Rates have gone from 2% to 20% and then down to 0.12%, They have nowhere to go but up now 20 15 10 5 0 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Fed Funds Rate Source: Federal Reserve Board of Governors Canbek Economics

10. Adjusted Monetary Base, USA, 1925-2010 To save the financial system from collapse Federal Reserve had to expand the monetary base by an unprecedented amount 2500 2000 1500 1000 500 0 1925 1935 1945 1955 1965 1975 1985 1995 2005 Adj Monetary Base Source: Federal Reserve Bank of St-Louis Canbek Economics

11. Total Reserves Adjusted for Reserve Requirements, US, 1959-2010 They had to inject over 1 trillion in liquidity into the US banking system 1200 1000 800 600 400 200 0 1959 1969 1979 1989 1999 2009 Total Bank Reseves Source: Board of Governors of the Federal Reserve System

12. MZM Money Stock (Broad Money Supply), US, 1959-2010 The money supply has risen less dramatically because banks are not as confident and have not been lending Thousands Thousands 10 10 8 8 6 6 4 4 2 2 0 0 1959 1969 1979 1989 1999 2009 Money Supply Federal Reserve Bank of St-Louis Canbek Economics

13. US Consumer Prices (CPI), 1959-2009 Consumer prices have remained remarkably tame so far in the face of such monetary expansion, but for how much longer? 250 200 150 100 50 0 1959 1969 1979 1989 1999 2009 CPI Source: US Dept of Labor, BLS Canbek Economics

14. US Federal Budget Deficit as Percent of GDP, 1900-2010 It has led to the biggest budget deficit in peacetime US history Percent (%) of GDP 30 25 20 15 10 5 0 -5 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Budget Deficit Canbek Economics

15. Federal and Total (state & federal) US Government Debt as Percent of GDP, 1900 - 2010 Gross US public debt is now approaching 100% of GDP 140 120 100 80 60 40 20 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 State Federal Canbek Economics

16. Total US Debt Outstanding: Household, Business & Government, 1974-2009 Total private and public debt in the US is now 370% of GDP Percent (%) of GDP Trillions of US Dollars 400 60 50 300 40 200 30 20 100 10 0 0 1974 1979 1984 1989 1994 1999 2004 2009 Total Debt to GDP Total Debt Source: Federal Reserve Board, Flow of Funds Accounts Z1 d3 Canbek Economics

17. General Government Net Debt: 2003-2008 Actual, 2009-2014 Projections The US is not unique, it is happening in Europe as well and to a less extent here in Canada 100 80 60 40 20 0 93-2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2014 Euro USA UK CAN Source: IMF, WEO, October 2009

18. Government Budget Deficits, Percent of GDP, 2009 Budget deficits have exploded all over with the worst affected being in the advanced industrial world UK Greece Spain Ireland USA Portugal France Japan Russia Turkey Belgium Italy Canada 0 2 4 6 8 10 12 14 16 Source: The Economist, EIU, January 16, 2010

19. Gross Debt-to-GDP Ratios, 2010 IMF Projections Debt-GDP ratios have been rumped up dramatically in many countries Japan Greece Italy USA Germany France UK Canada Spain Advanced G-20 Emerging G-20 0 50 100 150 200 250 Source: IMF, World Economic Outlook, April 2009 & October 2009

20. Where are we Headed from Here? We are navigating through Scylla and Charibdis • Governments will stay the course by keeping interest rates low and policy stimulus high to nurse economy into self-sustaing growth • Once this is achieved later in 2010 and 2011, they will start withdrawing stimulus packages • Short-term interest rates will start to rise • Government spending will start to fall and taxes will start to rise to bring deficits under control and stabilize high debt-GDP ratios • Given the unprecedented size of stimulus intervention, it will take a long time to bring deficits under control and • A meaningful self-sustaining expansion may be delayed until 2012 or 2013. Canbek Economics

21. What are the Risks Facing Us? Uncertainty is very high and the risks are huge • Exit strategies of central banks might stumble or fail and this may trigger a loss of confidence in their ability to control the value of money, and may trigger a bout of inflation and exchange rate instability • We may experience a sovereign debt crisis, with credit rating downgrades, drop in bond prices, rise in long-term interest rates and mortgage rates that will dampen housing values • The public may balk at restrictive fiscal and monetary policies and precipitate civil unrest and political crises Canbek Economics

22. The Great Conundrum of our Time To avoid inflation interest rates will have to rise; to avoid economic stagnation and rise in debt levels interest rates will have to stay low; but you can’t have it both ways! • With all this monetary easing, expansion in liquidity and money supply, central banks will have to raise interest rates to prevent inflation • Higher interest rates will slow down economic growth and raise the cost of funding public and private debts • It may become extremely difficult for governments to bring down deficits and public debt especially in the face of public opposition and political instability and civil unrest • In that case, the only exit strategy might be to allow inflation to rise Canbek Economics

23. A Time for Reckoning A difficult period lies ahead • No one can predict exactly the future • What one can say for sure is that we are headed for a difficult and protracted period of undertainty, economic, social and political adjustments • At least here in Canada, we will experience much less pain than others because we have gone through much of this adjustment already in the 1990s • Yet we will still feel the storm • THANK YOU ! • www.canbekeconomics.com