Managing in a Global Economy

MANAGING IN A GLOBAL ECONOMY FALL 2021 Lesson 1

Jean Ergas

M a te

ra lsp

re p a re

d b y S im

o n

Je a n E rg

a sc

o p y rig

h t

2 0 1

3

1

RISKY BUSINESS

 Debt restructuring

 Euro-zone bailouts! Who’s next?

 Is the Eurozone crisis over ?

 Is the best outcome scenario for the Eurozone stagnation ?

 Central banks diversifying their reserves - is this the end of the US Dollar’s primacy ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

2

EUROPEAN UNION M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

3

EURO-ZONE

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

4

DOES IT SOUND CONFUSING?

IT IS!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

5

IN THIS COURSE WE SHALL REVIEW

 Major risks facing companies - to name a few!

 Foreign exchange

 Interest rate

 Credit risk

 Political risk

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

6

FINANCING STRATEGIES

 We shall review some basic financing strategies

 How can we raise finance ?

 Short term – long term  Secured – unsecured  US Dollars – Foreign Currency

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

7

CHANGING RISKS

 How are the risks facing companies changing?

 Have the challenges facing companies changed with globalization?

 What are the pluses and minuses of globalization?

 Has the rise of an IT driven economy removed the size requirement for having a global presence ?

 Are we starting to see a move away from outsourcing and towards on – shoring ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

8

EMERGING MARKETS – YESTERDAY’S PAPERS ?

 Emerging economy currencies plummeting  Emerging economy massive:  Domestic  Foreign  Capital flight

9

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

EMERGING MARKETS – TIME FOR A RE-THINK ?

 Emerging economies are facing both:  External - Shift in monetary policy  Internal - Lack of infrastructure - inflation  Challenges  Do we need to rethink the role of the

emerging economies ?  Is the pendulum moving back to the

developed nations ?

10

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

11

“TOP DOWN” ECONOMY

 Are we in a “top down “ economy ?

 Will we need to focus more on government policy?

 Will the central banks and supra-nationals save the world again ?

 Will purely commercial considerations count for less ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

12

WHAT INSTRUMENTS ARE AVAILABLE TO MANAGE THE RISK

 We shall look at the different instruments to manage risk

 We shall learn their advantages and disadvantages

 We shall above all learn to identify risk exposures!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

13

TWO LEVELS OF RISK MANAGEMENT - TOP DOWN

 We shall look at a two tiered approach to risk management:

 Medium to long term – “top down “

 Risk mitigation - strategic response

 We change inputs - reduce raw material price risk

 We change clients - reduce credit risk  We change markets -reduce country risk

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

14

COMMODITY INDEX M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

15

COPPER PRICE

2/ 18

/2 01

1

1/ 5/

20 11

11 /2

2/ 20

10

10 /8

/2 01

0

8/ 25

/2 01

0

7/ 12

/2 01

0

5/ 28

/2 01

0

4/ 13

/2 01

0

2/ 25

/2 01

0

1/ 12

/2 01

0

11 /2

7/ 20

09

10 /1

4/ 20

09 0

0.5 1

1.5 2

2.5 3

3.5 4

4.5 5

copper price 2009-2010

copper price

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

16

OIL PRICE

Ja n-

08

Ap r- 08

Ju l-0

8

O ct

-0 8

Ja n-

09

Ap r- 09

Ju l-0

9

O ct

-0 9

Ja n-

10

Ap r- 10

Ju l-1

0

O ct

-1 0

0

20

40

60

80

100

120

140

160 Oil price 2008-2010

Oil price

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

17

TWO LEVELS OF RISK MANAGEMENT - BOTTOM UP SHORT TERM

 We work with the situation “as is”!

 Contracted and projected cash flows

 Expenses

 Revenues

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

18

FOREIGN INVESTMENT

 Why are FDI exposures different from commercial exposures ?

 What measures can companies take to protect themselves from the risks of foreign direct investment ?

 What is changing in the directional flows of foreign direct investment

 Is trade liberalization deterring or encouraging foreign direct investment ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

19

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

20

FOREIGN INVESTMENT

 Financing strategies for multinationals

 Advantages and disadvantages

 Availability of capital - depth of capital markets

 Cost of capital - interest rate differentials

 Cost of capital - stricter covenants

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

21

ALTERNATIVE FINANCING STRATEGIES

 Project finance

 Buyer finance

 Seller finance

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

22

ALTERNATIVE FINANCING STRATEGIES

 These strategies are often supported by:

 Government agencies - Export Credit Agencies

 Export – Import Bank of the United States

 OPIC - Overseas Private Investment Corporation

 Supranational institutions

 World Bank Group

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

23

ALTERNATIVE FINANCING STRATEGIES

 How does the relative availability of ECA financing drive off-shoring decisions ?

 How can companies minimize their costs and increase their capital availability via these vehicles ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

24

TRANSFORMATION OF THE WORLD ECONOMY

 The Global Economy has since 1945 gone through an Extensive Transformation

 We can distinguish 3 phases

1. The domestic economy 2. The multi-national economy 3. The global economy

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

25

THE DOMESTIC ECONOMY 1945-1960

 US companies produce and sell primarily in the USA

 Foreign markets seen primarily as sources for raw materials

 There are two convertible currencies

- The US Dollar and the Swiss Franc - The US Dollar replaces the pound Sterling

UK

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

26

THE WORLD SITUATION

 Large gap between the US economy and ROW

 Europe recovering from the Second World War

 Large part of the world controlled by Communist regimes

 Large part of the world still controlled by colonialist powers

 Resources are channeled through the colonialist power

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

27

COMMUNIST WORLD IN 1950 M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

28

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

29

TRANSFORMATION OF THE GLOBAL ECONOMY

 Following extensive aid from the Marshall Plan

 Marshall Plan 1947-1951

 US Dollars 13 Billion – US GDP US Dollars 258 billion

 By 1951 all recipients had surpassed their pre- war economic level

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

30

TRANSFORMATION OF THE GLOBAL ECONOMY

 German economy leads the European recovery

 Foundation of the European Common Market

 Six members - now it is called the European Union

 Inter European trade explodes!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

31

MARSHALL PLAN M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

32

COMMON MARKET FOUNDING MEMBERS M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

33

TRANSFORMATION OF THE GLOBAL ECONOMY

 While Europe re-asserts itself in Asia , Japan becomes the dominant economic power focus is on low cost production and export

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

34

THE MULTI-NATIONAL ECONOMY 1960 – 1980  Rapid growth of the European domestic

economies

 Strong increase in internal consumption

 US business moves abroad

 US business establishes production sites in each market

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

35

GDP EXPANSION OF EU 1960-1980

19 61

19 63

19 65

19 67

19 69

19 71

19 73

19 75

19 77

19 79

-1

0

1

2

3

4

5

6

7

GDP growth (annual %)

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

36

THE MULTI-NATIONAL ECONOMY 1960 – 1980

 Europeans see themselves under attack by US companies

 Publication in France of the book “The American Challenge”

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

37

THE MULTI-NATIONAL ECONOMY 1960 – 1980

 US goes off the gold standard 1971

 End of Bretton Woods

 Move towards floating exchange rates

 Emergence of a foreign exchange market

 Currency fluctuations become a major concern

 Founding of the G-6, later G- 7, in France

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

38

GOLD PRICES M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

39

THE MULTI-NATIONAL ECONOMY 1960 – 1980  A new player enters the global economy  The Middle East and the oil exporting nations

following two sharp oil price increases in the 1970’s

 The balance of financial power shifts

 Oil producers control a growing share of currency flows

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

40

OIL PRICE 1960-1980

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

Nominal Inflation Adjusted

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

41

THE GLOBAL ECONOMY 1980 – 1990 ACT 1

 Move towards the opening of the Chinese economy

 Rapid development of the Asian economies “Tigers”

 Move towards liberalization “Perestroika” in the Soviet Union

 Fall in the price of crude oil

 Allows developed economies to gradually emerge from recession

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

42

CHINA GDP 1980-1990

19 80

19 81

19 82

19 83

19 84

19 85

19 86

19 87

19 88

19 89

19 90

0

2

4

6

8

10

12

14

16 GDP growth (annual %)

GDP growth (annual %)

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

43

OIL PRICES 1980-1990

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

Nominal Inflation Adjusted

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

44

THE GLOBAL ECONOMY 1980 – 1990 ACT 1

 First major international currency agreements

 Plaza Agreement 1985

 Louvre Agreement 1987

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

45

THE GLOBAL ECONOMY 1990– 2000 ACT 2

 Collapse of Communism in Eastern Europe

 End of the Soviet Union

 Founding of the European Union

 From economic community to political organization

 Creation of the framework and introduction of the Euro - the single currency

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

46

EUROPEAN UNION IN 1992 M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

47

ORIGINAL EURO-ZONE

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

48

THE GLOBAL ECONOMY 1990– 2000 ACT 2

 Founding of NAFTA – North American Free Trade Agreement

 Rise of the BRICS

 Reforms in Brazil and India positioning to emerge as major economic powers

 China growing rapidly – but still 10th economic power

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

49

NAFTA COUNTRIES M

a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

50

INDIA GDP 1990-2000

19 90

19 91

19 92

19 93

19 94

19 95

19 96

19 97

19 98

19 99

20 00

0

1

2

3

4

5

6

7

8 GDP growth (annual %)

GDP growth (annual %)

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

51

CHINA GDP 1990-2000

19 90

19 91

19 92

19 93

19 94

19 95

19 96

19 97

19 98

19 99

20 00

0

2

4

6

8

10

12

14

16 GDP growth (annual %)

GDP growth (annual %)

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

52

THE GLOBAL ECONOMY 2000-2010 ACT 3

 Rapid development of the financial markets

 First speculative collapse - technology 2000

 Loose monetary policy - creation of massive bubbles

 Explosion of BRIC growth

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

53

THE GLOBAL ECONOMY 2000-2010 ACT 3

 Financial Collapse

 Collapse of global trade

 Extraordinary measures by governments acting together

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

54

THE GLOBAL ECONOMY 2000-2010 ACT 3

 Where are we now ?

 Crisis in the developed economies

 Rise of the BRICS

 Rise of the commodity currencies

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

55

GLOBAL GDP 2008-2010

2008 2009 2010 -1

0

1

2

3

4

5

6

GDP growth (annual %)

GDP growth (annual %)

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

56

BRICS GDP (% CHANGE) 2008-2010

2008 2009 2010

-10

-5

0

5

10

15

Brazil China India Russia

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

57

AUSTALIAN DOLLAR VERSUS US DOLLAR 2008-2010

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

58

BRAZILIAN REAL VERSUS US DOLLAR 2008-2010

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

59

CONSEQUENCES FOR GLOBAL BUSINESSES

Macro - Increase focus on the government role in the economy

 Sovereign intervention key

 Principal support for several developed economies

 In major emerging markets - state ‘s role in economy fundamental

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

60

MACRO – CHANGING STRUCTURE OF THE CREDIT SYSTEM

 Changed structure of the credit system

 Strong government support for credit institutions

 Critical in assessment of counterparty risk

 Have central banks evolved from being the lenders of last resort to being the takers of the last risk?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

61

MACRO - INCREASE FOCUS ON THE GOVERNMENT ROLE IN THE ECONOMY

 Dual demand stream in emerging markets

 Consumption - retail consumers  Investment - government entities

 Government investment in the emerging economies:

 Fueled demand for raw materials  And  pushed large infrastructure investment.

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

62

MICRO – RISKS INCREASE - RISK MANAGEMENT ESSENTIAL!

 Companies seek to minimize production costs

 Supply chain grows longer - production segmented in different countries

 Quality control issues increase

 Counterparty risk issues increase

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

63

DEVELOPMENT OF INTERNATIONAL TRADE

 Increasing liberalization

 Reduction of tariff barriers

 Opening of former socialist economies

 Increased access to better transportation

 Lower costs of communications

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

64

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

65

ADVANTAGES OF INTERNATIONAL TRADE

 Allows each country to focus on its specific advantage

 Law of Comparative Advantage

 Economies of scale = lower production costs

 Lower production costs + bigger markets = bigger profits

 Increased international investment flows - + capital for economic development

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

66

NEW TRADE INITIATIVES !

 Sovereign finances massively impacted by the crisis

 Sovereigns are now reducing spending  Sovereigns no longer able to stimulate

economy  Sovereigns are now seeking to grow

economies via:  Bilateral trade agreements  Multi lateral trade agreements 67

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

TRADE INITIATIVES COVER THE WORLD ?

 Free trade agreement between the US and the EU

 Free trade agreement between countries both sides of the Pacific

 Free trade agreement – Pacific Alliance:  Colombia  Mexico  Chile  Peru  Free trade discussions for Africa – from Cairo to

Cape Town ! 68

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

FOREIGN EXCHANGE RISK

 Effect of FX risk on company profits can be substantial

 If currency fluctuations cannot be offset by price increases !

 Volatility of foreign exchange rates – can make planning difficult!

 What factors might allow an exporter to raise prices to offset a devaluation of the currency of the sale?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

69

COUNTRY RISK

 Insolvency of government entity

 Who is your trade counterparty

 Transfer risk – counterpart cannot remit payment

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

70

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

71

CEN – DIRECT INVESTMENT

 Confiscation

 Expropriation

 Nationalization

 Strategic Risk

 Subsidization of local competitors

 Import tariffs or restrictions

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

72

THE INTERNATIONAL FINANCIAL SYSTEM THE GOLD STANDARD

 Gold standard basis for international financial system in the 19th and 20th centuries

 Rise of gold standard closely linked to expansion of international trade in the 19th century

 Progressive adoption by the major economies of the gold standard prior to World War 1

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

73

THE INTERNATIONAL FINANCIAL SYSTEM THE GOLD STANDARD  The gold standard underwent numerous modifications

 Use of gold coins as medium of exchange - gold species

 100 % gold backing of currency with gold and guarantee of convertibility by each central bank -

 Convertibility of US Dollar into gold – other currencies pegged to the US Dollar = de –facto convertibility

 This was the system designed in 1944 – Bretton Woods

 This lasted until 1971 with conversion into gold

 Smithsonian agreements December 1971 last attempt at reestablishing fixed parities to US Dollar of major currencies

 This agreements collapsed rapidly !

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

74

THE GOLD STANDARD

 Key arguments for the gold standard

 Governments are limited to the amount of money that they can issue

 Governments cannot print their way out of debt!

What would have happened if in 2008 we had been on the Gold standard ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

75

TRADE IMBALANCES BETWEEN COUNTRIES ARE SETTLED BY TRANSFERS OF GOLD  Deficit country ships gold to surplus country

 Less gold = less money = lower internal price level

 Lower price level = deficit country products cheaper

 Products cheaper = + exports

 But import prices higher due to lower wages

 Consumers in deficit countries buy local products

 Cheaper export products + buy local = deficit closes What are the parallels to today’s situation – China vs.

US ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

76

THE GOLD STANDARD COLLAPSES!

 However this did not always work!

 See in this instance the Great Depression

 Much discussion about its causes!

 Stock market speculation

 Shrinking of the money supply

 US tariff increases

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

77

THE GOLD STANDARD COLLAPSES!  However, many countries abandoned the Gold Standard

to reflate their economies - notably the UK in 1931

 US in 1933 / 1934 modifies currency relationship to gold – dollar is devalued

 The interwar years were the years of “beggar thy neighbor”

 These were the grim years of competitive devaluations

What parallels with today’s currency wars following the Great Recession?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

78

THE GOLD STANDARD COLLAPSES!

 The grim experience of the inter – war period

 Competitive devaluations seen prolonging the Great Depression and hastening the outbreak of The Second World War

 Led to decision to enhance economic cooperation

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

79

BRETTON WOODS AND FOUNDATION OF THE IMF  In 1944 Bretton Woods agreements

 Bretton Woods - avoid use of competitive devaluations

 Founding of the IMF in 1945

 IMF founded to administer Bretton Woods system

 IMF also empowered to provide finance to member countries to cover deficits and emergency balance of payments financing

 For example, during the oil shocks

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

80

BRETTON WOODS AND FOUNDATION OF THE IMF  Bretton Woods agreements start to weaken in the early

1960’s

 Rise of US deficits

 Loss of confidence in the US Dollar

 + sale of US Dollars for gold

 Pressure on US to maintain FX rate

 US ends convertibility into gold in 1968

 US ends fixed exchange rates in 1971

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

81

FLOATING EXCHANGE RATES  World moves towards floating exchange rates

 European nations form ERM – Exchange Rate Mechanism

 European nations form EMS – “the snake” European Monetary System

 European currencies linked to each other within fluctuation bands

 US Dollar floats vs. European currencies

 Foreign exchange market booms!

 Foreign exchange volatility very high!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

82

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

83

THE INTERNATIONAL FINANCIAL SYSTEM  US Dollar rises dramatically in the early 1980’s US fiscal

deficit +

 Needs foreign financing US sells bonds

 = + demand for US Dollars

 This leads to Plaza Agreements in 1985

   = concerted action by 5 governments

 = reduction in US Dollar value

 = boost to US economy in recession

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

84

THE LOUVRE AGREEMENTS 1987

 Aim of the Louvre Agreements was to stop collapse in the

 US Dollar - which created difficulties for non US exporters

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

85

COLLAPSE OF THE EMS  EMS collapses in 1992

 German reunification

 Germany needs to attract capital

 Germany raises interest rates

 Weaker European economies under pressure to maintain their parities within EMS

 Pressure greatest on Italy and UK

 UK currency object of massive speculation!

 UK and Italy exit!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

86

COLLAPSE OF THE EMS AND BIRTH OF EURO PROJECT

 From the ashes of the EMS rises the Euro

 European Common Currency in Maastricht Agreeement

 Maastricht agreement cornerstone for transformation of European Common Market from economic to political entity

 Europe would speak both politically and financially with one voice!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

87

COLLAPSE OF THE EMS AND BIRTH OF EURO PROJECT

 There was fierce competition among the EU countries to qualify for the Euro!

 Strict criteria to accede to the Euro

 GDP/Debt – Deficit/GDP but these were waived!

 Euro was above all a political priority!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

88

THE INTERNATIONAL FINANCIAL SYSTEM

 Euro – no thanks !

 Some countries did not join

 Most notably – the United Kingdom, Sweden and Danmark  UK did not join for fear of loss of sovereignty

 Also concern that Sterling value would suffer with inclusion of traditionally high debt and high inflation currencies – “Club Med” !

 Lack of fiscal discipline seen as a major concern

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

89

DO YOU THINK THAT THE UK WAS RIGHT ?

 UK deficit exceeded 12 % in 2010

 UK now facing a drastic austerity program

 Sterling era is over – UK no longer has the power to print a reserve currency

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

90

COLLAPSE OF THE EMS AND BIRTH OF EURO PROJECT

 Can the single currency work ?

 Will the Euro survive – arguments for and against ?

 Euro zone countries are now managing their economies within a fixed exchange rate system

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

91

COLLAPSE OF THE EMS AND BIRTH OF EURO PROJECT

 You cannot devalue your way out of a crisis

 This is what Italy and France did within the EMS

 Does the Euro appear to be a return to monetary and fiscal discipline previously associated with the gold standard ?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

92

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Greece

 Relative late comer to EU in the 1980’s

 Massive EU transfer payments a critical factor in growth

 Economy posts very fast growth rates

 Government spending erupts !

 German industry boosts sales to Southern Europe

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

93

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Greece

 Collapse caused by government spending inaccurate data supplied by government

 Complex financial transactions – allegedly concealing debt

 Reliance by lenders on both data and ECB “guarantee” !

 Greece has introduced a drastic austerity program wage reductions in the public sector

 push for increased tax revenue

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

94

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Ireland

 Celtic Tiger model focused on low cost service and IT economy

 Very successful as Ireland capitalizes on

 excellent geographical location  highly educated English speaking work force  low corporate tax rates - do you think that this is

unfair competition?

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

95

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Ireland

 As model comes under pressure

 Accelerated expansion of financial institutions

 Expansion facilitated by record low interest rates following the Tech bust and the 2001- 2003 recession in both the US and the Euro-zone

 Money is used by Irish banks to finance a huge property bubble

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

96

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Ireland

 Bubble bursts – huge losses for the banks in excess of Euro 30 billion rescue by the Irish government

 Run on Irish debt - sovereign and private

 Cannot fund itself in the market

 Bail –out in 2010 by IMF – ECB and the EU

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

97

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES Portugal

Economy grew not following extensive reforms but largely on massive EU transfer payments

 Portugal was the second rescue launched within the Euro-zone

 Relatively small economy

 Low growth rate within the Euro –zone  Competition from emerging markets rapidly eroding price

advantages -worsened by strong euro

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

98

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Portugal

 Portugal deficit explodes!

 Portugal enacts a stringent austerity plan

 Economy slows

 Great difficulty in refinancing - ECB buys Portuguese debt

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

99

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Portugal

 Limit cost of 10 year government debt – 7 %

 When this rate was exceeded - rescue launched

 Portugal bailout in excess of Euro 85 billion

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

100

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Who’s next?

Spain

 Strong economic growth following EU accession in the 1980’s

 “Catch up” effect following economic and political isolation under Franco

 Massive building boom financed by cheap money

 Savings banks regional institutions major lenders

 Regions ultimately supported by the central government

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

101

EURO - DIFFERENT PATHS TO FINANCIAL DIFFICULTIES

Who’s next?

Spain

 Property bubble bursts

 Banks left holding worthless loans

 Economy implodes

 Unemployment at approximately 20%

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

102

EURO - PROSPECTIVE SOLUTION  The Euro – zone countries established a first rescue fund

 EFSF – European Financial Stability Fund

 The fund was used to support euro-zone countries in difficulty

 The EFSF had Euros 440 billion but could not lend the whole amount

 Must keep about 220 billion to maintain credit rating

 The EFSF is being replaced by the ESM

 European Stability

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

103

ESM SUCCEEDS EFSF

 The EFSF is being replaced by the ESM

 European Stability Mechanism

 The ESM is a critical part of the joint strategy with the ECB to support Euro-zone sovereigns:

 Support shall be via the purchase of sovereign debt

 Support shall be extended only after acceptance of macro – economic reforms / targets

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

104

OTHER EXCHANGE RATE MECHANISMS  Parity to the US Dollar  In the 1990’s seen as a means to anchor

one’s economic policy to a fiscally responsible country following a period of hyper – inflation

 Brazil 1994 – Plano Real

 Argentina 1991 – move from Austral to the peso

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

105

OTHER EXCHANGE RATE MECHANISMS  Both countries were forced to abandon this parity

 Brazil in 1999    Problems included the rapid appreciation of the US Dollar

 Inflation had slowed but not to US levels!

 = less competitive exports = trade deficit in the current account

 Initially compensated by capital inflows = surplus in the capital account

   But increasing risk aversion by lenders and investors following the Asian

crisis versus emerging economies resulted in lower capital inflows

 = less inflow of foreign currency to defend parity to the US Dollar

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

106

OTHER EXCHANGE RATE MECHANISMS  Argentine Peso – US Dollar Parity

 Initially policy was successful

 Inflation below US level !

 Large capital inflows from abroad

 Increased borrowing on the international capital markets

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

107

OTHER EXCHANGE RATE MECHANISMS  Argentine Peso – US Dollar Parity

 But – US Dollar + Argentine Products Expensive

 Appreciation of US Dollar eliminated export competitiveness

 Major export markets were EU and Brazil

 Argentine agricultural exports were restricted by EU CAP Common Agricultural Policy

 Revaluation of dollar and fall of Euro put further pressure

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

108

OTHER EXCHANGE RATE MECHANISMS  Argentine Peso – US Dollar Parity

Brazil moves off US Dollar Parity!

 Faced with double punch!

 Brazil had abandoned the dollar parity in 1999

 Brazil had increased its own export competitiveness versus Argentina

 Brazil also an agricultural power house

 Argentine exports to Brazil became prohibitively expensive!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

109

OTHER EXCHANGE RATE MECHANISMS  Argentine Peso – US Dollar Parity - The

Collapse !

 Fall in capital inflows increased risk aversion by

 Foreign investors following Asian and Russian crises 1997 and 1998

 Public spending was increasing!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

110

OTHER EXCHANGE RATE MECHANISMS  Argentine Peso – US Dollar Parity - The

Collapse !

 The IMF imposed a restructuring program

 A differentiated FX rate was introduced for commercial transactions

 50 % US Dollar and 50 % Euro

 In 2001 government announces that it cannot pay its foreign debt

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

111

OTHER EXCHANGE RATE MECHANISMS  Argentine Peso – US Dollar Parity - The Collapse !

 The government executes debt swaps

 This is seen as a default

 There is a run on the banks and breakdown in public order

 The government imposes restrictions on bank withdrawals

 Game over! In January 2002 Argentina abandons parity

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

112

OTHER EXCHANGE RATE MECHANISMS  Dollarization –Ecuador

 The US Dollar is adopted as the official currency in 2000

 This policy was adopted following a massive economic collapse

 This included a sharp contraction in GDP, the collapse of the banking system and a debt default

 The economy posted strong results through 2007

 Ecuador defaulted on it’s sovereign debt in December 2008    Dollarization does not represent a guarantee of

payment!

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

113

KEY POINTS  Exchange rate policies are in constant evolution

 This represents considerable risks for foreign commerce and investment

 Adoption of the US Dollar is not a replica of the Bretton Woods agreements – replacement of the Gold Standard

 FX strategy must take into account:

 short – term commercial transactions

 Impact on investments

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

114

KEY POINTS

 When a country devalues you may suffer a triple loss:

 Lower amount of cash receipts    Lower sales as your product is priced out of

the market

 Rise of a local industry in previously client local market in direct competition with you !

M a te

ra lsp

re p a re

d b y S im

o n Je

a n E rg

a sc

o p y rig

h t2

0 1

3

115