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THEORY OF FINANCIAL CRISES Elective M1, FINANCIAL ECONOMICS TRACK ACADEMIC YEAR 2012 / 2013

THEORY OF FINANCIAL CRISES Elective M1, FINANCIAL ECONOMICS TRACK ACADEMIC YEAR 2012 / 2013. Professor : Nikolay NENOVSKY. Theory and History of Financial crises. Pr Nikolay NENOVSKY University of Picardie Jules Verne Former Member of Bulgarian Central Bank Governing Council.

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THEORY OF FINANCIAL CRISES Elective M1, FINANCIAL ECONOMICS TRACK ACADEMIC YEAR 2012 / 2013

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  1. THEORY OF FINANCIAL CRISES Elective M1, FINANCIAL ECONOMICS TRACK ACADEMIC YEAR 2012 / 2013 Professor: Nikolay NENOVSKY

  2. Theory and History of Financial crises Pr Nikolay NENOVSKY University of Picardie Jules Verne Former Member of Bulgarian Central Bank Governing Council EDHEC, Nice, May 2013 EDHEC May 2013

  3. Who is guilty?Two versions… EDHEC May 2013

  4. Sglut (excess) theory, Sglut countries Precautionary S in emerging markets Lack of safety net in China … Demand for safe US assets China accused of promoting export, trough undervalued currency, depressed C…. USA/Ben Bernanke version EDHEC May 2013

  5. USA accused for twin deficits… for spending more/low S for taking seignioragefrom dollar as world currency (exorbitant privilege) Similar discussion in EU….. China version … EDHEC May 2013

  6. EDHEC May 2013

  7. Malthus’s theory de retour …. EDHEC May 2013

  8. Regional (EU) dimension • Reproducing the world in a smaller scale/and Common currency .. • North Europe (Germany)/South Europe • EU moral hazard model, Insurance model • Free collateral for EU periphery.. • Real interests rate at the periphery are lower that at the core countries … r <r* because: (r – r*) = (i – i*) - (πexp – πexp*)- (φ – φ*) because πexp> πexp*but i=i* and φ = φ* EDHEC May 2013

  9. EDHEC May 2013

  10. EDHEC May 2013

  11. EDHEC May 2013

  12. EDHEC May 2013

  13. EDHEC May 2013

  14. EDHEC May 2013

  15. EDHEC May 2013

  16. EDHEC May 2013

  17. EDHEC May 2013

  18. EDHEC May 2013

  19. EDHEC May 2013

  20. EDHEC May 2013

  21. Second explanation: Monetary Policy EDHEC May 2013

  22. Low interest rates Liquidity glut not Saving glut … FED ECB Bank of Japan (… depression since 1990) But why ? USA version … China version… Easy money, easy monetary policy … EDHEC May 2013

  23. EDHEC May 2013

  24. Low interest rates FED ECB Bank of Japan (….depression since 1990) Monetary Policy EDHEC May 2013

  25. J Taylor interest rate rule (counterfactual)/what is and what ought to be… EDHEC May 2013

  26. EDHEC May 2013

  27. EDHEC May 2013

  28. One technical/neutral explanation… “Great Moderation”/Globalisation Benefits of globalization High productivity New information technologies Competition Stable price level Low inflation p – prices; w – wages; q – productivity p = (w, q) ∆p = ∆w - ∆q Why easy monetary policy?… EDHEC May 2013

  29. USA vision China’s demand for safety assets because lack of safety net/and repressed consumption/ China promotes export via competitive exchange rate (underappreciated) China vision USA Consumption, Investment euphoria (housing …) China accumulates foreign reserves against capital volatility coming from USA (… bad experience: IMF advised high interest rates in Asia after the Asian 1998 crisis and this was wrong ….) Why easy monetary policy? EDHEC May 2013

  30. EDHEC May 2013

  31. Yuan/USD exchange rate market EDHEC May 2013

  32. EDHEC May 2013

  33. Chinese exchange rate/2013 • Chinese Yuan looks close to its fair, equilibrium value, in 2005 was 30-35 % weaker… • CA surplus is around 3% GDP (in 2007 was 10%) • Surplus with USA, but deficits with he rest of the world…. • Normal exchange rate (real effective) that bring CA imbalances to a “normal” level …. EDHEC May 2013

  34. Third explanation Financial markets liberalisation Lack of financial regulation EDHEC May 2013

  35. Main points of concern …. Financial markets developments Modern finance theory and risk management Mixture of bad ideas and vested interests… EDHEC May 2013

  36. Financial sector disconnected from the real sector Financial to real transactions = 15 to 1 In 2010 Financial transactions: 800 trl USD Real transactions: 56 trl USD EDHEC May 2013

  37. Financial sector … Short term horizon/next bonus/predatory behavior …. Financial markets are short-sighted/Excessive risk taking, Efficiency market hypothesis is wrong… Speculation, derivatives/SPV.. etc… Lack of regulation, regulatory failures… EDHEC May 2013

  38. Financial instability hypothesis…. Hyman Minsky’s financial instability hypothesis: More stability → low perception of risks, more risks taking → crisis … Solution: Government intervention is need …. Levy Institute, http://www.levyinstitute.org/ EDHEC May 2013

  39. Kevin Dowd and Martin Hutchinson book, 2010, Alchemists of Loss. How Modern Finance and Government Intervention Crashed the Financial System Bad theory and ideas… Vested interests … EDHEC May 2013

  40. Benoit Mandelbrot (1924-2010) Financial theory is wrong because supposes normal probability distribution, in reality the probability distribution is not normal… … exist Fat tails… Poor risk management EDHEC May 2013

  41. Fat tails EDHEC May 2013

  42. Normal distribution means … N(μ,σ2) (bell curve/Gausses distribution): supposes events that deviate from the mean by 5σ or more are practically impossible…. Fat tails EDHEC May 2013

  43. EDHEC May 2013

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