Why do PIIGS matter to the price of corn in Indiana?

1. Why do PIIGS matter to the price of corn in Indiana? Philip Abbott

2. Euro Crisis • Unsustainable sovereign debt for Portugal, Italy, Ireland, Greece , Spain (PIIGS) • 166% of GDP in Greece • High interest rates (risk premiums) for PIGS • European banks exposed to defaults • Slow economic growth in Europe • Recession throughout Euro zone? • Weak, volatile currency • Euro may not survive crisis

5. Debt, Interest Rates, GDP growth in PIGS

9. Outline • Critical Issues of Euro crisis • Exchange rates – Devaluation • Monetary Policy – The ECB is not the Fed • Interest rates – Foreign capital flows to a safe haven, Investment • Fiscal Policy – Austerity • Financial Crisis – more severe than recession • Does this matter to the US? to agriculture? • Solutions and consequences

10. Exchange rates – Devaluation • Devaluation is the primary “cure” for a structural adjustment crisis • Improves export competitiveness • Inflates down debt in domestic currency • Greece can do neither of these • Fixed exchange rate countries cannot implement independent monetary policy • Weak dollar and commodity booms • Weak dollar from loose US monetary policy

11. Monetary Policy – The ECB is not the Fed • ECB mandate is just to limit inflation • Fed’s includes unemployment • No Euro bonds equivalent to treasury bills • Which country’s interest rates to control? • Buying government bonds by ECB is controversial • Inflation and monetizing debt • Printing Euro’s or financing from Germany, France • Politically unacceptable in Germany • Stabilization Fund • Bank regulation – there are central banks in each Eurozone country

12. Interest rates – Foreign capital flows to a safe haven • Historically, different interest rate policies by ECB versus Fed have been important to exchange rates • Influence investment, capital flows sooner than trade • ECB raised, but is now lowering short term rates • Foreign capital flows as important as trade flows in transmitting economic shocks across borders • US dollar strength as safe haven • Low interest rates on US treasury bills also due to safe haven/ “risk off” • IMF and Europe • IMF resources to increase stabilization fund, loans to Greece • European leaders asked for help from non-European nations (China, Brazil, but not US)

13. Fiscal Policy – Austerity • Austerity also part of the IMF structural adjustment cure - conditionality • Brought lost decade to Latin America, protests • Contradicts Keynesian prescription • Confidence of investors versus stimulus of government spending • Severe austerity in Europe has evidently slowed economic growth • Even US super committee fallback did a better job of timing deficit reduction • Solution should be to stimulate growth in short term with a commitment to reduce spending in long run • Tax revenue strongly related to business cycles • Austerity  recession lower tax collections  debt increases, deficit targets not met • Euro zone does not have common fiscal policy • Social protection varies across countries • Deficit targets and spending cuts

14. Financial Crisis – more severe than Recession • Financial crisis and recession not the same thing • Recession without financial crisis, more severe recession, or depression with financial crisis • Fed, US treasury policy motivated to avoid financial crisis • Euro rescue package – recapitalize European banks • Bank failures with defaults on sovereign debt • US affected by CDS, Swaps – guarantees on debt • Financial crisis in 2008/09 brought trade collapse • World trade in 2009 fell 23% relative to 2008 • Short term effects more severe in 2008QIV and 2009QI

15. Does this matter to the U.S. economy? to agriculture? • Exchange rates, inflation and agricultural prices • Historically a weak dollar and inflation have brought higher agricultural prices, growing farm income • Is inflation “contagious” • Recession spillovers? • Exports to Europe • Worldwide recession • Food is income inelastic • Financial crisis and trade collapse • CDS and US bank exposure • Agricultural trade not immune to crisis

16. Economic growth slowing worldwide - IMF

17. Corn versus Euro’s- stronger relationship recently, overshooting

19. Prices Up in 2008 & 2011, but Export demand (volume)is Inelastic, at least in short run Price does affect trade value significantly, and Dec 2008 corn futures fell from nearly $8 in July to almost $3 in December, With much of that fall after Lehman Brothers failed.

20. GDP has influenced trade volume, including agricultural trade, more so than pricesWorld total exports:

21. U.S. Agriculture somewhat more resilient to recession than overall trade – inelastic demand • From 2008III to 2009II, US trade declines were • Imports 35% Ag Imports 11% Oil imports 57% (6% in Q) • Exports 26% Ag Exports 19% • Ag trade back to peaks in 2011 www.bea.gov

22. Quarterly US exports – Total, Ag, Corn and Soybeans – 2005 to 2011:II

23. Some solutions? • Disorderly break-up of Eurozone • Export competitiveness with devaluations • Recapitalizing PIGS banks – Debts remain in Euros • Financial crisis likely • Monetizing PIGS debt • ECB buys PIGS bonds – prints Euros • Inflation in Germany • Stabilization Fund -- is it big enough, will it substitute for ECB bond purchases? • Severe austerity • Budget limits in EU treaty • Do differences in social protection persist? • Recession more likely, more severe • Tax collections fall with recession • Social Unrest • Rescuing European banks • Voluntary “Haircuts” on Greek bonds – why doesn’t this trigger CDS? • Liquidity, loans from Fed to ECB • Increased capital requirements

24. Closing Thoughts • U.S. stimulus measures should have meant weak dollar • Would have brought higher commodity prices • Weak Euro due to crisis counteracted this • Euro austerity more likely to bring recession • European countries have not delayed budget cuts • Euro crisis has already influenced corn, soybean prices • Exchange rates, recession, financial crisis • Longstanding problem, but actual crisis would have dramatic effects • Biggest risk is European financial crisis • Severe austerity means worldwide recession? • But bank failures and financial collapse may again have big effects on trade, including agriculture • ECB/ Fed moves to provide banks liquidity had most dramatic effects on markets • Fed policy to rescue banks based on fear of financial crisis