Talking points for presentation at the ILO Conference: “The Global Financial Crisis: How did we get here and how do we move forward?” Introduction: › Meeting at crucial juncture – G20 Meeting › Difference of Stakeholder Dialogue – not protest › Commend ILO for initiative • There are two common features of all financial crises. The first is that they are preceded by the rise and fall of a bubble, defined as an unsustainable path of price increases in financial assets, commodities or real estate, or of capital inflows. Secondly, the rapid expansion of credit fuelled the bubble followed by sharp contraction in lending. • The bubble was influenced by the surge of real estate prices in the United States fuelled by the sharp reduction of interest rates in that country in an effort by the Federal Reserve to combat the mild recession of 2001 prompted by the bursting of the 2001 Dot.com Bubble. • As any bubble, when economic agents realised that real estate prices were totally overvalued, fear develops that this process will come to an end, therefore reduced demand for houses generated a self-fulfilling prophecy: as demand for real estate drops, its prices start to decline. • In most countries this main vehicle for household savings, implied a hard negative blow to wealth which, in turn prompted the contraction of consumption and the increasing rate of defaults on mortgage debt. • Highly leveraged financial institutions were faced with significant liquidity challenges. In turn, this generated problems for financial institutions that required bailouts, mergers and rescues. • The financial crisis became systemic in the United States in September 2008 and rapidly turned global. • What lies behind this process is the massive use of mortgage-backed derivatives that were internationally traded. This meant the contamination of European and other foreign financial institutions balance sheets with “toxic” assets manufactured in the United States. • Once real estate prices in the United States collapsed, there was a global solvency problem on the part of international banks. • This initiated the credit crunch which, together with the negative wealth effect caused a spill-over of the financial crisis into the real sector. • The resulting increase in unemployment further increased the default on not only mortgage debt, but also on consumption and credit card debt which exacerbated the solvency problems of financial institutions. • Figures released by the International Monetary Fund (IMF) in mid March point to a gloomier situation than previously expected. Indeed, these forecasts indicate a contraction of 0.6% for the world economy, with United States output dipping by 2.6%, the Euro Zone by 3.2%, Japan by 5%, the United Kingdom by 3.8% and Canada by 2%. Latin America would contract by 0.6% in 2009. • In this scenario, small open economies will suffer negative external shocks through a variety of channels, including trade, tourist arrivals, remittances, foreign direct investment (FDI) and external financing. The contraction in world demand would be felt by all Caribbean countries, particularly through reduced volumes of merchandise exports. • The intensity of the global recession varies from country to country, but will undoubtedly be felt throughout the region. According to ECLAC’s forthcoming Preliminary Overview of the Caribbean 2008-2009 (www.), the relative macroeconomic impact on the region would depend on, among other things, the twin deficits – i.e. fiscal and current account – and the level of public debt and of international reserves. • At the end of 2008, most Caribbean countries had unsustainable levels of public debt and not enough international reserves. As a rule of thumb, any public debt exceeding 40% of GDP can be deemed to be unsustainable. However, public debt in Barbados, Jamaica, Dominica, Grenada and Saint Kitts and Nevis are above 100% of GDP. Meanwhile, Belize, Guyana, Antigua and Barbuda, Saint Lucia and Saint Vincent and the Grenadines, have debt-to-GDP ratios above 70%. On the international reserves side, with the exception of Barbados, Guyana and Trinidad and Tobago, no other Caribbean country has more than 3.5 months of import cover. • But the worse part of the story comes when one looks at the current account side. As a simple average, ECCU countries recorded current account deficits of almost 35% of GDP in 2008, the main problem being their fixed exchange rate regimes. • As any household has to do, if it spends over income someone has to finance this gap. The natural candidates are savings and borrowing. • At the national level, savings are international reserves that are insufficient in most Caribbean countries. The other source of financing is borrowing from the rest of the world. But, given the magnitude of the current world crisis, this is not a readily available option. Conclusions: › ECLAC’s views on the Way Forward: (1) Informed, concerted policy actions are required on a regional basis – • Applaud the CARICOM Task Force Initiative. (2) Several pre-existing conditions such as unsustainable levels of public sector debt and current account deficits could mean disastrous consequences for many Caribbean States and therefore require also concerted actions. (3) We believe that an inclusive and consultative process will yield the best solutions to the crisis, for the Caribbean and by extension, globally. (4) Among the possible solutions we see the need to broker a common understanding of support from the International Community/IFIs. (5) Need for orderly relaxation of fixed exchange rate regimes in order to avoid a possible currency crisis in many CARICOM countries.
Pages to are hidden for
"A currency crisis in the Caribbean"Please download to view full document