The crisis: How bewildered should we feel?

1
The crisisHow bewildered should we feel?

• Ricardo Hausmann
• Center for International Development
• Kennedy School of Government
• Harvard University

2
Agenda

• How is the world?
• How did we get here?
• What does this diagnostic imply?
• How scared should we (Latin Americans) be?
• How much should we change our economic policy
  beliefs?
• How will Latin American countries fare?

3
The world is a mess

• Biggest global recession since 1929
• Synchronized as never before
• Sept 15, 2008
• Starting in the center, not the periphery
• Spreading globally instantaneously
• Amazing collapses in asset values
• Response includes huge fiscal deficits, zero
  interest rates, incredible expansions of central
  bank balance sheets (US, UK and Japan)

4
What happened?

• Financial crisis
• A heart attack
• Not much use to discuss what caused it
• Too much booze, lack of exercise
• Or how to prevent the next one
• The asymmetry of regulation
• Now we want them to lend but they dont
• It caused a collapse in counter-party trust
• closing down all credit markets
• triggering an asset price collapse
• and a major decline in demand
• Access to credit, wealth effect and lower animal
  spirits

5
In other words

• A network of trust that disappeared
• Flight to safety
• Enter the super-borrower
• Increase in the ability to borrow of a few big
  governments
• They have the capacity to provide temporary
  rewiring of the global system
• Domestic fiscal expansion, GM, Citibank, etc.
• but are trapped in a country-focused political
  process
• Global problem, partial solution

6
Implications

• The problem
• The US is already spending more than it is
  earning
• Large current account deficit
• and is accumulating a ton of net debt
• The alternative (or the complement)
• Use the borrowing capacity to expand abroad
• Increasing export demand
• No increase in net debt new debt is matched by
  new assets
• Implementing
• Recapitalize the MDBs
• Buy a portfolio of EM securities, as Bernanke is
  doing with student loans and credit card debt
• Give the resources to the IFC to manage

7
How scared should we (Latin Americans) be?

• We have been here before
• Sudden stop in capital flows (1982, 1994, 1998,
  2002)
• Deterioration of the terms of trade
• Slower export demand
• ..we are more experienced
• we have better balance sheets
• did not have that much time to do stupid things
• The last crisis was as recent as 2002
• but things are also a bit different
• Many times in the past we got out through a real
  depreciation and an export boom
• This time around the crisis is global so getting
  out of it may be more challenging
• Like 1981-82, in the sense that it was a sudden
  stop and a global recession
• but harder then it was a desired recession
• it was followed by very rapid global growth

8
Should we change our ex-ante beliefs?

• Not much
• Old lessons are as good as ever
• Keep public debt low and well structured
• Level, currency denomination, maturity
• Keep exchange rate flexible and competitive
• Save fiscal resources in boom times
• Lean against the wind of excessive capital
  inflows
• Keep banks liquid, well capitalized and on a
  short leash
• Behave in a credible manner
• Budget institutions, credible supervisors,
  property rights
• Contrast Argentina and Uruguay
• Develop well structured safety net
• not just for the chronically poor
• but also for the suddenly impoverished

9
Should we change our views about crisis
management?

• Not too much
• Be as anti-cyclical as you can
• Do you have access to finance at reasonable cost?
• Are domestic real interest rates low?
• But we have not figured out what to do with our
  reserves
• We accumulated them for a purpose
  (self-insurance)
• But we are not sure what to do with them in a
  crisis
• We have let exchange rates take the hit instead

10
What would a better international financial
system do for us?

• Have sufficiently flexible access to
  international liquidity so we can feel more
  confident to expand at home
• Hence, would increase the scope for anti-cyclical
  policies
• We may need more multilateral lending to cope
  with a slow recovery of market access
• Recapitalized WB and IDB

11
Who will do well? Who will do poorly?

• Disciplined, market friendly countries will
  recover
• Brazil, Chile, Colombia, Costa Rica, Mexico,
  Peru, Uruguay
• With differences, given their different
  structures
• They may even surprise
• Crises change the choice between exploitation
  vs. exploration
• Leads to new diversification
• Neo-populists and neo-totalitarian governments
  will do poorly
• High taxes on exports, no access to credit
  markets, investor unfriendly, no economic freedom
  to spur innovation,
• Argentina, Ecuador, Nicaragua, Venezuela