ULI459U-GLOBAL POLITICAL ECONOMY
Chapter 5: Global Economic Crises
The Concept of Global Economic Crises
Different ideas emerge in the economy about what is to be understood about the crisis. In general, situations of recession, inflation and deflation are considered as the economic crisis.
1. Recession: The decline in real GDP due to a decline in economic activities of a state in at least two quarters, a stage of pause and contraction in economic activities. 2. Inflation: A continuous increase in the general price level of goods and services. 3. Deflation; also referred to as negative inflation, is the continuous decrease in average prices.
In the literature, the economic crisis types are divided into two groups as real sector crises and financial crises. Real sector crises means contraction in production or employment in the field of goods and services where as financial crises are the result of the sudden depreciation of more than half of the assets in the financial sector.
The main elements and characteristics of financial crisis can be listed as follows:
• Uncertainty in the financial system changes expectations to a great extent • Financial institutions worry about cash problems, • Decreases in profit will create a base for bankruptcies, • Increase in interest rates and contraction of economic activities, • Sudden and unexpected emergence, • To cause the crisis to grow or to cause a new crisis by spreading to another country, • To create new opportunities besides danger and threats, • The duration depends on the measures to be taken, • Reduction of the portion of capital evaluated in real production, • Speculative international capital movements, • Wrong economic policies and structural deteriorations, • Increase in public deficits, current account deficit and savings deficit, • Excessive exchange rate, • The banking system may be problematic, unchecked, and bank panics occur
The following is the list of these variables that effect the financial and economic crises:
Capital Account: International reserves, capital flows, short-term capital flows, foreign direct investments, differences between domestic and foreign interest rates,
Debt Profile: Total external debt, external debt of the public sector, short-term debt, distribution of debt according to interest and credit, foreign aid,
Current Account: Real exchange rate, current account balance, foreign trade balance, export and import, export price indices, savings and investments,
International Variables: Real growth rate, interest rates and price level,
Financial Liberalization: Loan growth, change in money multiplier, real interest rates, spread between bank borrowing and deposit rates,
Real Sector: Real GDP growth rate, production, wages, changes in stock prices, employment/unemployment, production deficit,
Budget Variables: Budget deficit, government expenditures and public sector loans,
Other Financial Variables: The amount of credit transferred by the Central Bank to the banking system, the gap between money demand and supply, bond yields, domestic inflation rate, shadow exchange rate, M2/international reserves,
Institutional-Structural Factors: Openness, foreign exchange controls, period of time in which fixed exchange rate system is applied, financial liberalization, banking crises, past crisis crises,
Political Variables: Government changes, political instability, developments that lead to loss of confidence, and unnecessary election decisions
However, based on a generally accepted approach, financial crises can be grouped under four categories:
1. Monetary crises, banking crises, systemic financial crises and external debt crises. The monetary crisis, also known as the foreign exchange crisis, is defined as the disappearance of the confidence in the currency of a country, speculative funds to leave the country as a result, in spite of all the efforts of the Central Bank, the failure to maintain the current exchange rate, the devaluation of the national currency, or leaving the national currency to fluctuate altogether. 2. Banking crises can be defined as the loss of confidence in one or more banks, people applying to withdraw their deposits in banks suddenly and widely, and that banks cannot meet this demand. 3. Systemic financial crisis can be defined as the financial markets being exposed to such deteriorations that they cannot effectively fulfill their routine functions, and as a natural consequence they cause large-scale losses to the real economy. 4. External debt crisis mean that a country is faced with the inability to pay its current foreign debts for public and/or private sectors.
The generation models for financial crises were marked by Krugman’s research:
First Generation Models: It was intended to explain the currency crises that occurred in Mexico and other Latin American countries between 1973-1982 in particular.
Second Generation Models: They were developed to explain the speculative attacks that emerged in Europe and targeted the currencies of various countries in the early 1990s.
Third Generation Models: However, the inadequacy of these two models in explaining the Southeast Asian Crisis in 1997 led researchers to develop new models The fact that after it emerged in Thailand, spread to other Asian countries, led to a new model called the third generation (contagion) crisis models.
Historical Development of the Global Economic Crises
As a matter of fact, the 1929 crisis, which was described as the most comprehensive, deepest and longest-lasting crisis in the 20th century. The most important factors leading to this crisis were excessive borrowing and deflation, identified nine factors: sales made to liquidate debts and to make ends meet; reduction of money supply due to non-payment of bank debts; decrease in asset price levels; start of bankruptcies due to the decrease in the value of the workplace; decrease in revenues; reduction of production, trade and employment; start of deflationary process with decreasing nominal interest rates.
As the World War II began in 1939, the US formed the Bretton Woods system to re-mobilize and stabilize world trade. Thus, the foundations of the international monetary system based on the dominance of the dollar were laid. The post-war period witnessed an economic development characterized as the golden age until the crisis that began in the late 1960s. In the first crisis of 1974-75, price increases were experienced with the recession and thus, it became increasingly difficult to achieve monetary stability. A second shock was the sharp increase in oil prices in 1979. The 1987 debt crisis that emerged as a result of the failure of countries to fulfill these obligations led to serious economic problems which have long-lasting effects in the developed and developing world and caused the global system to shrink economically as a whole. The US central bank has implemented a strict monetary policy and contributed to the economic recession due to the fear that the false expectations about inflation are likely to lead to a capital outflow. In the last quarter of the twentieth century, the phenomenon of globalization, which emerged in the world, left its mark on the whole system.
The Crises in the World and Turkey
We can list the most important financial crises i in Turkey and in the world as follows:
• 1992-1993 European Exchange Rate Mechanism (ERM) Crisis, • 1994-1995 Mexican (Peso) Crisis, • 1994 Currency and Banking Crisis in Turkey,
• 1997 South East Asian Crisis, • 1998 Russian Crisis, • 2001 Argentina Crisis, • November 2000 and February 2001 Currency and Banking Crises in Turkey, • 2008 Global Financial Crisis, • 2010 Greek Government Debt Crisis - Euro Crisis.
1992-1993 European Exchange Rate Mechanism (ERM) Crisis
On March 13, 1979, the European Monetary System (EMS) was established with the participation of Italy, Spain, Germany, France, Belgium, Luxembourg, the Netherlands, Ireland, and Denmark (Ekodialog, 2010). The exchange rate mechanism (ERM), which is included in the system, has been included in the European Monetary System (EMS), and it has been established between the countries outside the Eurozone and the countries within the Eurozone, and stabilized the fluctuation margin within the band of +/- 15%. Due to the deterioration of the balance of payments, the countries included in the system experienced economic contraction. With this contraction, the implementation of incompatible policies within the system caused the crisis to spread and unilateral policies of the union countries caused the crisis to deepen.
1994-1995 Mexican (Peso) Crisis
This crisis, which was mainly due to the spread of Neoliberalism, wrong monetary policies, speculation and domestic political events in Mexico, was effective in the global system until 2001. The crisis, which had an expansionist effect in the Latin America region, had become more and more felt all over the world and had become deeper and deeper.
1994 Currency and Banking Crisis in Turkey
The 1980s, when globalization movements and neoliberal policies gained momentum all over the world, caused a series of changes in Turkey.
The decrease in the demand for domestic borrowing papers due to the government’s policies, and the increase in the level of risk caused by the excessive borrowing in the international markets, the problem of external resources/cash had arisen. On April 5, 1994, an important policy was implemented in order to meet the financing needs of the country and to control the crisis. But interest rates reached to 406% and inflation figures climbed to 125%. On July 8, 1994, a stand-by agreement was signed with the IMF.
1997 South East Asian Crisis
The economic foundations of the East Asian countries were based on the funds provided by international capital flows, especially during the 1970s and 1980s. As a result of the crisis, the country’s markets were largely damaged,
national currencies were devalued and many banks and with sales and prices decrease as the sales increase. In this financial institutions were closed down. case, it is not possible to pay the loans again.
1998 Russian Crisis From Greek Debt Crisis to Euro Crisis
The main determinants of the 1998 Russian crisis can be The high public debt in countries such as Greece, Ireland, listed as follows: oil prices drop significantly; budget Italy, and Portugal increased with the impact of the 2008 deficits due to political and economic events in the Mortgage crisis, and the Euro crisis emerged. In 2008, the country; a major crisis in south east Asian countries; current account deficit to GDP ratio in Greece was 15%, political instability and the change of government in in Portugal 13% and in Spain 10%. Greece, which has a Russia in the period of march-august 1998; high level of public debt stock ratio of over 170%, is particularly consumption against low capacity production level; socio- noteworthy. Greece’s budget deficits have reached 15% of economic goals cannot be achieved with privatization; GDP in 2009. On May 2, 2010, a rescue package was state structure has not completed the transition to the jointly agreed with the Euro zone countries and the IMF. market system; existence of an informal, and an According to this package, it was decided to implement a underground economy; reduction of reserves due to wrong financial support program of €110 million to Greece and it policies. is foreseen that Greece will receive payments for three years. 2001 Argentina Crisis
The Argentine economy was affected negatively by the 1992-1993 European Exchange Rate Mechanism (ERM) crisis and the 1994 Mexican crisis. The deteriorating economic indicators led Argentina to a stand-by agreement with the IMF in March 2000. December 2001 was very destructive for the Argentine economy. In Argentina, which was forced to declare a moratorium on 24 December 2001, four governments were established in two weeks. Moratorium means the Borrower declares that they cannot pay all or part of their debts due to the loss of their ability to pay.
November 2000 and February 2001 Currency and Banking Crises in Turkey
With the deterioration in the balance of payments in Turkey, the year 2000 started with a pessimistic manner and problems. On January 1, 2000, a stand-by agreement was signed with the IMF. Liquidity shortage has emerged in Turkish financial markets. Accordingly, foreign exchange demand and interest rates have increased rapidly. Short-term interest rate hikes have led to significant negative impacts in the banking sector and even resulted in severe decreases in bond, stock and equity prices. In November 2000, the financial sector experienced a financial crisis. This crisis could only be prevented by a loan of $7.5 billion from the IMF. The financial structures of the banks that have to make overnight borrowing are further deteriorated, and due to the daily liquidity needs, the payments system is locked on February 2001. On April 14, 2001, the Program on Transition to Strong Economy, prepared with IMF support and under Derviş leadership, included both stabilization measures and long-term structural-institutional changes.
2008 Global Financial Crisis
In the 2008 Crisis, the banks began to sell mortgage contracts in the second-hand markets. With this method, banks are able to take out the non-liquid assets that are in their balance sheets and can provide low-cost and direct funds. In other words, banks are exporting toxic assets in their balance sheets. Creating liquid assets is only possible