CHAPTER 8
INTERNATIONAL DEBT AND FINANCIAL CRISES
Overview:
Front page news articles still deal with national debt and the financial crisis that began in the United States
in 2007, recovery from which has been very slow. Unemployment remains the long term outlook for millions whose
occupations have been outsourced to other nations or replaced by new production technologies and processes. Many
people in both the United States and Europe find themselves “underwater” because they owe more than their house
is worth. Many U.S. students have accumulated huge amounts of debt based on loans to pay for the cost of their
education. The Occupy Wall Street Movement staged protests and anti-austerity strikes in many cities in Europe, the
United States, and other countries.
Finance and debt issues remain clouded in mystery and “dark shadows”—supposedly too complicated for
ordinary people to understand. Until recently, it was easy to assume that the “experts” would make the right
decisions to manage national and global finance with everyoneffs best interests at heart. Meanwhile many bank
officials, central bankers, and financial industry leaders have revealed themselves to have made bad financial
decisions based on misleading ideological assumptions and incomplete information.
Debt is an important aspect of the international finance and monetary structure, and it is the focus of this
chapter. Individuals, businesses, and states all accrue debt for a variety of reasons including to stimulate
consumption, make investments, and to finance spending. Some amount of debt is necessary and a positive factor in
an economy.
Drawing on some of the concepts and history in Chapter 7, in this chapter we examine a number of causes
of debt and financial crises since the early 1980s including the Mexican debt crisis in 1994, the Asian crisis of 1997–
98, the crisis in Argentina in 2001, and the crisis that started in 2007 in the United States and that continues in
Europe today. Many LDCs have experienced a series of debt problems that have not been easy to solve and that act
as barriers to economic development. In the 1980s and 1990s many of the emerging economies in Asia and Latin
America experienced investment bubbles and speculative attacks on their national currencies, compelling many of
them to borrow from the IMF and World Bank. Many EU countries have adopted stringent austerity policies to
decrease their debt while also trying to borrow from the European Central Bank and IMF.
Financial crises have tended to engender struggles over the distribution of resources; governments face
major tradeoffs governments trying to resolve them. We also noted in Chapter 7 that one of the single most
important features of the global financial system is the globalization of capital. Trillions of U.S. dollars are traded in
the global currency markets every day. In the eyes of many economic liberals, increased capital mobility and
flexible exchange rates have made the global financial system more interconnected. However, the financial structure
is also more volatile; many would argue too volatile.
Crises also produce long-term changes in ideas about state-market relations and what is socially fair and
legitimate. Corrective measures help some and hurt others based on the degree of protectionist, austerity, and fiscal
measures taken to deal with debt. Today austerity measures in the European Monetary Union (EMU) have resulted
in many protests and demonstrations. Greece and Italy are considering dropping out of the Euro Zone and going
back to using their old currencies in order to recover from the crisis on their own. Many officials and experts are
worried that measures like these could push Europe even deeper into recession, which, as we discuss later, could
lead to the breakup of the EMU, if not the entire European Union.
The major arguments of the chapter are the following.
• Events of the past thirty years indicate that finance and debt crises are not “black swan” events; rather,
they are endemic to market-driven globalization. Crises have become geographically broader-based
and longer-lasting, posing ever more serious threats to economic and political stability in the United
States and Europe.
• The complexity and interconnectedness of global finance have made it more difficult for states and
international institutions to manage the financial structure. The polarization of political elites in the
United States and the fragmentation of interests in the Euro zone engender policies of financial
brinksmanship.
• There is a growing consensus that the solutions to debt crises proposed by economic liberals—
grounded in austerity and the structural adjustments of the Washington Consensus—do not work well
and may even delay economic recovery. A more effective system of global governance and national
bank regulations is needed to promote stability and mitigate the impact of financial markets on the
worldffs poorest people.
• From a structuralist perspective, capitalism seems to be laying the seeds of its own destruction. The
traditional welfare state is imploding. Inequality and class warfare are on the rise.
• In surprising contrast to their experiences in the 1980s and 1990s, the BRICs (Brazil, Russia, India,
and China) and some other developing countries have emerged relatively unscathed from the 2007
financial crisis—due in part to their growing middle classes and robust global prices for oil, minerals,
food staples, and other exported commodities.
Learning Objectives:
• To describe and explain the extent to which monetary and finance issues now transcend national borders.
• To explain why in the 1980s the IMF and World Bank became more concerned with orderly debt payments as
the IMF shifted its role in the international monetary and finance system to become a lender of last resort in
these situations, providing conditional assistance to developing nations.
• To describe and discuss how and why IMF assistance was contingent on debtors agreeing to implement
structural adjustment policies that reflected the “Washington Consensus” about economic liberal values and
policies that would help debtors overcome their debt and help develop their economies.
• To describe and examine a typical IMF rescue package that involves austerity measures such as currency
devaluation, price stabilization, fiscal austerity, tariff liberalization, and the enhancement of the social safety net
to reduce social tensions.
• To discuss and analyze why IMF measures often conflicted with domestic political realities in debtor nations.
• To explain and discuss some of the many reasons some more successful emerging economies in Asia have
experienced speculative attacks on their national currencies. In some cases they borrowed from the IMF and
World Bank in order to re-establish monetary stability and to attract foreign direct investment (FDI). Why some
states rejected this strategy and increased capital controls and other protectionist measures to limit their
dependency on financial IOs and developed states.
• To account for the chapterffs thesis that parts of the global monetary and finance system are quite fragile, subject
to debt and finance crises, financial bubbles, speculative attacks, and currency crises. This necessitates a system
of global governance to promote stability in this system.
• To explain some of the central political-economic elements of the debt crisis of the 1980s including the
Mexicoffs threat to default on its bank debt.
• To explain the connection between this crisis and Mexicoffs reasons for going heavily into debt in the first place.
• To explain some of the main elements of a Balance of Payments crisis, but also to describe and explain some of
the policy problems and issues associated with the seven stages of a financial crisis.
• To discuss and analyze in more detail some of features of a speculative attack when currency speculators
confront a central bank that doesnfft have enough U.S. dollars to payoff investors, leading to a major devaluation
of a currency (crises).
• In the case of two case studies to describe and examine many of the causes and implications of the Asian
Financial Crisis of 1997 and current global financial crisis.
• To analyze closely the role of the IMF in both contributing to and helping deal with this crisis.
• To explain why the IMF is often criticized for trying to impose a one size fits all solution on different nations
and seems more concerned about their investors than citizens who were impoverished by the crisis.
• To examine why these sorts of crises seemed more prevalent in the 1990s and why they seem to rapidly spread
throughout a region (the contagion effect).
• To explain in some detail what contributed to the real estate bubble in the United States and why it spread so
quickly throughout the globe.
• To examine some of the austerity measures imposed on citizens in the United States and Europe to bring down
their debt.
• To examines some “countermovement” effects of these austerity policies, including the Occupy Wall Street
movement and efforts to regulate banks and financial institutions.
• To examine some of the theoretical and policy implications of economic liberal, mercantilist, and structuralist
ideas about trade and production (Chapter 6), monetary and finance (Chapter 7), and debt issues.
• To explain the critical judgment of the authors that the world clearly needs a stable finance and foreign
exchange system that is able to adapt effectively to changing structural conditions.
Chapter Outline:
DEBT AND ITS RAMIFICATIONS
a) Debt serves a vital function in capitalism—facilitating new investments that help an economy grow and
increase productivity.
b) Private businesses take on debt for a variety of reasons—most importantly to finance new investments in
plants and equipment, acquire other companies, and cover short-term expenses. They raise capital by
issuing stocks and bonds or by borrowing from financial institutions.
c) States borrow to cover budget deficits or finance a trade deficit. They typically raise money by selling
government securities and bonds. National and international creditors (lenders) include foreign
governments, corporations, banks, hedge funds, and pension funds—some of the same actors who lend to
companies.
d) Governments and companies can roll over or refinance old debt by getting new loans, unless creditors think
they are so indebted that it is too risky to extend them more money—except at a higher interest rate.
e) At this point, debt can become a destructive force, catching borrowers in a debt trap of ever-increasing
expenses or bankruptcy, which makes it difficult to borrow in the future.
f) International debt problems often lead to a balance-of-payments crisis—see details in Chapter 7.
g) They can also lead to a currency crisis as discussed in some of the recent crises below.
THE DEBT CRISES OF THE 1980s AND EARLY 1990S.
a) The first debt crisis began in 1982 when Mexico announced that it would default on its bank debt, which
created fear that other countries would follow Mexicoffs lead.
b) Mexicoffs easy access to unsustainable credit was a result of the infusion of petrodollars into Western banks
(see chapter 7). Many LDCs were encouraged to borrow money by Northern countries and economists,
which according to economic liberal theory should have resulted in economic growth in these states.
c) Banks remained willing to loan money to LDCs for economic development, and also to sustain interest
payments on earlier loans. Debt ballooned exponentially resulting in a “debt trap.”
d) Overall, too much was loaned to too many.
e) Banks and the IMF extended loans to many states in exchange for them adopting trade liberalization and
cutbacks in state spending. Most states went deeper into the red.
f) The Baker Plan aimed at helping debtor nations grow their way out of debt. The plan aimed at instituting
market–oriented structural changes in debtor economies combined with an effort to convince banks to
provide $20 billion in new loans over three years. However, as countries expanded their exports at once,
commodity and oil prices collapsed, leaving many nations worse off than before.
g) “Donor fatigue” gripped debtor states, where the social and political tensions related to the policies already
adopted to relieve the debt limited the willingness of debtor states to cooperate with international debt
management efforts. The Reagan administration encouraged “debt swaps.”
h) Banks found themselves in a “prisonerffs dilemma” where each bank wanted other banks to forgive the debt
but would not do it for fear that if they did, the others would not have to share in the cost of solving the
problem.
i) In 1989, the Brady Plan proposed that old debt be exchanged for new bonds that could be exchanged for
new bank loan. Negotiations for these bonds were carried on between the banks and each debtor state.
j) Private banks exchanged their Mexican debt for a lesser amount of U.S. government securities— Brady
Bonds—backed by Mexican obligations. Mexico would pay the U.S., which paid the creditors.
k) Mexico benefited from some debt relief, the banks reduced the risk of default, and the U.S. government
avoided increasing international financial instability.
A New Role for the IMF
a) In the 1980s, IMF (and World Bank) policies became more concerned with orderly debt payments.
b) The IMF often serves as a lender of last resort in these situations, providing conditional assistance to
developing nations to help solve their debt problems.
c) IMF assistance was conditional on debtors agreeing to implement “structural adjustment policies” that
reflected the “Washington Consensus.” A typical IMF rescue package should involve such economic
liberal measures as: currency devaluation, fiscal austerity (cutting government social welfare programs),
tariff liberalization (free trade), higher interest rates to attract foreign investors, and privatization of
national industries.
d) IMF measures often conflicted with domestic political realities in debtor nations, lowered living standards,
and generated civil unrest and opposition to the IMF and World Bank.
The Peso Crisis of 1994
a) The Mexican Crisis of 1994–1995 was the first crisis in the new era of global finance and investment,
where global financial flows were more volatile and harder to regulate nationally.
b) Paul Krugman emphasized its spread to nearby states.
c) After Mexico joined NAFTA, many investors flocked into Mexico expecting big profits in an “emerging
market.”
d) What ensued was the growth of an investment bubble.
e) Political instability led to investors panicking and shifting their money out of Mexico, leaving Mexico in
need of U.S. dollars to pay them off in U.S. dollars as they left.
f) A currency crisis ensued, resulting in a devaluation of the peso and increased interest rates on
investments—or what many called a “tequila hangover.”
THE ASIAN FINANCIAL CRISIS
a) The crisis was kicked off in 1997 by a speculative attack (discussed below) by hedge fund investors who
started a chain reaction of damaging economic, political, and social effects that spread (the contagion
effect) to Indonesia, Malaysia, Taiwan, Hong Kong, South Korea, and beyond the region. The result was a
currency crisis.
b) When investors began to pull out of Thailand, panic set in, resulting in a dramatic devaluation of the Thai
baht, capital flight out of the country, and the necessity for Thailand to borrow from the IMF to stabilize its
economy.
c) A speculative attack is essentially a confrontation between a central bank that has pledged to maintain its
countryffs exchange rate at a certain level, and international currency speculators that are willing to wager
that the central bank is not capable of maintaining its exchange rate goal.
d) The attack on the Thai baht (see below) began when the fixed exchange rate between the U.S. dollar and
baht led currency speculators to believe that the Thai government would not be able to pay back the money
Thai banks had borrowed from U.S. banks.
e) Some critics, usually economic liberals, also blame the crisis on bad loans by Thai banks and corruption
associated with crony capitalism.
f) As long as investment capital can easily move between countries without constraints, the sorts of currency
crises that are caused by speculative attacks and investment bubbles are likely to occur.
g) People who traded with these Asian nations were affected by the crisis. When the cost of many Asian
goods dropped significantly, many states such as Indonesia, South Korea, and Malaysia called for trade
protection to support their industries that were hurt by cheaper imports from abroad.
h) Many Thai citizens and business people who acted rationally by investing in new Thai businesses found
themselves bankrupt and their entire savings wiped out. For many, the situation was another Great
Depression.
i) As the crisis spread into other countries, many people lost their jobs and savings.
j) The IMF stepped in to make loans to some of these nations, but soon found itself under attack for its
compelling debtors to reform their economies by adopting structural adjustment policies.
k) Russia became the next domino to fall, followed by Argentina from 1999 to 2002.
l) These crises badly damaged the reputation of the IMF; their bailouts were judged to be “too little, too late.”
m) The IMFffs SAPs were hard for society to tolerate.
THE GLOBAL FINANCIAL CRISIS OF 2007
a) The current crisis is not unique in history; it is the latest in a series of financial crises.
b) By September of 2008, the U.S. real estate bubble had imploded, generating a full-blown global financial
crisis that froze the circulation of credit between national and international banks and causing a deep global
recession.
c) Immediate causes of the crisis were:
1. a U.S. balance of payment problem;
2. lack of an effective U.S. regulatory regime that led to excessive debt and unwise lending practices of
banks and other financial institutions;
3. a myopic economic liberal ideology that frowned on regulation;
4. irrational, unethical, and even illegal behavior; and
5. weak global governance.
The Run up to the U.S. Finance Crisis
a) In the history of capitalism, recessions occur routinely and are regarded as a side effect of capitalism.
b) During the Great Depression of the 1930s the ideas of J. Maynard Keynes (review Chapter 3) were the
most popular when it came to explaining and dealing with recessions and financial crises.
c) In the early 1970s Keynesian ideas and polices were replaced by those of Milton Friedman who preferred a
limited role of the state in the economy. U.S. President Reagan and Prime Minister Margaret Thatcher of
England helped popularize Friedmanffs “free market” ideas.
d) By the 1990s economic liberal ideas about tax cuts and deregulation were entrenched in the ruling classes
of the U.S. and other developed nations (especially Great Britain).
e) In the 1990s investment speculation lead to technology, communication, and real estate bubbles in many
emerging economies such as China, India, and Mexico, but also in the United States and other developed
nations.
f) In 1999 the U.S. Congress repealed Glass-Steagall, allowing investment banks to merge. Many banks
added risky investments in technology and real estate to their financial functions.
g) After the dot.com investment bubble imploded in the U.S. in 2000, U.S. officials remained confident that
low interest rates and self-regulated markets in real estate investment would not lead to another recession.
h) Many banks promoted risky subprime mortgages to borrowers with questionable qualifications.
i) Many of the “big banks” became overleveraged, i.e., they were loaning greater amounts of money in
relation to their capital reserves.
j) Many “securitized” subprime mortgages were sold to investors all over the world, in an attempt to decrease
bank risk and accountability for these loans.
k) The U.S. was running huge deficits in its balance of payments that in many cases were financed by the
investments of other states (via their sovereign wealth funds).
l) Sovereign wealth funds are large pools of government money invested in foreign markets.
Box: Coding the Money Tree
a) Derivatives are mathematical tools that contributed to the financial crisis.
b) On the one hand they helped spread default risk so as to make them safer to invest in. However, they also
generated huge profits for banks, while leaving investors vulnerable to the investment bubble associated
with their prolific growth.
c) Coupled with deregulation, derivative trading was increasingly viewed as dangerous, mispriced financial
weapons.
d) Many states are undecided about how much to regulate derivatives given the amount of money they make
for banks or because their complexity makes it difficult to understand exactly how they work.
e) Derivatives raise many political issues about the “fast and loose” style of U.S. capitalism.
The Bubble Bursts
a) During the Bush administration a number of experts warned about a real estate bubble and possible
financial crisis.
b) In early 2007 a number of notable mortgage companies with huge portfolios of subprime loans filed for
bankruptcy.
c) Mortgage companies in other countries including the UK, Japan, and France, failed as well.
d) The U.S. Federal Reserve and in the European Central Bank lowered interest rates and injected billions of
dollars into the money supply to encourage bank borrowing at low rates.
e) In the first half of 2008 many U.S. “big banks” began to fail and were absorbed by other big banks.
f) Many bank officials were arrested for bank fraud.
g) In the summer of 2008 the U.S. real estate bubble imploded. Panicky investors unloaded their stocks in the
Fannie Mae and Freddie Mac loan agencies.
h) Many investors shifted their focus on oil, gold, and agricultural commodities.
i) In September, stock markets around the world plunged and global credit froze up.
j) The U.S. Federal Reserve did not rescue Lehman Brothers but later rescued others and the giant insurance
American International Group (AIG), generating fear among investors that the U.S. government would not
bail out the big banks after all.
k) Because of their tight interconnectedness, these failures led to contagion in the United States and Europe.
l) One in ten U.S. homeowners could not make payments on their homes, resulting in a glut of bankruptcies.
Likewise, record numbers of mortgage defaults occurred in parts of Western and Eastern Europe.
We Are All Keynesians Now
a) As the fear of a second Great Depression mounted, many economic liberals—including former Fed
Chairman Alan Greenspan—sounded more like supporters of Keynes than Milton Friedman when it came
to dealing with the recession. A temporary coalition of officials and academic experts urged the U.S.
Federal Reserve (along with central banks in other nations) to help prime the economy by putting more
money into circulation.
b) In September 2008, a $700 billion emergency U.S. rescue (“bail out”) package (the Troubled Assets
Relief Program—TARP) was created to help buy up bad (“toxic”) assets in banks so as to help keep credit
moving. However, most banks kept the money instead of loaning it out to main street banks and businesses.
c) Many OELs preferred to let the market run its course where the biggest and strongest ones would survive.
d) Many U.S. and other officials felt that big banks were “too big to fail” and that their governments would
always bail them out.
Contagion Takes Over
a) In November the new G20 met in Washington DC and failed to arrive at a common strategy to deal with
the crisis.
b) Many of the emerging economies with surplus capital were encouraged to invest more money in the United
States and other developed countries to help them deal with their debt.
c) In a second round of lending, the U.S. Fed shifted strategies from buying up toxic assets to recapitalizing
banks so as to encourage them to lend money to one another. In so doing the Fed was becoming the “lender
of last resort.”
d) In December 2008, the Fed and Bank of England began a policy of quantitative easing, which increased the
money supply by purchasing hundreds of billions of dollars of bonds and other assets. However, banks
continued to hold on to their capital assets and limit lending new money.
e) By January 2009, unemployment reached record numbers in the United States and Western Europe.
Offer the Ramparts We Watched
a) At his inaugural address, President Obama promised to impose tough sanctions on banks and put people
back to work.
b) His administration helped fund the auto corporations Chrysler and GM.
c) In February 2009, Congress passed the American Recovery and Reinvestment Act—a mini New Deal plan
to boost jobs.
d) A clash emerged between economic liberal neo conservatives and resurgent Keynesians. Fiscal
conservatives and conservative Democrats supported austerity policies to cut government spending for
Medicare and Social Security, opposed new regulations of financial institutions, and advocated for
decreasing taxes.
e) Tea-Party Republicans blamed the housing bubble and financial crisis on the quasi-state finance agencies
Fannie Mae and Freddie Mac.
The Countermovement
a) Historian Karl Polanyi argued that because economic liberal polices always produce the conditions for their
own undermining, a countermovement.
b) Similarly, neo-Keynesian (HIL) economists such as Paul Krugman, Robert Reich, Brad DeLong, and
Joseph Stiglitz believe that government must correct the fundamental flaws of unregulated capitalism. They
often assert the following: austerity lowers incomes and weakens demand, thereby stalling economic
recovery; government deficit spending boosts demand and creates jobs; moderate inflation is not a problem
in the short run; the state should invest heavily in education, infrastructure, and new energy industries; the
wealthy and major corporations should be forced to pay higher taxes.
c) According to Farrell and Quiggin, the spread of the financial crisis opened the door to re-acceptance of
Keynesian ideas amongst a network of expert economists whose policy proposals spread like wildfire to
Washington, D.C., Brussels, and Berlin.
d) Neo-classical economists who dominated the U.S. economics profession were suddenly on the defensive.
Martin Feldstein and Larry Summers publicly supported fiscal stimulus. Europeans who suddenly
supported deficit spending and massive central bank intervention in financial markets included IMF
Director-General Dominique Strauss-Kahn and Financial Times columnist Martin Wolf.
e) Obama came under attack by progressives for choosing Timothy Geithner—former President of the New
York Fed—as Secretary of Treasury. He and other such as Larry Summers favored watered-down reforms
of the financial industry.
f) The administration was slow to prosecute Wall Street insiders for improprieties leading up to and during
the crisis.
g) Congress also took a tepid approach to reforming the banking and finance sectors.
h) Johnson and Kwak argue that weak regulations are the result of a “new American oligarchy” that spends
millions of dollars lobbying against these efforts.
i) Others argue that “free market” and opposition to “big government” and the “nanny state” ideas still
resonate with many people.
Occupy Wall Street: “We Are the 99%”
a) With its key slogan “We Are the 99%,” beginning with a September 2011 demonstration in New York
against big banks, OWS soon spread to many other U.S. cities but also later to other global cities such as
London, Rome, Santiago, Madrid, Athens, Sydney, and Toronto.
b) Its most important policy recommendations are as follows:
•
Reduce inequality by raising taxes on the rich and redistributing wealth
•
Re-regulate banks and limit the influence of corporate money in the political system
•
Provide bailouts (like mortgage relief, tax cuts, unemployment benefits, and student loan forgiveness)
to ordinary families and workers
•
Expand the welfare state and workersff rights
•
Reject electoral politics in favor of direct political action
c) OWS also favored the break–up of “too big to fail” banks.
d) Other supporters such as Robert Reich and Joseph Stiglitz focused on the high degree of inequality in the
U.S. economy such that it threatens the U.S. democratic system.
THE EUROPEAN DEBT CRISIS: IS THE DREAM OVER?
a) The EMU is at a crossroads. At least five countries have exorbitant levels of debt and have sought
assistance from the “troika” of the IMF, EU Commission, and European Central Bank (ECB) to help pay
down their debt.
b) In exchange, the troika and many national leaders favor the implementation of “bitter medicine” austerity
policies to bring down national debt levels.
c) The public has strongly resisted these strident policies. Between 2010 and 2012, eleven governments in the
seventeen-member Euro zone fell apart or were voted out of office. The widespread perception that
international lenders are inflicting severe socioeconomic pain on people who were not responsible for the
crisis continues.
d) Some officials and experts are predicting the end of the euro. Others suggest that the “modern welfare
state” might be done as well.
Box: The “Bitter Medicine” of Austerity
a) In response to the adoption of austerity policies that attack welfare policies, some people in the Euro zone
region have committed suicide.
b) Many states have adopted measures to limit state spending for the poor and even the middle class in areas
such as education, care for the elderly, wages for public servants, and services such as garbage collection,
food banks, and transportation. Public service jobs have been cut and taxes increased on the poor and
middle class.
c) The Greeks have been collecting taxes by attaching them to utility bills.
The EMU Debt Trap: Beware the Greeks
a) Who or what caused the financial crisis in Europe?
b) Many neoliberal analysts have been quick to blame countries like Greece and Italy for reckless government
spending, corruption, and lax tax collection.
c) However, the European debt problem cannot simply be attributed to excessive government borrowing; a
more complicated story that involves structural flaws in EU institutions, political constraints, and reckless
lending.
d) The Maastricht Treaty of 1992 required EMU members to meet specific criteria regarding the size of their
budget deficit and government debt, but most did not strictly adhere to their own rules. At first members
were doing quite well economically. Multinational financial institutions and private investors bankrolled
Europeffs IT industries, real estate, tourism, green energy projects, and infrastructure. London, Paris,
Barcelona, and Milan were booming metropolises.
e) The debt crisis can is also partly attributed to the unwillingness of countries like Italy and Greece to reform
their economies so as to increase productivity and competitiveness.
f) But debt was not a problem until the crisis started in Europe in 2008.
g) A third cause of the European sovereign debt crisis is the flip side of the over–borrowing: over-lending.
Ratings agencies that masked the riskiness of investments, international and domestic creditors of Portugal,
Italy, Ireland, Greece, and Spain extended loans and bought government bonds at low interest rates before
the downturn after 2007. They failed to anticipate a systemic crisis in the Euro zone. Germany for many
years had been running a huge trade surplus with southern European countries. As southern European
companies became less competitive within the Euro zone, they were unable to boost exports through
devaluation of their own currency. So trade deficits in these countries were covered with capital inflows
from northern European countries that caused excessive indebtedness.
h) What does the future hold for Europe? We note three potential scenarios that are touched on again in
Chapter 12. First, the major players in Europe may continue to muddle through with more austerity. Many
Keynesians believe a better approach is pro-growth stimulus spending with shared sacrifice throughout
Europe.
i) Second, things may get worse if Europe cannot find ways to deal with Greece—the supposed “spoiled
child” of Europe—and other big borrowers. If contagion spreads, some states might withdraw from the
euro, or the EMU could totally collapse.
j) Third, structural weaknesses of EU institutions might be overcome. European policy makers could either
try to extend their reach and power or throw in the towel and return to a less-integrated, less-supranational
community.
k) The EU has taken some steps to construct a common fiscal policy, at the cost of Euro zone members giving
up more sovereignty to the ECB and Brussels.
CRISIS, CHOICE, AND CHANGE!
Corrections and Courses
a) Today the world still faces a situation that could easily turn into a global catastrophe. In the conclusion
we discuss some potential corrections and courses.
Rebalancing the Global Glut
a) Many OELs point to the global glut of capital that emerging economies did not (rationally speaking) spend
on U.S. bonds and securities as a factor in the current financial crisis. Emerging economies with excess
capital should stop holding huge foreign currency reserves that protect them from having to turn to the
IMF for support.
b) Countries like China, Japan, and Saudi Arabia should increase spending and consumption at home,
save less, and adjust their domestic economies to the global economy.
c) In Europe Germany could reduce its trade surpluses by either letting inflation rise or pulling out of the Euro
zone and letting a new deutschemark appreciate against the euro.
d) Greece could also leave the Euro zone in an “orderly manner” so that it could devalue its currency to help
it out of its debt trap by exporting more goods.
Regulation of the Domestic Economy
a) Domestic regulation of the lack thereof, contributed to both the Asian and current global crises.
b) The result was that banks benefited from their encouragement to borrow heavily and run up substantial
debt.
c) Most OELs argue that the state must share the blame for these crises because they intervened too much in
the market. They blame Asian mercantilist states for industrial policies that picked winners and losers, and
although export-oriented, restricted imports and investments. Also the U.S. Federal Reserve dropped
interest rates and made loans easily available for the middle class. The injection of more credit into the
economy made lending agencies more reckless.
d) Rather than intervening in the market, states should limit spending on bailout packages, allow banks to fail,
refrain from regulating finance, and decrease taxes, especially for higher income groups.
e) Most HILs support using a stimulus package to help economies recover. Keynes would suggest (see
Chapter 2) that recovery of the economy outweighs the political and social costs associated with failing to
overcome the crisis.
f) Paul Krugman also notes that historically, the level of debt relative to GDP is low and it is unlikely that
inflation will be a big problem in the future provided the economy grows enough to overcome the debt.
g) Many HILs want reform on the margins of what they believe is basically a good capitalist system gone bad.
To counter rent-seeking, no banks should be allowed to grow “too big to fail.”
h) Banks that fail should be allowed to fail, and bigger banks should be broken into smaller banks to limit
their risk taking.
i) Banks should be required to maintain bigger capital reserves to back their loans, and savings and consumer
investment banking should once again be separated. The pay and bonuses of bank officials should be
capped and linked to the economic success of the bank.
j) Finally, governments should create more effective programs to help consumers deal with their mortgages
and credit cards.
k) Structuralists believe that more effort should be made to control the shadow banking system state and
regulate those with connections to or interest in banks or lobbying firms they are supposed to regulate.
l) As the crisis worsened, bank mergers and acquisitions have left only four or five major banks in the U.S.,
limiting competition.
Addressing Economic Ideology and Inequality
a) Many HILs recommend that economic theory include a human element.
b) Economists should investigate human behavior, including psychology, rather than limiting their attention to
rational choice methodology.
c) Economists also need to test their methods in the real world.
d) Keynesian HILs believe that globalization can be made to work as long as debt and LDC development
issues are given more consideration in free market ideology.
e) China and Indiaffs success is based on their “cherry picking” the policies that best work for them.
f) Some mercantilists–realists worry that the Mexican, Asian, Argentinian, and now the global crisis have
undermined the U.S. version of capitalism and democracy in those societies. Anti– globalization sentiments
have contributed to the re-emergence of the left in Central and Latin America. The gap between the rich
and poor must be significantly reduced if genuine economy recovery is to benefit society. Facing stagnant
median wages and high debt, the lower and middle classes cannot raise aggregate demand to fuel growth.
g) The European Unionffs un-communitarian and short-sighted financial policies are tragically eroding the
model of regional cooperation that Europe offered to the world.
Global Governance
a) Lack of global governance did not cause but contributed to the financial crisis.
b) While many OELs prefer less global governance and more laissez-faire policies and globalization, HILs
advocate reforms to the IMF and World Banks that allocate more voting power to the BRICS.
c) Many HILs want regional institutions and groups to promote cooperation on finance and debt relief, while
the new G20 encourages states to use stimulus packages to help their economies recover.
d) The IMF should be strengthened to help desperate states borrow capital to restart their economies but it
should not be looked to as the lender of last resort.
e) Yet the high degree of interdependence and global integration requires more global governance to match
expanding market forces or risk the collapse of markets as they did in the 1930s.
Key Terms:
• structural adjustment policies (SAPs)
• conditionality
• currency crisis
• crony capitalism
• speculative attack
• subprime mortgage loans
• sovereign wealth funds
• credit default swaps
• Troubled Asset Relief Program (TARP)
• quantitative easing
• Volcker rule
• shadow banking system
Teaching Tips:
• It is important to clarify to students that Chapter 8 is an extension of Chapter 7 (and some of the themes
developed in Chapter 6 as well). Debt (that takes different forms) is often an outcome of financial and monetary
problems. How prepared and well equipped the money and finance structure is a matter of some debate and
varies depending on the actors and their interests.
• While Chapter 8 has a good deal of detail in it, it should be easier to communicate many of the concepts and
ideas here given the chronological focus on financial crises in Asia and then the current global financial crisis.
• The current global financial crisis is examined in some detail in this part of the book. Instructors should refer
back to less detailed coverage of the current global crisis in Chapters 1, 3, and 7 to help students become even
more familiar with the issues and different IPE dimensions of this highly debated and important topic.
• It may be helpful to students to establish a chronology of important events along with a list of the many
different causes of each crisis. Each crisis is similar but different from the other. Ask students why this is so.
Have them use the three IPE approaches to help analyze and explain why financial crises like these appeared in
the 1990s and then again in the 2000s. What role did the IMF, World Bank, and other finance institutions play
in these crises? How much did they help or worsen the situation?
• Much has been written that is both supportive and critical of the IMF and World Bank. Two of Joseph Stiglitzffs
books criticize the IMF and explore it and the World Bankffs role in developing nations in quite a bit of detail.
Take a bit of time to go over some of these major arguments. His books also explore some of these issues as a
part of a critical assessment of ideas about globalization and some policy consequences of his recommendations
in the world today.
• Meanwhile, another important aspect and feature of this chapter is some detailed coverage of currency
speculation, an issue some experts argue contributed to, if not directly caused, these crises. An excellent video
to show on the Asian crisis, currency speculation, and the role of the IMF in this crisis is The Crash (Frontline
Video, 2000). Parts of the video could be shown in 2 or 3 classes, depending on what aspects of the chapter and
crisis are focused on.
• Another documentary that covers the U.S. financial crisis is Inside Job (Sony Pictures Classic, 2011).
• There are many short video pieces on You Tube for example that cover developments in different countries
in Europe, especially Greece where demonstrations have made headlines the world over.
• This issue is a good one to end these three interconnected parts of the chapter along with many of the themes of
Chapters 6 and 7 because it challenges students to think about their own personal connection to some of these
issues. Ask students if they can explain or give examples of many of the connections between chapters 6, 7, and
8.
• Ask students to what extent they think states, IOs, NGOs, or individuals are or can be the most effective actors
to solve these sorts of issues. (Note: students may want to also read Chapter 12 on the EMU debt crisis before or
along with this chapter.)
• As is all the other chapters, all of us associated with this book recommend that from time to time instructors use
small (3–4) discussion groups where people exchange ideas about some aspects of the reading for 10–15
minutes. Instructors can pose a series of questions to students before class with the expectation that these
questions will be discussed in the small groups, and then in class as a whole in the next class. We encourage
you not to assign particular questions to specific groups as students should come to class prepared to discuss all
of the questions. (Note: this technique can easily be applied in large university settings where a teaching
assistant serves as moderator when students explore different questions and answers in their section meetings.)
Sample Essay-Discussion Questions:
1. Ask students to describe and explain the difference between more recent “financial crises” and debt and poverty
problems in the 1980s in many developing nations and more recently in the HIPCs (see Chapter 11).
2. Ask students to explain the different between a “balance of payments” crisis and a speculative currency attack.
Outline some of the policy implications when it comes to managing or ultimately solving these different types
of crises.
3. Outline some of the more important features of the recent global financial crisis and its impact on the U.S. and
Europe. Why does austerity generate such a big response in Europe, but not so much in the United States?
4. Discuss some of the implications of these crises in terms of capitalism in the international political economy. In
other words, are these problems correctable by reforming institutions or adopting different state and IO policies,
or are they fundamentally inherent in capitalism?
Sample Examination Questions:
1. Which factor is NOT usually cited as contributing to the debt crisis of the 1980s?
2. Which of the following statements best describes the “debt trap” that occurred in many LDCs in the 1980s?
d) Many LDC leaders pocketed a good deal of bank investment and deposited it in offshore banks, leaving
their states with massive debt.
3. This controversial plan set up by U.S. Treasury Secretary James Baker, adopted a number of market- oriented
policies combined with $20 billion in assistance to promote economic development and overcome the debt
crisis.
a) the Reagan Plan
4. This condition accounts for situations when investors quickly shift their funds out of a nation in search of a
d) a panic attack
5. More than anything else, this event signaled the beginning of the Asian Financial crisis in July of 1997.
a) when George Soros made a killing by speculating against the British Pound Sterling
6. Which of the following is NOT usually cited as a cause of the financial crises in Asia?
a) IMF policies
7. Which of the following is NOT a SAP as recommended by the IMF?
8. A system in which a government gives banks preferential treatment in return for bribes from the banks is called
a) credit default swaps.
9. In 1999 the U.S. congress repealed this Great Depression era measure, thereby allowing for mergers between
commercial and investment banks.
10. This idea accounts for situations where many U.S. banks feel that no matter what they do, the government will
always stand behind them because
a) the government is dependent on them for new monies.
11. A Toxic Security is another name for
d) a new drink in honor of all the CEOs of major businesses who lost their jobs during the financial crisis.
12. The policy of the U.S. Fed and Bank of England to increase the money supply by purchasing hundreds of
billions of dollars and pounds in bonds and other assets of financial institutions is called?
d) the Dodd-Frank Act
13. What is “bitter medicine”?
d) a slogan of the OWS movement
d) some countries like Greece and Italy refused to reform their economies
15. Which of the following is not a member of the “troika”?