Effects of the International Economic Crisis in Latin America. Alejandro Diaz-Bautista, Ph.D., UCSD Presentation, January 2013

1. Effects of the International Economic Crisis
in Latin America.
Alejandro Díaz-Bautista, Ph.D.
Professor of Economics and Researcher
adiazbau@gmail.com
http://www.facebook.com/adiazbau
Economic and Financial Crisis Presentation
Graduate School of International Relations and Pacific Studies,
UCSD
January 9, 2013

2. Introduction
 The presentation examines the difficult international economic
situation and the outlook for the rest of the decade.
 The global economy is facing difficult conditions again at the end
of 2012 and the beginning of 2013.
 A number of European economies are mired in deep recession and
their governments are having serious difficulties in reconciling the
need to regain growth with the urgency of reducing their high
levels of deficit and debt. As a result, mounting uncertainty and
turmoil are sapping a global recovery that is already the weakest
in 40 years.
 Although the United States is performing somewhat better than
the euro zone, its recovery remains fragile.
 Moreover, its economy could slip back into recession in the first
quarter of 2013 if major scheduled tax hikes and spending cuts go
ahead.

3. Introduction
 Over the next few years, the developing countries,
particularly China and other emerging economies, will
continue to be the main engine of the global economy and
trade, while growth in the industrialized countries remains
slow and volatile.
 The industrialized countries still have some way to go in
reducing household and public sector debt. During this
process, which could take another three to five years,
financial constraints seem likely to continue, as do stringent
fiscal consolidation and public debt requirements, short and
erratic recoveries, high unemployment and further public
sector interventions in finance and the economy.

4. Introduction
 Regarding trade policy in this complex
international scenario, restrictive global trade
practices remain at moderate levels. However,
there are significant risk factors that could
increase trade restrictions.
 In trade negotiations, the protracted stagnation
of the Doha Round of the World Trade
Organization (WTO) has accentuated an already
strong tendency towards negotiating preferential
agreements. Much of this activity involves the
economies of Asia and the Pacific.

5. Introduction
 The Trans-Pacific Partnership is the first international
commercial agreement pursued by this US administration
to date from scratch. And, it would be the largest one since
the 1995 World Trade Organization. It would link Australia,
Brunei, Chile, Malaysia, New Zealand, Peru, Singapore,
Vietnam, Mexico and Canada into a free trade zone similar
to that of NAFTA.
 The subject matter being negotiated extends far beyond
traditional trade matters. TPP’s 29 chapters would set
binding rules on everything from service-sector regulation,
investment, patents and copyrights, government
procurement, financial regulation, and labor and
environmental standards, as well as trade in industrial
goods and agriculture.

6. Financial Contagion
 Financial contagion refers to a scenario in
which small shocks, which initially affect
only a few financial institutions or a
particular region of an economy, spread to
the rest of financial sectors and other
countries whose economies were
previously healthy, in a manner similar to
the transmission of a medical disease.
 The definition of the term contagion
remains highly controversial (see Forbes
and Rigobon 2002). A relatively agnostic
proposition derives from the asset pricing
literature and defines contagion as co-
movements of equity returns above and
beyond what can be explained by
fundamentals.

7. Financial Contagion
 Financial contagion happens at both the international level
and the domestic level.
 At the domestic level, usually the failure of a domestic bank
or financial intermediary triggers transmission when it
defaults on interbank liabilities and sells assets in a fire
sale, thereby undermining confidence in similar banks.
 An example of this phenomenon is the failure of Lehman
Brothers and the subsequent turmoil in the United States
financial markets.
 International financial contagion, which happens in both
advanced economies and developing economies, is the
transmission of financial crisis across financial markets for
direct or indirect economies. However, under today's
financial system, with large volume of cash flow, such as
hedge fund and cross-regional operation of large banks,
financial contagion usually happens simultaneously both
among domestic institutions and across countries. The
cause of financial contagion usually is beyond the
explanation of real economy.

8. Financial Contagion
 While there was a period of systemic crisis in
emerging countries in the early 1980s, both
academia and policy circles did not analyze the
crisis from a systematic point of view.
 Even when Latin American countries fell like
dominoes with successive devaluations and
depreciations, banking crises and deep
recessions, much of the blame was placed on
poor domestic policies and high real interest rates
in the United States, with little attention focusing
on the possibility that financial crises could be
spreading and contagious.

9. Financial Contagion
 The term “contagion” was first introduced in July
1997, when the currency crisis in Thailand quickly
spread throughout East Asia and then on to
Russia and Brazil. Even developed markets in
North America and Europe were affected, as the
relative prices of financial instruments shifted and
caused the collapse of Long-Term Capital
Management (LTCM), a large U.S. hedge fund.
 The financial crisis beginning from Thailand with
the collapse of the Thai baht spread to Indonesia,
the Philippines, Malaysia, South Korea and Hong
Kong in less than 2 months. After that episode,
economists realized the importance of financial
contagion and produced a large volume of
researches on it.

10. Financial Contagion
 A branch of research emphasizes contagious
currency crises, relating such crises to various
monetary and financial sector vulnerabilities and
trade factors. These studies often look for the
underlying causes behind a simultaneous set of
speculative attacks. For instance, Goldfajn and
Valdés (1997) find that the intermediaries' role of
transforming maturities is shown to result in
larger movements of capital and a higher
probability of crisis, which resemble the observed
cycle in capital flows: large inflows, crisis and
abrupt outflows.
 Kaminsky and Reinhart (2000) document the
evidence that trade links in goods and services
and exposure to a common creditor can explain
earlier crises clusters, not only the debt crisis of
the early 1980s and 1990s, but also the observed
historical pattern of contagion.

11. Financial Contagion
 The second branch of literature explains contagion
transmission as a result of linkages among financial
institutions. Alen and Gale (2000) and Lagunoff and Schreft
(2001) analyze financial contagion as a result of linkages
among financial intermediaries. The former provide a
general equilibrium model to explain a small liquidity
preference shock in one region can spread by contagion
throughout the economy and the possibility of contagion
depends strongly on the completeness of the structure of
interregional claims. The latter proposed a dynamic
stochastic game-theoretic model of financial fragility,
through which they explain interrelated portfolios and
payment commitments forge financial linkages among
agents and thus make two related types of financial crisis
can occur in response. Van Rijckeghem and Weder (2000)
present evidence that spillovers through bank lending
contributed to the transmission of currency crises during
the recent episodes of financial instability in emerging
markets.

12. Financial Contagion
 In an era of rapid financial
globalization, Gai and Kapadia
(2010) prove that while high
connectivity may increase the spread
of financial contagion and adverse
aggregate shocks and liquidity risk
also amplify the likelihood and extent
of financial contagion.

13. Financial Contagion
 A third branch of literature emphasizes financial
contagion among financial markets. It tries to
explain contagion through a correlated
information or a correlated liquidity shock
channel. Under the correlated information
channel, price changes in one market are
perceived as having implications for the values of
assets in other markets, causing their prices to
change as well, as in King and Wadhwani (1990).
Calvo (1999) argues for correlated liquidity shock
channel meaning that when some market
participants need to liquidate and withdrawal
some of their assets to obtain cash, perhaps after
experiencing an unexpected loss in another
country and need to restore capital adequacy
ratios. This behavior will effectively transmit the
shock.

14. Financial Contagion
 Some explanations for financial contagion, come
after the Russian default in 1998, which are
based on changes in investor “psychology”,
“attitude” and “behavior”.
 This stream of research date back to early studies
of crowd psychology of Mackay (1841) and
classical early models of disease diffusion were
applied to financial markets by Shiller (1984).
 Eichengreen, Hale and Mody (2008) focus on the
transmission of recent crises through the market
for developing country debt. They find the impact
of changes in market sentiment tends to be
limited to the original region. They also find
market sentiments can more influence prices but
less on quantities in Latin America, compared
with Asian countries.

15. Financial Contagion
 Besides, there are some researches on
geographic factors driving the contagion.
De Gregorio and Valdes (2008) examine
how the 1982 debt crisis, the 1994
Mexican crisis, and the 1997 Asian crisis
spread to a sample of twenty other
countries. They find that a neighborhood
effect is the strongest determinant of
which countries suffer from contagion.
Trade links and pre-crisis growth
similarities are also important, although to
a lesser extent than the neighborhood
effect.

16. Panics
 A bank run occurs when a large number of bank
customers withdraw their deposits because they
believe the bank is, or might become, insolvent. As a
bank run progresses, it generates its own momentum,
in a kind of self-fulfilling prophecy (or positive
feedback); as more people withdraw their deposits,
the likelihood of default increases, and this
encourages further withdrawals. This can destabilize
the bank to the point where it faces bankruptcy.
 A banking panic or bank panic is a financial crisis that
occurs when many banks suffer runs at the same
time. A systemic banking crisis is one where all or
almost all of the banking capital in a country is wiped
out. The resulting chain of bankruptcies can cause a
long economic recession.

17. Top Bank Panics
 18th century
 Panic of 1792.
 Panic of 1796–1797.
 19th century
 Panic of 1819, a U.S. recession with bank failures; culmination of U.S.'s
first boom-to-bust economic cycle
 Panic of 1825, a pervasive British recession in which many banks failed,
nearly including the Bank of England
 Panic of 1837, a U.S. recession with bank failures, followed by a 5-year
depression
 Panic of 1847
 Panic of 1857, a U.S. recession with bank failures
 Panic of 1866
 Panic of 1873, a U.S. recession with bank failures, followed by a 4-year
depression
 Panic of 1884
 Panic of 1890
 Panic of 1893, a U.S. recession with bank failures
 20th century
 Panic of 1907, a U.S. economic recession with bank failures.

18. Crashes
 A stock market crash is a sudden dramatic decline of stock
prices across a significant cross-section of a stock market
resulting in a significant loss of paper wealth. Crashes are
driven by panic as much as by underlying economic factors.
They often follow speculative bubbles.
 Stock market crashes are social phenomena where external
economic events combine with crowd behavior and psychology
in a positive feedback loop where selling by some market
participants drives more market participants to sell.
 Crashes usually occur under the following conditions: a
prolonged period of rising stock prices and excessive economic
optimism, a market where P/E ratios exceed long-term
averages, and extensive use of margin debt and leverage by
market participants.
 There is no numerically specific definition of a stock market
crash but the term commonly applies to steep double-digit
percentage losses in a stock market index over a period of
days. Crashes are distinguished by panic selling and abrupt,
dramatic prices declines.

19. Important Crashes
 Paris Bourse, January 19, 1882
 Wall Street 1929
• Black Thursday - October 24, 1929
• Black Monday - October 28, 1929
• Black Tuesday - October 29, 1929
 1973-4 UK stock market crash
 October 19, 1987
 Friday the 13th Mini-Crash, October 13, 1989
 Asian Contagion Mini-Crash, October 27, 1997
 Dot-com Bubble and Crash, peak, March 10,
2000
 Flash Crash – May 6, 2010.

20. Crash of 1929: Black Monday

21. Crash of 1929
600 AT&T
500
Bethlehem
400
Steel
300 General
200 Electric
Montgomery
100
Ward
0 National Cash
3-Mar- 3-Sep- 13- Low Register
1928 1929 Nov- 1932 RCA
1929

22. Post WW II: Boom

23. Top Banking Crises
 18th Century
 Crisis of 1772–1773 in London and Amsterdam, begun by the collapse of the bankers Neal,
James, Fordyce and Down.
 19th Century
 Australian banking crisis of 1893
 20th century
 Panic of 1907, a U.S. economic recession with bank failures
 Great Depression, the worst systemic banking crisis of the 20th century
 Secondary banking crisis of 1973–1975 in the UK
 Savings and loan crisis of the 1980s and 1990s in the U.S.
 Finnish banking crisis of 1990s
 Swedish banking crisis (1990s)
 1997 Asian financial crisis
 1998 Russian financial crisis
 Argentine economic crisis (1999–2002)
 21st century
 2002 Uruguay banking crisis
 Financial crisis of 2007–2010, including:
 Subprime mortgage crisis in the U.S. starting in 2007
 2008 United Kingdom bank rescue package
 2008–2009 Belgian financial crisis
 2008–2009 Icelandic financial crisis
 2008–2010 Irish banking crisis
 2008–2009 Russian financial crisis
 2008–2009 Spanish financial crisis
 2008–2009 Ukrainian financial crisis

24. Crash of 1987: Black Monday
 Black Monday refers to Monday,
19 October, 1987, when stock
markets around the world crashed,
shedding a huge value in a very
short time. The crash began in Hong
Kong, spread west through
international time zones to Europe,
hitting the United States after other
markets had already declined by a
significant margin.
 The Dow Jones Industrial Average
dropped by 508 points to 1738.74
(22.61%).
 By the end of October, stock
markets in Hong Kong had fallen
45.5%, Australia 41.8%, Spain
31%, the United Kingdom 26.4%,
the United States 22.68%, and
Canada 22.5%.
 New Zealand’s market was hit
especially hard, falling about 60%
from its 1987 peak, and taking
several years to recover.

25. Important Events in the 1990s
 January 1990 – Crash of Japan leads to
the yen carry trade.
 September 1992 – Sterling’s Black Monday
spurs foreign exchange as an asset class.
 1994-1995 – Economic and Financial Crisis
in Mexico. Tequila Crisis.
 December 1996 – Alan Greenspan warns
against “irrational exuberance”.
 1997 – Asian financial crisis prompts Asian
countries to build up reserves of dollars.

26. Tequila Crisis
 The 1994 Economic Crisis in Mexico,
widely known as the Mexican peso
crisis, was caused by the sudden
devaluation of the Mexican peso in
December 1994.
 The impact of the Mexican economic
crisis on the Southern Cone and
Brazil was labeled the Tequila Effect.

27. Tequila Crisis
 Some country-risk issues precipitating the Tequila crisis:
 The EZLN's violent uprising in Chiapas in 1994 along with the
assassination of Presidential candidate Luis Donaldo Colosio
made the nation's political future look less certain to investors,
who then started placing a larger risk premium on Mexican
assets.
 Mexico had a fixed exchange rate system that accepted pesos
during the reaction of investors to a higher perceived country
risk premium and paid out dollars. However, Mexico lacked
sufficient foreign reserves to maintain the fixed exchange rate
and was running out of dollars at the end of 1994. The peso
then had to be allowed to devalue despite the government's
previous assurances to the contrary, thereby scaring investors
away and further raising its risk profile.
 When the government tried to roll over some of its debt that
was coming due, investors were unwilling to buy the debt and
default became one of few options.
 A crisis of confidence damaged the banking system, which in
turn fed a vicious cycle further affecting investor confidence.[

28. 1997 Asian financial crisis
 The Asian financial crisis was a period of financial crisis that
gripped much of Asia beginning in July 1997, and raised fears of a
worldwide economic meltdown due to financial contagion.
 The crisis started in Thailand with the financial collapse of the Thai
baht caused by the decision of the Thai government to float the
baht, cutting its peg to the USD, after exhaustive efforts to
support it in the face of a severe financial overextension that was
in part real estate driven. At the time, Thailand had acquired a
burden of foreign debt that made the country effectively bankrupt
even before the collapse of its currency. As the crisis spread, most
of Southeast Asia and Japan saw slumping currencies, devalued
stock markets and other asset prices, and a precipitous rise in
private debt.
 Indonesia, South Korea and Thailand were the countries most
affected by the crisis. Hong Kong, Malaysia, Laos and the
Philippines were also hurt by the slump. The People's Republic of
China, India, Taiwan, Singapore, Brunei and Vietnam were less
affected, although all suffered from a loss of demand and
confidence throughout the region.

29. Currency crisis
 A currency crisis, which is also called a balance-of-payments
crisis, is a speculative attack in the foreign exchange market. It
occurs when the value of a currency changes quickly, undermining
its ability to serve as a medium of exchange or a store of value.
Currency crises usually affect fixed exchange rate regimes, rather
than floating regimes.
 A currency crisis is a type of financial crisis, and is often
associated with a real economic crisis. Currency crises can be
especially destructive to small open economies or bigger, but not
sufficiently stable ones. Governments often take on the role of
fending off such attacks by satisfying the excess demand for a
given currency using the country's own currency reserves or its
foreign reserves (usually in the United States dollar, Euro or
Pound sterling).
 Recessions attributed to currency crises include the 1994
economic crisis in Mexico, 1997 Asian Financial Crisis, 1998
Russian financial crisis, and the Argentine economic crisis (1999-
2002).

30. Financial Events during the 1990s
 March 1998 – Citigroup and Bank of
America mergers create banks that
are “too big to fail”.
 August 1998 – Russia defaults on
debt and Long-Term Capital
Management melts down.

31. Economic Crisis
 Economic crisis - a long-term economic state characterized
by unemployment and low prices and low levels of trade
and investment.
 In economics, a recession is a business cycle contraction, a
general slowdown in economic activity. During recessions,
many macroeconomic indicators like production, as
measured by Gross Domestic Product (GDP), employment,
investment spending, capacity utilization, household
incomes, business profits fall during recessions, while
bankruptcies and the unemployment rate rise.
 Recessions generally occur when there is a widespread drop
in spending often following an adverse supply shock or the
bursting of an economic bubble. Governments usually
respond to recessions by adopting expansionary
macroeconomic policies, such as increasing money supply,
increasing government spending and decreasing taxation.

32. Economic and Social Effects
 The living standards of people
dependent on wages and salaries are
more affected by recessions than
those who rely on fixed incomes.
 The loss of a job is known to have a
negative impact on the stability of
families, and individuals' health and
well-being.

33. Recessions in the United States
 In the United States the unofficial beginning and ending
dates of national recessions have been defined by an
American private nonprofit research organization known as
the National Bureau of Economic Research (NBER).
 The NBER defines a recession as "a significant decline in
economic activity spread across the economy, lasting more
than a few months, normally visible in real gross domestic
product (GDP), real income, employment, industrial
production, and wholesale-retail sales".
 There have been as many as 47 recessions in the United
States since 1790 (although economists and historians
dispute certain 19th-century recessions). These downturns
are driven by changes in the government's regulatory,
fiscal, trade and monetary policies. Cycles in agriculture,
consumption, and business investment, and the health of
the banking industry also contribute to these declines. U.S.
recessions have increasingly affected economies on a
worldwide scale, especially as countries' economies become
more interdependent.

34. Economic Recessions: Peak to Trough

35. Recessions in the United States
 According to economists, since 1854, the U.S. has encountered 32
cycles of expansions and contractions, with an average of 17
months of contraction and 38 months of expansion.
 However, since 1980 there have been only eight periods of
negative economic growth over one fiscal quarter or more, and
four periods considered recessions:
 July 1981 – November 1982: 14 months
 July 1990 – March 1991: 8 months
 March 2001 – November 2001: 8 months
 December 2007 – June 2009: 18 months

 For the past three recessions, the NBER decision has
approximately conformed with the definition involving two
consecutive quarters of decline. While the 2001 recession did not
involve two consecutive quarters of decline, it was preceded by
two quarters of alternating decline and weak growth.

36. Financial Crisis 2007-2009
 June 7, 2007 – Ten-year Treasury yields
hit 5.05 percent.
 June 19, 2007 – Bear Sterns Hedge
Fund appeals for help.
 August 3, 2007 – Jim Cramer declares
“Armageddon” in the credit markets.
 August 7-9, 2007 – Big quant hedge
funds suffer unprecedented losses.
 August 9, 2007 – European Central
Bank intervenes after BNP Paribas
money fund closes.

37. Financial Crisis 2007 – 2009
 August 17, 2007 – Federal Reserve cuts rates
after Countrywide Financial funding crisis.
 September 13, 2007 – The run on Northern
Rock.
 October 31, 2007 – World stock markets peak.
 November 1, 2007 – Fear of losses at Citigroup
prompts a sell-off.
 March 16, 2008 – Bear Stearns rescued by JP
Morgan.
 July 14, 2008 – Oil and the dollar rebound –
the end of the decoupling trade.
 September 7, 2008 – Fannie Mae and Freddie
Mac nationalized.

38. Financial Crisis 2007 – 2009
 September 15, 2008 – Lehman Brothers goes
bankrupt.
 September 18, 2008 – AIG is rescued, Reserve
Fund breaks the buck, money market panics.
 September 29, 2008 – Congress votes down the
TARP bailout package.
 October 6-10, 2008 – Global correlated crash.
 October 24, 2008 – Emerging markets hit bottom
as China rolls out stimulus package.

39. Subprime Crisis

40. Late 2000’s financial crisis
 The US subprime mortgage crisis was one of the
first indicators of the late 2000’s financial crisis,
characterized by a rise in subprime mortgage
delinquencies and foreclosures, and the resulting
decline of securities backed by said mortgages.
 Approximately 80% of U.S. mortgages issued to
subprime borrowers were adjustable-rate
mortgages. After U.S. house sales prices peaked
in mid-2006 and began their steep decline
forthwith, refinancing became more difficult. As
adjustable-rate mortgages began to reset at
higher interest rates, mortgage delinquencies
soared.

41. Late 2000’s financial crisis
 Securities backed with mortgages, including
subprime mortgages, widely held by financial
firms, lost most of their value.
 Global investors drastically reduced purchases of
mortgage-backed debt and other securities as
part of a decline in the capacity and willingness of
the private financial system to support lending.
 Concerns about the soundness of U.S. credit and
financial markets led to tightening credit around
the world and slowing economic growth in the
U.S. and Europe.

42. Global crisis of 2007-2009
 The collapse of global equity markets
between August 2007 and March 2009 has
been part of the most severe global crisis
since the Great Depression. While the
crisis initially had its origin in the US in a
relatively small market segment, the
subprime mortgage market, it rapidly
spread across virtually all economies, with
many countries experiencing even sharper
equity market crashes than the US.

43. Components of Real GDP since 2007

44. The United States debt-ceiling crisis 2011
 The United States debt-ceiling crisis can be
considered a financial crisis in 2011 that resulted
when the United States mentioned it would be
unable to continue spending appropriated funds
on time unless the debt ceiling was increased.
 The Obama administration claimed that, without
this increase, the U.S. treasury would default on
the interest and/or principal of U.S. Treasury
securities.
 The crisis arose because the increase in the debt
ceiling required approval of both houses of
Congress, which initially could not agree on how
the situation was to be resolved.

45. U.S. GDP and Government Spending

46. Default on Debt
 Former Treasury Secretary Lawrence Summers
warned in July 2011 that the consequences of such a
default would be higher borrowing costs for the US
government (as much as one percent or $150
billion/year in additional interest costs) and the
equivalent of bank runs on the money markets and
other financial markets, potentially as severe as those
of September 2008.
 In January 2011 Treasury Secretary Timothy Geithner
warned that "failure to raise the limit would
precipitate a default by the United States. Default
would effectively impose a significant and long-lasting
tax on all Americans and all American businesses and
could lead to the loss of millions of American jobs.
Even a very short-term or limited default would have
catastrophic economic consequences that would last
for decades."

47. US debt from 1940 to 2010.

49. AAA rating downgrade
 On August 5, 2011, Standard & Poor's credit
rating agency downgraded the long-term credit
rating of the United States government for the
first time in its history from AAA to AA+.
 The downgrade reflects our opinion that the fiscal
consolidation plan that Congress and the
Administration recently agreed to falls short of
what, in our view, would be necessary to stabilize
the government's medium-term debt dynamics.
 A week later, S&P senior director Joydeep
Mukherji said that one factor was that numerous
American politicians expressed skepticism about
the serious consequences of a default, an attitude
that he said was "not common" among countries
with a AAA rating. The other two major credit
rating agencies, Moody's and Fitch, continued to
rate the federal government's bonds as AAA.

50. AAA rating downgrade

51. Fitch reaffirms AAA rating for U.S.
 The budget cuts in the deal were enough to stabilize the U.S. debt burden
at about 85% of total economic output by the middle of the decade.
 While that would be "substantially higher" than any other AAA-rated
company, Fitch said the U.S. benefits from the dollar and U.S. Treasury
securities both being global benchmarks.
 Fitch warned that the country "is at the limit of the level of government
indebtedness that would be consistent with the U.S. retaining its ‘AAA’
status despite its underlying strengths."
 And the company said a downgrade could come if the special congressional
"super committee" charged with finding $1.5 trillion in budget cuts isn't
able to reach an agreement. Even though there would be $1.2 trillion in
automatic spending cuts if the committee can't agree.
 "In the event that the Joint Select Committee is unable to reach an
agreement that can secure support from Congress and the administration,
Fitch would be less confident that credible and timely deficit-reduction
strategy necessary to underpin the U.S. ‘AAA’ sovereign rating and stable
outlook will be forthcoming despite the ($1.2 trillion ) of automatic cuts
that would follow."

52. European sovereign debt crisis
 On 27 April 2010, the Greek debt rating was decreased to the
upper levels of 'junk' status by Standard & Poor's amidst hints of
default by the Greek government. Yields on Greek government
two-year bonds rose to 15.3% following the downgrading.
 Some analysts continue to question Greece's ability to refinance
its debt. Standard & Poor's estimates that in the event of default
investors would fail to get 30–50% of their money back. Stock
markets worldwide declined in response to this announcement.
 On 3 May 2010, the European Central Bank suspended its
minimum threshold for Greek debt "until further notice", meaning
the bonds will remain eligible as collateral even with junk status.
The decision will guarantee Greek banks' access to cheap central
bank funding, and analysts said it should also help increase Greek
bonds' attractiveness to investors. Following the introduction of
these measures the yield on Greek 10-year bonds fell to 8.5%,
550 basis points above German yields, down from 800 basis
points earlier. As of 26 November 2010, Greek 10-year bonds
were trading at an effective yield of 11.8%.

53. European sovereign debt crisis
 From late 2009, fears of a
sovereign debt crisis
developed among fiscally
conservative investors
concerning some European
states, with the situation
becoming particularly tense
in early 2010. This included
euro zone members Greece,
Ireland and Portugal and also
some EU countries outside
the area.

54. European sovereign debt crisis
 Iceland, the country which experienced the
largest crisis in 2008 when its entire international
banking system collapsed has emerged less
affected by the sovereign debt crisis as the
government was unable to bail the banks out.
 In the EU, especially in countries where sovereign
debts have increased sharply due to bank
bailouts, a crisis of confidence has emerged with
the widening of bond yield spreads and risk
insurance on credit default swaps between these
countries and other EU members, most
importantly Germany.

55. European sovereign debt crisis
 While the sovereign debt increases have been most pronounced in
only a few euro zone countries they have become a perceived
problem for the area as a whole.
 In May 2011, the crisis resurfaced, concerning mostly the
refinancing of Greek public debts.
 The Greek people generally reject the austerity measures and
have expressed their dissatisfaction with protests. In late June
2011, the crisis situation was again brought under control with the
Greek government managing to pass a package of new austerity
measures and EU leaders pledging funds to support the country.
 Concern about rising government deficits and debt levels across
the globe together with a wave of downgrading of European
government debt created alarm in financial markets.
 On 9 May 2010, Europe's Finance Ministers approved a
comprehensive rescue package worth €750 Billion (then almost a
trillion dollars) aimed at ensuring financial stability across Europe
by creating the European Financial Stability Facility (EFSF).

56. European sovereign debt crisis
 In 2010 the debt crisis was mostly
centered on events in Greece, where the
cost of financing government debt was
rising. On 2 May 2010, the eurozone
countries and the International Monetary
Fund agreed to a €110 billion loan for
Greece, conditional on the implementation
of harsh austerity measures. The Greek
bail-out was followed by a €85 billion
rescue package for Ireland in November,
and a €78 billion bail-out for Portugal in
May 2011.
 This was the first eurozone crisis since its
creation in 1999.
 The sovereign debt crisis that is unfolding
is a fiscal crisis of the western world.

57. Debt to GDP ratios for EU countries

58. Runaway Debt in Europe

61. Public Debt as Percent of GDP

62. Debt and Debt/GDP by country

63. Total Public Debt vs. Fiscal Balance as
a Percentage of GDP

68. Peso Depreciated during August 2011
 Mexico’s foreign currency exchange and stock lost
ground due to a spike in risk aversion after the
release of weak data in the United States.
 That while private sector employers in the U.S.
created more jobs in July than expected, service
sector activity slowed unexpectedly to its lowest
level since February 2010. The news added to the
growing concerns that the efforts of the world’s
largest economy to reduce spending will affect
their growth, hitting the willingness of investors
to acquire assets that are considered risky.

69. Dollar vs. Peso

70. Dollar vs. Peso

71. Euro vs. Peso

72. Global Market Volatility in 2011 - 2012
 Global markets seem to have entered another period of
instability, which is reminiscent of the traumatic events of
2007-2009.
 There is no doubt that if the developed world does enter
another period of recession that there will be a cyclical
impact on emerging market economies, particularly in the
commodities, IT and industrial sectors.
 Domestic growth may slow, but, with many emerging
economies operating at or near full capacity, that would not
be a disaster. Potentially more disruptive would be a
sovereign default by a major country, with Italy and Spain
being the obvious candidates.
 In the long-term the Euro members must either become
more fiscally integrated or they will have to go their
separate ways. However, neither eventuality appears to be
imminent.

73. Global Market Volatility
 Unfortunately, all of the world’s
economies, including the emerging
markets, will be affected to a greater
or lesser degree by the events in
europe, and therefore the challenge
is to mitigate the degree of economic
and financial impact.

74. Opportunities in Emerging Markets
 The strong fiscal positions and relatively low
levels of debt in most emerging market countries
stand in stark contrast with the industrialized
countries.
 Some Emerging Markets have a banking system
with little exposure to potential problems in
Europe and generally have high levels of core tier
capital, so their financial systems should not be
significantly disrupted if there is a default.
 The economic case for emerging markets remains
fundamentally strong, there is no escaping that in
the short-term the degree of correlation between
all equity markets remains high.

75. Opportunities in Emerging Markets

76. Shifting GDP Growth in Emerging Markets
vs. Developed Economies

77. Opportunities in Emerging Markets

78. Opportunities in Emerging Markets

79. Latin American Economies

80. Mexico’s Economic Growth
 Mexico is Latin America's second biggest
economy. After lagging way behind other
Latin American economies, it has in recent
months seen a combination of solid growth
and low inflation, but it is dependent on
the United States, which buys around 80
percent of its exports.
 Mexico’s outlook is for an economic
expansion of around 3.5 to 4 percent this
year in 2012.

81. International Reserves

82. Mexico’s countercyclical stimulus’ measures
 Mexico has $160 billion in foreign-exchange
reserves, as well as a more than $70 billion line
of credit with the International Montetary Fund.
 That means that Mexico has more than $230
billion to ensure it can respond in an orderly
fashion to any external financial markets shock.
 Mexico will remain committed to responsible
policies and a long-term vision and will apply
‘countercyclical stimulus’ measures consistent
with an approved budget deficit equal to 0.5
percent of GDP and public-sector spending
growth of 6.1 percent.

83. Mexico’s Economic Growth in
2011-2012
Mexico should approve the structural
reforms to boost the country’s
economic growth and development.
Mexico has the need for a second
generation energy reform, a fiscal
reform, labor reform, education
reform and competitiveness reform.

84. Mexico Sells $1 Billion of 100-Year Bonds
 During August 2011, Mexico sold $1 billion worth of 100- year bonds
overseas, taking advantage of a plunge in benchmark U.S. borrowing
costs to bring back a record-long maturity it unveiled a year ago.
 The government sold the bonds due 2110 to yield 5.96 percent, or 242
basis points above 30-year U.S. Treasuries. Mexico first sold the
securities in October, issuing $1 billion at a yield of 6.1 percent to
become the only Latin American country with dollar bonds of that
maturity.
 Yields on the Mexican bonds have declined 16 basis points, or 0.16
percentage point, in the past month to 5.95 percent in the secondary
market, tracking a tumble in U.S. Treasury yields that was sparked by
concern the global economic expansion is faltering. Thirty-year Treasury
yields have dropped 67 basis points during the past month to 3.54
percent, the lowest in almost a year.
 Mexico’s foreign debt is rated BBB by Standard & Poor’s and Fitch
Ratings, the second-lowest investment-grade ranking.
 The sale is Mexico’s third this year in international markets. The country
has raised $2 billion of debt overseas this year, compared with $4.1
billion in the year-earlier period, according to data compiled by
Bloomberg.

85. Global FDI Flows 2011- 2012
 Global FDI inflows are likely to be around $1.6
trillion.
 Foreign direct investments worldwide are
projected to return to pre-crisis 2008 levels this
year, with inflows expected to be up to USD 1.6
trillion.
 Recovery of FDI inflows would continue this year
while pegging the amount at around USD 1.4
trillion to USD 1.6 trillion.
 Brought down by the 2008 financial meltdown
and its ripple effects, FDI worldwide tumbled to
just USD 1.19 trillion in 2009. Last year, the
inflows were slightly better at USD 1.24 trillion.

86. FDI in Mexico

87. Real GDP Growth: Emerging and Developing Economies
vs. Advanced economies

88. Average Real GDP Growth during 2010 - 2011

90. Latin America’s Economic Growth

91. International Economic Policy
Implications
 Financial contagion is one of the main
causes of financial regulation.
 How to make domestic financial regulation
and plan the international financial
architecture to prevent financial contagion
become the top priority for both domestic
financial regulators and international
society, especially when the global
economy are being under challenge from
the US Subprime mortgage crisis and
European sovereign debt crisis.

92. Conclusions
 European Union leaders have made two major
proposals for ensuring fiscal stability in the long
term.
 The first proposal is the creation of the European
Financial Stability Facility.
 The second is a single authority responsible for
tax policy oversight and government spending
coordination of EU member countries, temporarily
called the European Treasury.
 The stability facility is financially backed by the
EU and the IMF.

93. Conclusions
 The European Parliament, the European
Council, and especially the European
Commission, can all provide some support
for the treasury while it is still being built.
 Strong European Commission oversight in
the fields of taxation and budgetary policy
and the enforcement mechanisms that go
with it have sometimes been described as
potential infringements on the sovereignty
of eurozone member states.

94. Conclusions
 The institutional, legal and financial infrastructure
supports business growth and innovation and
Fitch continues to forecast that the US economy
(and tax base) will, over the medium term, be
one of the most dynamic amongst its high-grade
and ‘AAA’ peers and support the stabilization and
eventual reduction in government indebtedness.
 The US long term economic growth will be of at
least 2.25% a year.
 Mexico’s expected growth is between 3.5 to 4%
in 2012. Mexico's economic growth will likely slow
down in 2013 to 3.5%, mainly due to the
uncertain backdrop in the euro zone and the U.S.

95. Conclusions
 A main finding emerges from the analysis of the
determinants of contagion, which turn out to be
mainly the strength of countries’ fundamentals
and the quality of their institutions.
 Countries with poor macroeconomic
fundamentals, high sovereign risk, and poor
institutions experienced by far the largest equity
market declines and are most severely affected
by contagion.
 The fact that domestic fundamentals played such
a key role in the transmission of a crisis is
reminiscent of the old “wake-up call” hypothesis,
whereby a crisis initially restricted to one market
segment or country provides new information
that prompts investors to reassess the
vulnerability of other market segments or
countries, ultimately spreading the crisis across
markets and borders around the world.

96. Conclusions
 There’s a chance that Greece will leave the euro,
with prolonged economic weakness and spillover
for the currency bloc.
 Worsening turmoil in Spain and Italy may make
European politicians less willing to give further
help to a country that keeps on missing its
targets. Even with the Spanish bank rescue, both
Spain and Italy are likely to need some form of
full bailout in 2013.
 Latin America is exposed to risks in Europe,
where many indebted countries haven't been able
to find a definitive solution, and to the fiscal
uncertainty in the U.S.

97. Conclusions
 Of all the external channels through which the
economic and financial crisis has been
transmitted to Latin America, the drop
 in remittances is the least important. The most
widespread effects come the exchange rate, the
decline in the volume of international trade and
the sharp deterioration in the terms of trade for
commodities. In addition, a period of very
restricted external private-sector financing lies
ahead. The Latin American region's economies
have entered this crisis in a stronger position
than in the past, mainly because public debt is
lower and international reserves are large.

98. References
 ECLAC, 2012, Latin America and the Caribbean in
the World Economy 2011-2012. Santiago de
Chile: ECLAC.
 OECD (2011), “Policy Brief: Economic Survey of
Mexico, 2011”, Organization for Economic
Cooperation and Development (OECD).
 OECD (2011), “Policy Brief: Economic Survey of
Brazil, 2011”, Organization for Economic
Cooperation and Development (OECD).

99. References
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contagion, and confusion, Journal of International Economics 51,
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Claessens, Stijn and Kristin Forbes, (2009), International Financial
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100. Additional References
Calvo, Guillermo A., (1999), Contagion in emerging
markets: When Wall Street is a carrier, Working
paper, University of Maryland.
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Stijn and Kristin Forbes.
De Gregorio and Valdes, (2008), “Crisis Transmission:
Evidence from the Debt, Tequila, and Asian Flu
Crises”, working paper.

101. Additional References
R. Chang and A. Velasco (2001), 'A model of currency crises in
emerging markets'. Quarterly Journal of Economics 116 (2), pp.
489-517
De Gregorio and Valdes, (2008), “Crisis Transmission: Evidence from
the Debt, Tequila, and Asian Flu Crises”, working paper.
Kristin J. Forbes and Roberto Rigobon, (2002), No Contagion, Only
Interdependence: Measuring Stock Market Comovements, The
Journal of Finance, Vol. 57, No. 5, pp 2223-2261.
Pesaran, M.H. and Pick, A. (2007). Econometric issues in the analysis
of contagion. Journal of Economic Dynamics and Control 31,
1245–77.
Kristin J. Forbes and Roberto Rigobon, (2002), No Contagion, Only
Interdependence: Measuring Stock Market Comovements, The
Journal of Finance, Vol. 57, No. 5, pp 2223-2261.
Bekaert, G, M Ehrmann, M Fratzscher, and A Mehl (2011), “Global
crises and equity market contagion”, NBER Working Paper, No.
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Díaz Bautista, Alejandro (2012), Regional Economic Growth and
North American Economic Integration.

102. Effects of the International Economic Crisis
in Latin America.
Alejandro Díaz-Bautista, Ph.D.
Professor of Economics and Researcher
adiazbau@gmail.com
http://www.facebook.com/adiazbau
Economic and Financial Crisis Presentation
Graduate School of International Relations and Pacific Studies,
UCSD
January 9, 2013