if i were minister of finance…: gaining understanding of financial crisis through a simulation...

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Developing countries which havefaced financial crises in the pasttwo decades include Mexico (1982

and 1994–5), Chile (1982), Brazil (1982,much of 1986–1993 and 1999), Thailand(1997), and Russia (1998), to name only afew. But even Finland (1992) and Sweden(1990) have faced similar crises, and evenso-called ‘fortress’ Britain was compelled todevalue the pound in 1992, when it cameunder speculative attack. (Speculativeattacks are explained below in Round 3.)

Why do financial crises arise at all? Thefirst step is to understand that mostcountries’ currencies – Thai baht, Indianrupees, or Argentinian pesos – are notaccepted as payment when goods are soldacross borders. To carry out internationaltransactions, one has to have so-called‘hard currency’: dollars, euros, or one of avery few other currencies such as the yen,the Swiss franc or the British poundsterling. (In the simulation, all kinds ofhard currency are referred to as ‘dollars’.)For example, suppose one wants to import

goods into Argentina from another country.One must pay in dollars. Of course, if creditis available one does not have to pay thosedollars immediately. But, sooner or later,one has to come up with enough dollars topay – and if it is later, of course one has topay back not only the principal (that is, theoriginal money borrowed), but interest aswell.

The second step in understandingfinancial crises and why they arise is torecognise that anyone who wants to obtaindollars normally gets them by selling thelocal currency and buying dollars. (Forconvenience, local currencies were repre-sented by the peso in the simulation.) Inmost countries, only the Central Bank, or afinancial institution authorised by theCentral Bank, is allowed to sell dollars andbuy pesos. (At least, this is the theory.) Inpractice, there may be a black market, butthe simulation ignores that complication inthe first round.

The third fact to bear in mind is thatalthough the words ‘crisis’ and ‘devaluation’

If I were Minister ofFinance…: gaining understanding of financial crisisthrough a simulation workshopMehrene Larudee and Caren Grown

Financial crises (also known as debt crises, currency crises or balance of payments crises) havebecome endemic in the modern world. The countries at greatest risk have been developing countries.This article discusses a workshop,‘If I were Minister of Finance…’, which we ran at the Associationfor Women in Development (AWID) conference in Guadalajara in October 2002. In the workshop,participants took part in a simulation of the Argentine currency crisis. The simulation sought togive participants a better understanding of the causes of a currency crisis, and the tough, limitedchoices a government faces in trying to prevent it. Simulations like the one described in this articlecan be helpful to activists and women’s organisations in moving a gender-sensitive economic policyagenda forward.

Gender and Development Vol. 11, No. 1, May 2003

g) Larudee 11/6/03 3:57 pm Page 59

Gender and Development60

suggest pain and suffering, there are bothlosers and winners in a currency deval-uation. The losers are those who are holdingpesos when the devaluation happens,because after the devaluation, the pesos canbuy fewer dollars than before. For instance,after the Mexican peso devaluation of1994–5, there was a steep drop in cross-border shopping by Mexicans from CiudadJuárez, who normally spend considerablemoney in El Paso in the USA, buyingclothes, toys, appliances and other goods.Women who are responsible for repro-ductive work can also lose out fromdevaluation, as the prices of necessities andbasic goods rise; women then have to makedo with less.

In contrast, the winners from deval-uation are those who successfully anticipateit and buy dollars just in advance of it.After the devaluation, they can buy backtwice as many pesos, and may well end upbetter off. In fact, all those who are holdingdollars after devaluation have an advantage.For example, after the Asian financial crisis,the Wall Street investment firm GoldmanSachs was able to buy up hotels and realestate in a number of Asian countries.

The workshop process

The AWID workshop simulation wasdesigned for participants with no previousknowledge of economics. The workshopwas run twice and, all together, a total ofabout 30 women were taught the basicprinciples of balance of payments, as thisaffects the lives of people in developingcountries. The same simulation has alsobeen used in a class at the University ofKansas, and a simpler version was runduring the 2002 UN Committee on theStatus of Women meetings in New York ata teach-in hosted by UNIFEM.

Each participant took one of nine roles,and followed a script spelling out heractions during four rounds of play, duringwhich balance of payments problemsbecame progressively more serious, and

unfolded into a crisis. At times, the work-shop seemed near chaos, as workersfeverishly manufactured ‘soccer balls’while toy manufacturers struggled to sellthem and remain profitable in the face ofimports, which were suddenly cheaperthan local products. Meanwhile, Argentina’sCentral Bank tried to hang on to its dollarreserves, as the rich put their money intodollar savings outside the country, andcurrency speculators waited to pounce.

In our simulation, the nine players sitaround a table, and each is given a quantityof pesos (white beans), dollars (black beans),and debt (red cards) that are appropriate toher role. There are three foreign and sixdomestic players. The foreigners are aForeign Lender, a Foreign Investor whoalso runs an export-import business, and aCurrency Speculator. The domestic playersare a Central Banker, a Local Banker, theArgentine Government, a Rich Argentine, aToy Manufacturer and a Worker in the ToyManufacturing Business. The central bankerand the toy manufacturer are the busiest andhave the most complex tasks; at the otherextreme, the currency speculator does nothingexcept watch for the first couple of rounds,and springs into action late in the game.

The worker and the manufacturer startout with nothing. The manufacturer borrowspesos from the local bank at 20 per centinterest to pay local wages, and also borrowsdollars from the foreign lender at 10 percent interest to import inputs (sheets ofpurple paper) with which to produce soccerballs. The workers then manufacture soccerballs (by crumpling the paper into balls),and the soccer balls are sold, some abroad(to the foreign investor with the export-import business) and some at home (to therich Argentine). With the sales revenue, themanufacturer pays the worker, and thenrepays the loans with interest, making asmall profit. The worker spends some ofher money on imported goods, as does therich Argentine.

The Argentine government already has$200 debt at the beginning of the simulation,


and in each round has to pay 10 per centinterest on that debt. To do so, it has to useits tax revenues and exchange them fordollars with the Central Bank, since theinterest must be paid in dollars. (We handfour rounds of tax revenues to thegovernment at the beginning of the game,in order to keep matters simple.) However,the government does not have any netprincipal repayments on the $200 debt,since it rolls over the loan each round; thatis, it pays back exactly as much principal asit borrows anew.

In addition, though, the governmenthappens to have a persistent budget deficit– a common, though not universal, featureof economies headed for crisis – and thedeficit is financed by borrowing fromabroad. For this purpose, the governmentalso borrows an additional amount in eachround, so that in each subsequent round ithas to pay additional interest at the world interest rate, which stays at 10 percent throughout.

Similarly, each player buys, sells,borrows, lends, invests, or disinvests, asspecified in the script. Each time such atransaction involves changing pesos intodollars or dollars into pesos, the players seethe Central Bank’s stack of dollars fall orrise. The main point for participants to takeaway is this: a financial crisis simply meansthat the Central Bank is running out ofdollars. That stack of dollars in Argentina’sCentral Bank – which in real life is actuallykept in a bank somewhere in New York – is called the Bank’s ‘foreign exchangereserves’ or ‘foreign currency reserves’.Some transactions cause dollars to be takenfrom the stack. Others cause dollars to beadded to the stack.

As a rule of thumb, a central banker ishappiest when the stack contains enoughdollars to pay for at least three andpreferably six normal months’ worth ofimports, and when, year after year, thestack remains around that size. The dollarreserves act as a kind of guarantee tointernational investors and lenders that,

even if for some temporary reason theinflow of dollars slows or the outflowincreases, the country will still haveenough dollars to continue making its debtpayments as well as buying imports tokeep its economy going. In a very realsense, the central banker is happiest ifnothing happens to her dollar reserves atall. But once the dollar reserves fall close tozero, pandemonium breaks out. Theapproaching crisis sets off behaviour bycertain economic actors which make thatcrisis far harder to avoid.

But this is getting ahead of our story.Our workshop unfolds over four rounds ofthe simulation.

How the simulation works

Round 1: A stable peso, no balance ofpayments problem; learning basicprinciplesIn the simulation, the action focuses on theCentral Bank: the central banker sellsdollars to some players, receiving pesos inexchange, and buys dollars from otherplayers, giving pesos in exchange. InRound 1, the exchange rate is set at 1 peso= $1. In this round, the players just getaccustomed to their roles in a situation inwhich there is no crisis, and the balance ofpayments is balanced. Dollars flow in andout of the Central Bank, but at the end ofthe round (which represents a time periodof a year or so) the Central Bank holds thesame $100 with which it started.

In this round, players see that it is theflows of dollars into and out of the countrythat matter, and they see the variousreasons why foreigners, local manu-facturers, the government and variousprivate producers and consumers mightwant to buy dollars and sell pesos, or selldollars and buy pesos.

The simplest example of this is imports:if an Argentine has pesos and wants toimport a car, he needs to go to the CentralBank, sell his pesos and buy dollars. He will

Gaining understanding of financial crisis through a simulation workshop 61


be able to pay for the imported goods withhis dollars. (Equivalently, the car dealer orimporter may actually obtain the dollars;the point is that someone has to give uppesos for dollars in order for the car to beimported.) Likewise, if an Argentinebicycle manufacturer exports bicycles, thenshe receives dollars in payment, and goesto the Central Bank and exchanges these forpesos, which she uses to pay her employeesand local suppliers. For simplicity, in thesimulation we slightly altered the details ofthis scenario, but the basic idea is sound. IfArgentina has $40 billion in imports and$40 billion in exports, then the overall effecton the dollar reserves in the Central Bank isto leave them unchanged. But if Argentinaimports $5 billion more in goods than itexports, and nothing else changes, then theCentral Bank’s dollar reserves will fall by$5 billion as long as the exchange rate isstill 1 peso = $1.

Of course, there are many kinds oftransactions besides trade that bring dollarsinto the Central Bank: foreign lending toArgentine private firms or to the govern-ment, for instance. There are also manykinds of transactions that vacuum dollarsout of the Central Bank, such as paymentsof interest on foreign loans (which have tobe paid in dollars). A variety of these sortsof transactions are illustrated in subsequentrounds of the simulation.

Round 2: Brazilian currency is devalued;Argentina’s dollar reserves shrink

In Round 2, Brazil, a major tradingpartner of Argentina, undergoes a largedevaluation, just as it did in January 1999.Suddenly, Brazil’s goods are much cheaper.Argentina now has a harder time exportingto Brazil and, within Argentina, consumersbuy more Brazilian goods. A decline inexports and an increase in imports throwthe balance of payments out of balance. Inthis round, about twice as many pesos areoffered for sale as dollars. So if theexchange rate is to remain at 1 peso = $1,either some peso sellers will not find

buyers, or else the Central Bank will haveto use some of its dollar reserves to buy upthe extra pesos.

Once dollars seem to be flowing outfaster than they are flowing in at theprevailing exchange rate, players begin tosee the dilemma facing the Central Banker.She has three options, none of themappealing. The first option, the one whichthe script dictates in Round 2, is to goahead and use her dollar reserves to buy allthe extra pesos offered for sale, and somaintain ‘parity’ at one peso per one dollar.This has the advantage that it offerspotential foreign investors a stable,predictable exchange rate. It preventsdevaluation for the moment, but unfor-tunately it also reduces the Central Bank’sstack of dollars. Next year, if there are morepesos for sale than offers to buy them, theCentral Bank will face the same choices.But if the Central Bank sops up the extrapesos each time this occurs, it will verysoon run out of dollars, and a financialcrisis will ensue. At that point the govern-ment will have to appeal to the InternationalMonetary Fund (IMF) for an emergencyloan, and knuckle under to the IMF’sdemands for austerity measures.

A second option is to let the value of thecurrency be determined by letting allparties freely trade it. In other words, theCentral Bank may drop its insistence oncarrying out all peso–dollar trades and may let the currency float down to a new,lower value which the Bank believes willeliminate the outflow of dollars. The bankcan then announce its intention to defendthe new, lower value of the peso. This iswhat is meant by a devaluation. It is oftenunpopular – especially just before anelection – because it typically causesinflation. In the simulation, the devaluationhappens only in Round 4 after all otheroptions have been exhausted.

The third option is the one used inRound 3, and is explained below.



Round 3: Central Bank raises interestrates; a crisis approachesThe third tool in the Central Bank’s toolbox– to raise interest rates – is no morepolitically attractive than a devaluation.Round 3 illuminates why increasinginterest rates can be temporarily effective.

By the beginning of the round, the levelof dollar reserves has fallen so low that, atmost, one or two months of imports can bepurchased. This triggers responses bycertain players which set in motion adestabilising process that is hard to stop.One response is capital flight: the richArgentine sells pesos and buys dollars, inanticipation of the devaluation. Similarly,the foreign investor sells the shares in thetoy manufacturing firm which she boughtin Round 2, and takes her dollars out ofArgentina. Alarmed by these develop-ments, and seeing that its ability to sop upthe additional pesos sold is limited by itsdwindling dollar reserves, the Central Bankimposes higher interest rates. Raisinginterest rates persuades the foreign investornot to take her money out of the countryjust yet. It also slows down the currencyspeculator, who senses an approachingdevaluation and seeks to borrow pesos inorder to sell them later for dollars.However, in light of higher interest rates,she waits to be sure she has her timingright, because the higher the interest rate,the more costly any mistake will be.

The other factor that precipitates thecrisis is that in Round 3 the currency specu-lator goes into action. She borrows hugequantities of pesos, and then exchanges thepesos for dollars at the one-for-one exchangerate. Because she is adding to the numberof pesos being offered for sale, she essentiallyforces the Central Bank to buy those pesos,and so speeds up the exhaustion of itsdollar reserves. If she gets the timing right,she forces a devaluation of the peso. Oncethis happens – in Round 4 – she will be ableto use only about half her dollars to buyback all the pesos she needs to repay the

loan with interest – and to keep theremaining dollars as profit. In 1992, whenGeorge Soros used $10 billion of his moneyto force devaluation of the British pound,he ultimately made $2 billion on the deal(www.soros.org).

Although the high interest rate can slowdown the exit of capital, it can unfortunatelyalso have negative effects on the economy.The toy manufacturer finds that all herprofits are eaten up by interest on the loan.If high interest rates persist, she will go outof business, and her employees will losetheir jobs. And if this happens to many firms,the local banks may also become insolvent.Foreign lenders may then stop lendingaltogether, and this will trigger a crisis.

Round 4: Capital flees, currencyspeculator attacks, Central Bankdevalues the peso

In Round 4, the situation deteriorateseven further. Both the rich Argentine andthe foreign investor sell their pesos and buydollars, and – even if nothing else changes– this capital flight uses up the CentralBank’s last dollar reserves, forcing it todeclare a currency devaluation.

The impact of financialcrises

When crises hit, countries often turn to theInternational Monetary Fund for help. TheFund usually imposes a structural adjust-ment programme as a condition of itslending, which is not included in oursimulation. Many readers will be familiarwith the features of structural adjustmentbut, in brief, the IMF forces the governmentto balance its budget so that it will not keepadding to its debt, and usually also forces adevaluation of the currency, which restoresnear equality between exports and importsand halts that source of drain on the dollarreserves. Countries often balance theirbudgets by cutting public expenditure,often for education, health, and other



services essential to the poor and workingclass, and by imposing fees for service.Public sector workers may suffer wage cutsor retrenchment, as government is down-sized. Public utilities like water andelectrical power are often privatised, andfees are raised, hurting the poor.

Some financial crises have not beenpreceded by significant governmentbudget deficits. For instance, in Chile in1982, and several Asian countries in1997–8, there was little or no governmentbudget deficit, and the crisis was rooted inprivate sector debt. Nevertheless, a budgetdeficit might appear after the crisis breaksand austerity measures may be imposed tominimise that deficit, as was the case inEast Asia.

The impact of financial crises is, bynow, quite well known. Analyses of the1998 Asian financial crises have shown thatwomen bore a disproportionate share ofthe costs – see Lim (2000) and Frankenberg,Thomas, and Beegle (1999). Poor andworking-class women, especially, providedthe unpaid work that was critical to familyand community survival. Low-incomewomen – and their daughters – spent moretime and effort to produce non-marketsubstitutes for goods and services thatbecame too expensive or were no longeravailable. In addition, women sought morepaid work, often in informal employment,where returns were low, to make up forreduced family income. Girls were pulled outof school before boys, in order to help theirfamilies. In South Korea and Indonesia, joblosses were higher for women than for menas the public and private sectors contracted.Studies on financial crises in other regionsof the world find similar impacts.

Conclusion

Simulations like the one described here arean effective tool for teaching a complex andtechnical subject. At AWID, the responsewas overwhelmingly positive; several

participants said they had had no idea howextraordinarily important it was tounderstand these basic principles. Perhapsmost startling was the realisation of howvery narrow the scope is for central banks tomanoeuvre, once a crisis is well underway.

Teaching about financial crises throughrole-play works surprisingly well, evenwhen the simulation is complicated. Inorder to play their roles, participants haveto ask questions. Through the game, theygain clarity about various currency trans-actions, the reasons why one buys or sellsdollars, and the effect of these transactionson different sectors of the economy. All theplayers see the Central Bank’s dollarreserves declining, and they see that theone recourse – to raise interest rates –makes matters worse in many ways. Theysee, too, that once the crisis approaches, theefforts of the Central Bank to avert it can bethwarted by capital flight and speculativeattacks on the currency. Like it or not, thecountry ends up in the stifling embrace ofthe IMF.

So what is the solution to financialcrises? The proposal by late Nobel prize-winner James Tobin is still on the table, fora tax on international financial transactionswhich would limit the lurching of capitalinto, and then out of, developing countries.Billionaire and wizard investor George Soroshas advocated the same thing, and hassome ideas of his own, spelled out in hisrecent book, George Soros on Globalisation(2002). Several feminist economists –including Diane Elson, Nilüfer Cagatay,Irene Van Staveren, Stephanie Seguino and others – have also made the case forTobin-type taxes on speculative financialcapital, as well as for national-level actionsthat include controls on both inflows andoutflows of capital, as well as changes infiscal and monetary policy. Each of theseproposals should be put on the agenda ofthe international women’s movement.


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g) Larudee 11/6/03 3:57 pm 4

Mehrene Larudee is Assistant Professor ofEconomics at the University of Kansas. Herresearch is on the effect of trade and investmentliberalisation on employment, wages andgrowth, especially in Latin America. Address:Economics Department, University of Kansas,1300 Sunnyside Ave., Room 213, Lawrence, KS66045-7585. [email protected]

Caren Grown is Director of the PovertyReduction and Economic Growth Team at theInternational Center for Research on Women.Her recent research has focused on the effect of gender inequality on macroeconomic andother development outcomes. Address: 1717Massachusetts Avenue, N.W., Suite 302,Washington, D.C. 20036. [email protected]

References

Baden, S. (1996) ‘Gender issues in financialliberalization and financial sector reform’,Brighton, UK: BRIDGE Publications,Institute for Development Studies

Elson, D. (2002) ’International financialarchitecture: a view from the kitchen’,Femina Politica, Spring

Frankenberg, E., D. Thomas, and K. Beegle(1999) ’The real costs of Indonesia’seconomic crisis: preliminary findingsfrom the Indonesia family life surveys’,Labor and Population Program WorkingPaper Series: 99–04, RAND,www.rand.org/labor

Ghosh, J. (2002) Argentina: a cautionary talefrom South America, InternationalDevelopment Economics AssociatesNetwork (IDEAS),http://networkideas.org

Lim, J. (2000) ’The effects of the East Asiancrisis on the employment of men andwomen: the Philippine case’, WorldDevelopment 28 (7): 1285–1306

Rodrik, D. (2002) ’Reform in Argentina,take two trade rout’, The New Republic,14 January 2002, http://tnr.com/

Singh, A. and A. Zammit (2000) ’Internationalcapital flows: identifying the genderdimension’, World Development 22 (10):1249–68. Oxford: Elsevier Science Ltd

Soros, G. (2002) George Soros on Globalisation,New York: Public Affairs

Stiglitz, J. (1999) ’Responding to economiccrises: policy alternatives for equitablerecovery and development’, TheManchester School Vol. 57 (5): 409–27



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