Lecture III

All that goes up comes crashing downDo you want to grow? Then give it a

big push

Money and the Real World

• Money is created by the banking system• Conditionally to a congruous amount of reserves• Bank credit and bank deposits: a chain with

some leakages. • The problem: long-term assets and short-term

liabilities• How to assess whether reserves cover liabilities?

A bubble

• Credit creates money since it generates deposits• ...but deposits must be trustworthy.• Banks finance members of the public to buy other

people’s debt (debentures or equity) by accepting as collateral newly issued debentures or equity.

• People repay back by issuing more debt underwritten by members of the public

• Banks finance yet more debt...banks directly underwrite debt

Bursting the bubble

• A member of the public is unable to finance his or her debt.

• He or she must sell:..selling begins with few willing to buy: stock value goes down.

• Collateralised bank credit loses value: bank assets flounder.

• Trust on bank deposits weakens• More sales to attempt to pay debt back: more

losses.

The stock exchange comes down

• Black Thursday (Black Friday in Europe because of the time lag), October 24, 1929 Wall Street crashes.

• Some banks lose their creditworthiness and suffer a run on their deposits.

• Wall Street keeps on plunging....• Banks stop extending credit to firms and other

institutions (other banks at home or abroad)

Wall Street, October 1929

The run on the American Union Bank

Spreading the panic

• Most European countries are involved• Even developing countries are involved:

commodity prices plunge• Firms, short of credit, stop investing...other firms

stop producing.....unemployment• Unemployment and falling effective demand. • Can we ever trust the banks any more? • Strengthening the Central Banks• The Glass-Steagall Act in the U.S.: separating

commercial banking from investment banking.

The unemployed

Towards World War II and Development Economics

• The world economy never recovered before WWII.

• Franklin D. Roosevelt and the New Deal • Economic theory tried to grapple with the

problem by providing new concepts and new tools.

• The former: Keynes theory of effective demand• The latter: the macroeconomic approach and

national accounts: economic policies

World War II, the aftermath

• Rosenstein-Rodan and the plan to develop Southern Europe

• The supply and demand sides: low level equilibrium traps.

• Then, act on both sides; increase incomes and increase capacity.

• If this is the approach: one needs nothing short of a full-fledged plan.

The New Order

• Pre-war failures and the international monetary order: Bretton Woods.

• IMF and the World Bank: what for?• The failures of the pre-war period cast a

sombre shadow on the development outlook.• Can openness to trade be relied upon?• The world splits up in two...actually in three

Market or plan?• The Soviet Block• But is there a third way? The non-aligned movement

and the Bandung Conference.• India’s way: a very mixed.. yet an almost closed

economy• Plans and the State: betting one’s own stakes on fast

industrialisation starting from the heavy industries.• Agriculture: the Achilles’ heel of Indian planning• Key: Eric Hobsbawn (1994): ‘The Age of extremes: the

short tewnthieth century’. Michael Joseph, London

The Centre-Periphery Argument

• Countries in the centre and countries in the periphery

• Unequal exchange: strengthening the non-aligned countries’ case.

• Prices of raw materials and commodities and prices of manufactured goods

• Wages in raw materials producing countries and wages in the Centre.

A lopsided deal

• The upshot of productivity increases in raw-material producing countries and in manufactured goods producing ones

• The terms of trade• Protecting raw materials producers: the buffer

stock idea• UNCTAD is ushered in• Nice principle, scarcely effective.

If credit is plenty why not borrow?

• Borrowing to invest or borrowing to consume?• Can debt be repaid? • Yes, out of investment proceeds• No, if you use for consumption purposes unless

you squeeze somebody and make him/her bleed to death.

• ....or else roll it over• A mounting debt crisis: interest rates go through

the roof (for some countries and some currencies)

Debt in US dollars? Then repay in US dollars

• Turn a balance of payments deficit into a balance of payments surplus.

• Trust the Washington consensus to do that • Become competitive and start at once exporting

what you can produce now and what the world market wants

• Get rid of all consumption directly controlled by the government: cut down subsidies, public expenditure and public services

...continued

• Make sure that domestic money be supported by foreign money (i.e. U.S. Dollars), hence rein in the Central Bank and keep under strict scrutiny.

• Reschedule the debt at a sustainable interest rate

• Keep the economy under the strict supervision of international organisations (IMF) and committee of creditors (banks).

Forging ahead...falling behind

• Some developing countries did forge ahead:• Those that:• mobilised internal resources for investment,• promoted the growth of technological

capabilities,• implemented policies that enhanced productivity

levels and competiveness• Protected for a period of time but vigorously

engaged in international trade.

A great divide .... Lasting perhaps only 200 years!!!

• China and India• Incredibly fast development: quite different

countries.• What did it?? • The ‘world’ never learns: yet another financial

crisis.• Where do we go from here??

The hunger map

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