First Financial Crisis of 21st century

This is a nice paper on economic history. The paper/case-study is nicely titled “Northwest of Suez: The 1956 Crisis and the IMF” and is available here.

The author James Boughton is an IMF Historian. IMF Chief Michel Camdessus commented post crisis in Mexico in 1995 that it is the ” first financial crisis of the 21st century”. The author differs and says the Suez Crisis ion 1956 had all the elements of the financial crisis seen in 1995 and IMF had already been through the experience.

First the abstract:

Egypt’s nationalization of the Suez Canal in 1956 and the failed attempt by France, Israel, and the United Kingdom to retake it by force constituted a serious political crisis with significant economic consequences. For the United Kingdom, it engendered a financial crisis as well. That all four of the combatants sought and obtained IMF financial assistance was highly unusual for the time and had profound effect on the development of the IMF. This case study illustrates the complexities in isolating the current account as the basis for determining balance of payments “need” and shows that the speculative attack on sterling—and the IMF’s response to it—were remarkably similar to financial crises in the 1990s.  

The sequence of events can be read in the case study. It is nicely done with detailed explanation of the political scenario behind the first IMF bail-out. I would like to point out how the crisis was similar to the ones we see now: (abridged version)

  • United Kingdom faced in 1956 was almost purely a speculative attack on a stable currency against a backdrop of reasonably sound economic policies. That is, it was a financial and not an economic crisis, and its primary effect was on the capital account of the balance of payments. Similarly, Mexico in 1995 had a current account deficit and faced speculative pressures to maintain its fixed exchange rate.
  • In both cases the crisis was precipitated by a clash of policy goals, between maintaining a stable exchange rate and simultaneously establishing open markets for the currency.

(Readers may ask, why was there a clash of policy goals? Well, as most Central Banks are formed with the objective of managing inflation, I assume that Central Banks would be managing it even then. Hence, we have a case of Impossible Trinity.)

  • In both cases, a rapid response was essential. Despite the limited convertibility of sterling in 1956, Britain began losing reserves rapidly after the United Nations condemned its invasion of Egypt in early November. The IMF had to respond by early December if Britain was to avoid floating the pound. The length of time between the onset of the attack and approval of the financial package was almost the same as in the peso crisis of 1995.
  • The key in both cases was to post a large enough number to impress financial markets, convince speculators that a bet against the currency could not be won, and persuade investors to keep their money in the country. 
  • The IMF’s involvement in both cases was necessitated by the unwillingness of the United States to provide sufficient resources bilaterally, despite its acknowledged self-interest in a successful resolution of the crisis.

A nice case study for finance professionals/scholars.  

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